Last week, the Federal Trade Commission announced its intentions to take DirecTV (NYSE:DTV.DL) to court as it alleges DirecTV engaged in deceptive marketing. Specifically, the federal government called out the largest satellite broadcaster on two practices: First, it alleges that DirecTV's discounted 12-month programming package is deceptive marketing because the overall deal requires a 2-year commitment with increasing fees in the second year. Second, the company's 3-month free premium channel offer does not disclose that subscribers need to proactively cancel the channels.
DirecTV responded in kind:
We will vigorously defend ourselves, for as long as it takes. We go above and beyond to ensure that every new customer receives all the information they need, multiple times, to make informed and intelligent decisions. For us to do anything less just doesn't make sense.
Meanwhile, another federal agency, the Federal Communications Commission, announced another "pause" of its 180-day countdown leading up to the proposed DirecTV merger with AT&T (NYSE:T) on Friday. And while it is prudent to mention the pause was not due to the pending lawsuit, it's safe to assume any litigation is an unwelcome distraction for both acquirer and target in this $48.5 billion cash and stock deal.
Direct litigation costs could affect takeover price and make target less desirable
For those wanting a merger, this brings two large issues. First is the obvious loss of cash through increased legal fees and a potential settlement or government fine. Although each case is different, it should be noted that DirecTV has settled with the FTC before for violating the Do Not Call registry rules -- it paid $5.3 million in 2005 and $2.3 million in 2009.
Obviously this is different, as the allegations center on actual billing practices. Last year the FCC found AT&T and Sprint guilty of cramming customer's cell phone bills and fined both $105 million. If litigation costs approach nine figures, this could put a wrinkle in the deal. For the record, AT&T estimates $1.6 billion in annual cost-savings synergies, but synergies tend to be overestimated, with Business Management Consultant Bain and Company noting 70% of companies announce higher synergies than expected as both companies involved grow larger.
In addition, AT&T should consider the costs to rectify the problem, along with reputational degradation. DirecTV added US subscribers, albeit just barely, by finishing 2014 with roughly 100,000 subscribers more than it had at the beginning of the year -- going from 20.25 million to 20.35 million in a tough pay-TV market. In order to accomplish that goal, DirecTV spent $2.9 billion in subscriber acquisition costs and $1.3 million in customer retention. Those are huge costs to land and keep subscribers, pointing to a competitive market; the last thing AT&T needs is for revenue to stagnate or marketing costs to increase due to a long, publicized tit-for-tat with the FTC.
AT&T wants into Latin America and is paying DirecTV to achieve that -- not to fight the US government
Still, DirecTV has something that AT&T wants -- easy access into Latin America. Although last year growth slowed to 3.2% on a year-over-year basis, down from its torrid pace of 24% annualized from 2010-2013, the Latin American market is still poised for strong growth. A digital TV forecast estimates the number of digital TV households in Latin America will double by 2020 as more citizens trade up in quality and enter the pay-TV market as they attain Middle-Class status. AT&T is paying for DirecTV's US and Latin American pay-TV businesses, not to inherit its problems.
AT&T has recently entered into Mexico's wireless market with its purchase of Iusacell, gaining 9 million subscribers. As a part of Mexican President Enrique Nieto's reforms to address monopolies -- most notably against Carlos Slim -- AT&T finds a willing government in this battle. But more broadly, its purchase of Iusacell and the proposed merger with DirecTV show it's making a play for Latin America. DirecTV may be steadfast in defending its marketing policies, but it could win a Pyrrhic victory if it delays the merger or results in large legal expenses. In the end, it may be better for shareholders to quickly settle with the federal government and to work with the FCC to get the merger approved.