AT&T In Agreement To Buy DirecTV: Where Is The Value?

May.25.14 | About: AT&T Inc. (T)

Summary

AT&T deal to buy DirecTV has some short-term benefits but no significant long-term benefits.

DirecTV's video business is facing unfavorable demographic trends and cashflows will likely turn south over time.

This deal does nothing to long-term shareholders and only helps its competitors.

Recently AT&T (NYSE:T) announced its intent to buy DirecTV (DTV) in a $48.5 billion deal. Yes, DirecTV has great cashflow, and yes, debt is cheap nowadays, and yes, AT&T can make the numbers work. The deal is likely to be accretive to AT&T, and DirecTV stockholders get a nice return. And, yes this one is likely to go through, as there are no big antitrust issues at stake.

But how does this deal make long-term sense for AT&T? Isn't DirecTV a broadcast player in an increasingly on-demand world? Has this deal arisen out of desperation to get a deal done and increase the company's size? Where is the value add to the long-term stockholders?

With the excitement of the deal behind us and as some of the dust settles, we take a look at the fundamentals behind this deal to see what the implications are for various industry players.

The first thing that is glaringly obvious with this deal is a lack of any long-term synergies between the companies. Yes, there will be some cost savings through the consolidation of the customer base, a few cross selling opportunities, and a little bit more operational leverage, but fundamentals of the video distribution business that AT&T is chasing are questionable at best.

AT&T CEO Randall Stephenson says that "video is a key growth driver for this entire industry" and we agree. But we believe the video that is driving the industry is on-demand video and not broadcast video. The up and coming internet savvy generation does not care much for seeing TV in its current form. The "cut the tether" movement is strong and has already depressed the growth rate of much of the industry. DirecTV's model is very capital-efficient but in a world where people want customized content on demand, DirecTV is a dinosaur.

To be sure, DirecTV is invaluable for remote parts of the U.S., developing countries, and places where there is limited internet access. However, these poorly-connected areas in the U.S. are increasingly a smaller share of the pie. The international market can be a good growth story for DirecTV, but its differentiation and revenue generation capability in these markets is somewhat limited. And, the extent of revenue and margin growth in the developing world is unlikely to make up for the decay in the U.S. market.

The major differentiating feature of DirecTV's urban customer base - sports packages - is something that is out of the control of DirecTV and AT&T beyond the guarantees set in the programming contracts. Even in the sports segment, the demographic trends are not favorable. While the big professional sports still rule, the sports market is slowly but certainly moving into micro niches - places where DirecTV or AT&T have no real advantage over any of their competitors. This fragmentation of the market will only increase with the passage of time.

The competition for eyeballs is intense, and no broadcast TV can ever hope to touch the richness of an on-demand internet platform. The most valuable asset to own with the upcoming customer dynamic is a fat internet connection to the client - wired or wireless. This is something that DirecTV does not have. Consequently, the value of what DirecTV offers to customers reduces by the day, and it is only a question of time before that lack of value shows up in the company's cash flows.

So, why did AT&T feel compelled to do this deal? As much as anything else, we believe this foray has to do with AT&T's failed deal to buy T-Mobile (NASDAQ:TMUS). That ill-advised deal cost AT&T stockholders considerably, not just in terms of what happened in the past, but in terms of what is happening now. In a quest for size, which by itself is of questionable advantage, the company is chasing deals that make less and less economic or strategic sense.

Looking at AT&Ts key business areas, we see multiple challenges. The wireline voice business is on a decline; the business solutions market is not doing particularly well; the U-Verse platform is limited, competes poorly with Comcast (NASDAQ:CMCSA), and does not address customer needs in most parts of the U.S.; and the wireless business has lost its primary differentiation since the iPhone days and is under constant threat by Verizon (NYSE:VZ), Sprint (NYSE:S) and T-Mobile.

What AT&T needs to do to solve many of its challenges is to strengthen its access to its customer base - that means a thicker pipe in to customers' homes and business, and more spectrum to address the needs of its mobile customers. This deal gives them neither. And the announcement of this deal may have inadvertently helped Comcast in its bid for Time Warner Cable (NYSE:TWC) and Sprint in its potential bid for T-Mobile. Both Comcast and Sprint can now make a more effective case to the regulators on why their deals should be permitted. And Dish Network (NASDAQ:DISH) is probably enjoying the prospect of a less nimble, distracted AT&T for a competitor instead of the old DirecTV.

All things considered, the companies that benefit from this deal are AT&T and DirecTV's competitors. Every which way we look at this deal, it seems to be bad idea. Instead of focusing on staying ahead of its competition in its core businesses, we now have a distracted management chasing deals with questionable value. We view this as net negative for AT&T and net positive for its key competitors.

Our Sentiment: Avoid

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.