Here's Why AT&T Isn't Destined For Success With DirecTV

| About: AT&T Inc. (T)

Summary

AT&T offered to buy DirecTV after the stock rallied strong.

DirecTV growth isn't the panacea projected.

Bundled offerings aren't guaranteed to attract customers.

The massive deal by AT&T (NYSE:T) to buy the video subscribers of DirecTV (DTV) isn't the automatic success that the company suggests.

Back in May, AT&T agreed to pay $95 in a stock-and-cash transaction for the nearly 39 million video subscribers of DirecTV. The company offered up various reasons for the deal including creating a leading content distribution network, a leading pay TV provider in Latin America, improved financial benefits via cost synergies and a improved revenue mix. As well, the company thinks the combined offering will deliver significant benefits to customers via a stronger competitive alternative to cable.

While some of those objectives might come to fruition, the reality is that the results are far from certain as presented by the buyout press release. Competitors from Verizon (NYSE:VZ) to DISH Network (NASDAQ:DISH) will have a lot to say about the success of bringing these assets together and offering a bundle that consumers actually want.

Significant Growth Potential In Latin America

While it might be true that Latin America offers some long-term growth potential with a typical television penetration rate of only 40%, the reality is that DirecTV is struggling to produce revenue and subscriber growth. As of the end of Q2, the satellite provider has 18.83 million subscribers in Latin America when counting the 6.36 million subscribers of Sky Mexico that it only owns 41%.

For the second quarter, Latin America revenue and income were mixed due to large drops in ARPU from $51.13 in the prior year to $48.88 in the last quarter. The good news is that net subscribers grew by a combined 543,000 in the Sky Brasil and PanAmericana divisions. Even better, the relatively flat overall revenue was due to declines in the local currencies providing some hope that stable currencies going forward will return the division to faster growth. The Latin America revenue only reaches just over 20% of total DirecTV revenue suggesting the growth impact won't be that significant on the new combined company with the massive revenue base of AT&T.

Improved Revenue Mix

Another fallacy is that additional paid TV subscribers improves the revenue mix for AT&T. With all of the competition in the sector, DirecTV isn't producing much in the way of revenue growth these days with total Q214 revenue only up 5% over the prior year period. If anything, the stock gains by the sector over the last couple of years could attract even bigger competitive threats. In fact, it's very possible that the paid TV sector heads toward a decline similar to the landline phone business already owned by AT&T.

The ability to offer a triple play offering of broadband, television and wireless is extremely attractive on the surface, yet bringing that together is years away. The suggestion is that the deal increases the triple play offering to 70 million customer locations, but it still leaves a major hole in the domestic market. It doesn't though provide those customers with OTT services that will lead users to swapping a TV consumer for a broadband one.

In addition, a lot of the problems faced in bundling services in the past is that consumers always want best of breed that is nearly impossible to maintain within an offering encompassing three different service offerings. If a user thinks Verizon offers a better mobile service or DISH Networks offers a better satellite package, the bundled offering from the new AT&T will falter.

Bottom Line

Considering AT&T is paying $95 for a stock that only traded at less than $45 within the last two years should have investors concerned about the value of this deal. The pay TV market is very saturated and the market is now highly competitive especially with younger consumers consuming video via Internet services such as Netflix (NASDAQ:NFLX) and Hulu. At about 16x current year earnings, the deal isn't cheap considering the lack of growth at DirecTV. The recommendation is that investors use this deal to exit positions in DirecTV especially as the realized priced gets closer to the offering price.

Disclosure: The author is long T, DTV. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.