AT&T’s Potential Acquisition of Discovery, Explained

AT&T, the world’s largest telecom company (by revenue) and second-largest provider of mobile telephone services, is reportedly in talks to spin off its media business and merge it with Discovery.

What this means is that AT&T’s vast media assets such as recently acquired WarnerMedia (2018) which includes CNN, HBO, TBS, TNT etc. would be divested into a separate entity and combined with Discovery’s networks such as HGTV, Animal Planet, Food Network, TLC etc.

The new entity could be valued at $150bn, including debt. If successful, this could be the biggest merger in the media/entertainment industry since Viacom and CBS’s merger in December 2019.

WarnerMedia and Discovery will merge through a complex all-stock tax efficient structure called a ‘Reverse Morris Trust’ that would see AT&T receive $43bn in cash, debt securities, and WarnerMedia’s retention of certain debt. AT&T’s shareholders would in turn receive shares representing 71% of the new company.

Discovery CEO David Zaslav is speculated to lead the merged company as its CEO whereas the fate of WarnerMedia CEO Jason Kilar looks uncertain. The companies say the deal is expected to close in 2022, subject to shareholder and regulatory approvals.

What’s the goal here? Perhaps yet another attempt by traditional players to take on the rising domination of streaming giants aka Netflix and Disney+? It also follows the latest line of consolidation in the media industry in an attempt to find new ways to reach and retain audiences who are gradually moving away from cable TV.

Let’s bring you up to speed with the what’s what of this interesting transaction.

And That’s the AT&T

This is a grand old company in the American media history that traces its origin from the days of Alexander Graham Bell, the inventor of the telephone himself. Formerly known as the American Telephone and Telegraph Company, it was founded in 1885 and has established a pioneering presence in US cable TV, telephone as well as mobile network operations. At one point, AT&T assumed a monopoly status on phone services throughout North America.

Fast forward to 2018. With the winds of change blowing across the entertainment industry and the entry of Netflix, Amazon Prime etc., AT&T rose to the occasion and placed its own bet in the game by acquiring another large media house, Time Warner. The $81bn acquisition was done with the two goals in mind.

First, to bring Warner Bros (WB) into its fold. WB, a former Time Warner-subsidiary, is a century-old movie and TV studio with famous money-making franchises like the Batman series and Harry Potter to its credit. Second, to take the content-churning engines of WB and market it through the broadcasting machinery of HBO Max, a streaming service that would give Netflix a run for its money.

How Successful Were These Goals?

AT&T’s strategy seemed plain as day. Go on a buying spree, acquire as many crown jewels of Hollywood as possible and create a one-stop platform where the customer could be offered enriched content through eased streaming access on affordable data plans. In other words, combine wireless, data and video content services.

But this tripling-down strategy by putting content and distribution businesses together, however ambitious, was ultimately flawed. AT&T hit many mismatches in calculations.

The acquisition was entered into at a time when the company was also planning expansion into its next-gen wireless services. So costs kept piling. Debts mounted (long-term debt crossed $159bn). Employees were laid off, as many as 2,000.

So, AT&T began cutting its losses by offloading some acquisitions that were no longer profitable, like DirecTV, which it had acquired in 2015 for $48bn. It was sold to the private equity firm TPG for $16bn, exactly a third of its purchase price.

Some would say the sale was desperate and a sign of capitulation for AT&T, signalling that it had bitten off more than it could chew. But to be fair, instances of companies shedding their media assets have only risen of late.

Verizon, another mobile carrier service, went on a selling spree too with the sale of HuffPost, Yahoo and AOL to private equity groups and decided to focus on its investments in 5G technology. Even Fox operates as a trimmed-down media company now after selling its entertainment business to Disney in 2017. AT&T itself sold its anime video unit Crunchyroll to Sony for $1.2bn in December 2020.

On the other hand, one could argue that consolidating all businesses under one roof could streamline operation and revenue channels. That is another lesson to take away from the Disney-Fox acquisition, when you look from Disney’s point of view.

The world is witnessing a rapid transition in media and entertainment businesses, most of which is precipitated due to the rise in Netflix and other alternate media outfits. So if you are a part of the old media, the most obvious bet is to bring a shift from theatrical distribution towards subscription-based distribution channels. Distribute programmes though paid television and multiple paid windows rather than offering multi-channel packages.

Which is what AT&T did (or attempted to do) with the Time Warner acquisition. So why is it that after less than three years since that acquisition, AT&T is marching towards another hefty purchase with Discovery? What is different this time around?

The Discovery’s Landing

Discovery has famously relied on lifestyle and other non-fiction content. Its content is heavy with reality television, like unscripted cooking and home-renovation shows that are of particular liking to a certain class of the audience.

But most importantly, it has gained sizable traction in its streaming service called Discovery+ which reached 15 million subscribers recently. HBO and HBO Max combined, have a global subscriber base of 63.9 million. So, we are essentially looking at a joining of forces by both camps to compete with the heavy hitters in the streaming space, like Netflix which alone commands over 200 million subscribers.

Both AT&T and Discovery have been faced with challenges in the traditional TV business with retaining customers who are bailing on cable TV and satellite connections. This also explains AT&T’s increased obsession with its streaming-video strategy and immense importance on the growth and marketing of HBO Max. Teaming up with Discovery, therefore, supplements the streaming reach of AT&T.

But at what cost?

The Cost of Unwinding Crown Jewels

For a company that is heavily debt-laden, funding another acquisition is hardly conducive to financials. Even if WarnerMedia’s revenue-generating capabilities are substantial ($8.5bn as of last quarter only) and the post-merger profits could be promising, the combined subscription base of HBO Max and Discovery+ isn’t anywhere close to that of Netflix or Disney+ as of now.

HBO Max also has one of the highest subscription prices in the market ($15 compared to $8 each for Netflix and Disney+). As the pandemic gradually recedes and lockdowns get lifted, more and more audiences may be inclined to shed cabin anxiety and throng to the theatres rather than continuing to stream content online. If Netflix’s recent drop in quarterly earnings are any indication, then AT&T might hit a snag on the road to profits post merger.

There are legal considerations too. The 2018 acquisition of Time Warner came under heavy federal scrutiny due to distortion in market play and possible antitrust issues. It could happen again with two big companies like Discovery and AT&T combining.

On the contrary, breaking down silos within a giant corporation could have its own benefits. Subscribers of HBO Max who are paired with AT&T’s phone and broadband services, could be persuaded against cancelling if they knew new content (by Discovery+) was in the offing. The merger could also have CNN racing on a bigger scale with rivals like Fox and Comcast’s NBC in the online news streaming segment.

However, a lot of questions remain unanswered regarding the details of the reported merger. Until they are answered, the biggest takeaway is the fact that AT&T is putting more skin in the game to chase its dream of streaming dominance.

(Originally published May 17th 2021 in transfin.in)