T-Mobile's new TV strategy has long-term potential but may crimp short-term earnings more considerably than management has indicated.
The company has essentially admitted that its first attempt, with the Layer3 acquisition, bombed, but the write-down is sufficiently small to be almost immaterial.
T-Mobile insists it will run the service at breakeven, but that doesn't seem possible.
But higher engagement, reduced churn, and wireless growth could justify the losses. The service could also boost T-Mobile's early-stage home broadband efforts.
It wasn't too long ago that I took a fresh look at T-Mobile (TMUS) and reaffirmed my bullish rating, on the basis of their strong spectrum position and the consolidation of the wireless industry into three major players, which will harm consumers but almost certainly richly reward investors in the years to come.
My article was based solely on T-Mobile's wireless business, which is currently in the process of integrating the old Sprint customer base and launching 5G service. Now, T-Mobile has refreshed its nascent TV service, TVision, and appears to have rekindled its ambition to disrupt pay-TV the way it disrupted wireless. This article will focus solely on this new business, and analyze whether it alters my conclusions when T-Mobile was a pure phone service play.
Bird's Eye View
T-Mobile's TVision initiative is only a few days old - the new version of it, anyway - so there wasn't as much light shed on it during the earnings conference call as there might have been if it had a little more mileage under its belt. Still, management has been pretty clear about the long-term vision: TVision, so goes the plan, will be run at break-even. It won't hurt T-Mobile's investment in other areas, but it also won't be used as a profit center. Instead, its purpose will be to deepen engagement with T-Mobile customers, reduce churn, increase market share over AT&T (T) and Verizon (VZ) and spur adoption of T-Mobile's pending new home broadband service.
In general, I agree with most of this. TVision should indeed reduce churn and perhaps induce a few more customers to leave competitors for T-Mobile's network. And it could be a very powerful tool for the sale of T-Mobile's new broadband service, especially in early days when consumers may be reluctant to try it.
However, management's assurance that it won't be a drag on earnings in the near term seems a little more questionable to me... unless it fails so completely that it doesn't attract enough subscribers to be noticeable. The new TVision also means accepting the failure of the old one, which involved a write down on assets for T-Mobile.
However, these risks seem more than acceptable for the potential payoff, especially with regard to spurring broadband adoption. Therefore, I am not changing my long position. While this article will attempt to chronicle the near-term downsides T-Mobile faces, the long-term upside TVision could generate should not be ignored for being a little harder to put numbers on.
Facing The Music, Paying The Piper
The initiative is essentially a relaunch of T-Mobile's first foray into TV, which was built around their Layer3 acquisition. T-Mobile essentially charged the standard $100 price for a full suite of channels with all the bells and whistles, and then gave a $10 discount off that price to wireless customers.
As I noted at the time, the only real difference between TVision 1.0 and a typical cable/satellite subscription was that T-Mobile was refreshingly honest about how much its TV service cost - instead of a bunch of unadvertised fees, T-Mobile told you upfront that it intended to push your monthly TV bill into the triple digits.
T-Mobile already admitted this didn't work very well. In fact, last quarter, they took an over $200 million write down on their Layer3 acquisition, essentially admitting that it would never become the new TV powerhouse platform they had hoped for. At the time of Layer3's acquisition, I had hypothesized that perhaps it was more about getting access to Layer3's compression technology, which was said to be capable of transmitting HD video signals at near SD bandwidths. But T-Mobile's gone quiet about this point, too, so Layer3 looks like just about a total miss at this point.
But a $200 million loss shouldn't faze investors. It is an almost insignificant fraction of the company's post-merger assets - the 2.5 GHz spectrum alone is worth $100 billion - and T-Mobile has provided massive returns to shareholders over the last several years by experimenting with new ways of boosting consumer satisfaction. The occasional misfire is the price of innovation and success. And T-Mobile has now decided to try again.
Breaking Down The Bundle
Despite CEO Mike Sievert's insistence that he does not see TVision as a loss-leader, I have a hard time seeing how it can be run at even a break-even level. Philo, the only real comparison for its Vibe service, doesn't seem to be generating much profit yet despite charging twice what Vibe does, and while the Vibe service is slightly smaller and may have a better cost profile, it's hard to see a 50% price cut producing a profitable product.
TVision Live probably doesn't fare much better. At just $40 a month, Disney's (NYSE:DIS) package of channels alone is probably eating up close to half of the budget. Disney was generating $12.58 per month for its cable networks in 2017. ACC Network hadn't even launched then, so that plus three years of increases on the other channels probably puts Disney's cable nets at well north of $15 per month.
It's broadcast net ABC has to be added on top of that. So do the others, so we can do ABC, FOX, and NBC as a group. Along with CBS, these channels form the heart of any live-TV service. S&P Global research put the cost for just those four channels at close to $3 each for the major affiliate owners like Sinclair (SBGI) and Tegna (TGNA) - and this was in the first quarter of 2019. As early as 2018, Sling TV's President said that local TV stations "could soon" cost as much as $16 per month.
I will subtract $6 from that for CBS, which is sold by TVision outside the Live bundle and normally costs $6 for its All Access service. That leaves $10 per month, and frankly, I expect that is probably below the true figure. Altogether, I'd say broadcasters and Disney's cable nets cost close to $30, even if they don't quite reach that high.
News is the other key part of a live service, and it's expensive too. The richest channel here is Fox News, which charges more than any other cable news channel, at least $2 and maybe $3 per month. CNN and MSNBC don't quite reach this level, but they're not freebies. Five years ago, these two channels combined were charging about as much as Fox News. I'll call it $5 per month for news, but again, I think that's a little low.
Sports Ruins The Bundle, As Usual
At close to or maybe even a little above $35 per month, that leaves just $5 for all the other channels in TVision Live. Considering that YouTube TV hiked prices $5 two years ago when it decided that it would bite the bullet to add Turner networks to its lineup, that's probably the last of Live's budget right there, for TNT and TBS. Even if you think they're cheaper than the full $5, what about Fox's sports nets, NBC Sports Network, and all of Fox's and Comcast's other cable nets?
The last argument might be that some of the channels I just listed are only available in TVision's Live+ tier, giving T-Mobile an extra $10 per month to cover them. Fair enough, but that tier also includes the Big Ten Network, the NFL Network - which alone cost $1.67 per month three years ago - and most importantly, Comcast's regional sports networks (though not Sinclair's, which have been left out in the cold by yet another pay-TV distributor.)
How much do the RSNs cost? Put it this way: AT&T (T) now charges a $10 RSN fee on its DIRECTV/U-Verse bills. After Comcast signed the Chicago Cubs' new Marquee Network in Chicago, it raised the local fee all the way to $14.45! Even if we cut the numbers in half, to reflect the lack of Sinclair's RSNs - not every TVision customer will have an RSN in their area - and the variances among different cities, very little is left to help cover the shortfall in the core Live package. In fact, Live+ might even be an extra dollar or two underwater. We have not counted the operating costs of the service yet, either, but let's stop here. I think the point has been proven.
The only saving grace here might be non-wireless subscribers. T-Mobile has already signaled it intends to charge higher prices to non-wireless subscribers, how much higher exactly we don't know. The discount last time for wireless customers was $10, and it wouldn't surprise me to see the "non-customer surcharge" stay around the same ballpark. At that higher price, T-Mobile would probably be able to generate at least a little gross margin on non-wireless subscribers and help defray these expenses.
I doubt it would be enough to push TVision back to break-even, though. Especially since those higher prices will mean fewer non-wireless subscribers joining to begin with.
Other Potential Risks
The foregoing analysis is based entirely on a successful service taking root, which I believe it will. But obviously, there is also always execution risk.
And there are a few potential pitfalls for T-Mobile to get snared in. For one thing, TVision Vibe's advertised price, unlike TVision Live, does not include DVR. If customers want to add that on - which many probably will - T-Mobile will charge them an extra $5. That's almost cable company like in its "gotcha"-ness
T-Mobile also confirmed taxes and regulatory fees still apply (though unlike traditional TV, regional sports fees and broadcast TV fees do not) which will feel strange to T-Mobile customers after the Un-Carrier has made such a big deal about including them in the headline prices of its wireless plans.
What's more, some of T-Mobile's content partners are apparently challenging the new service as a breach of contract. Obviously, if this dispute blows up and content starts disappearing from TVision, that will be a potentially fatal blow. Though T-Mobile continues to insist that there is no issue, here, with CEO Sievert declaring forcefully during the earnings call that:
we are complying with all of our media contracts and at the same time, we're working with them because we're open-minded. Some would like to see changes. And if those changes are great for customers and help us continue to smash customer pain points, we're open-minded.
Finally, T-Mobile's list of device partners at launch does not include Roku (ROKU) though it does include Amazon Fire (NASDAQ:AMZN). Launching without Roku didn't go so well for HBO Max and Peacock, but T-Mobile management apparently feels it won't cause them the same hiccups. We'll see.
Despite all of this, TVision offers a considerable long-term upside for the company. Assuming that content overages on Live/Vibe and operating costs for TVision come to no more than $10 per month and that the average of three wireless lines per account does not change, T-Mobile is paying about the same as its Netflix On Us promotion - with which management and analysts have been very satisfied - for a potentially far stickier video service to attract subscribers and add a "fourth line" of home broadband to the account.
If that fourth line is priced at the same level as current cable broadband - around $60 per month - and adds on a highly lucrative $10-$15 equipment rental fee like most providers do, at a 70% gross margin converting just one in five TVision subscribers to T-Mobile Home subscribers will more than defray the cost. This is before we consider any benefits of reduced churn on the wireless side.
This article ends the way it began - with me reaffirming my bullish recommendation. I have gone into considerable detail about potential downsides so that investors can be forewarned and forearmed against whatever short-term headwinds TVision may produce. I am not entirely persuaded that there is any way to run TVision on a break-even basis.
But I am also not persuaded it needs to break-even to be good for the company. Home broadband, not TV, appears to be T-Mobile's true "next frontier," and a TV service with broad consumer appeal could be pivotal in marketing and launching that service. That is worth a few extra bucks in the content budget every month.
I remain long T-Mobile.
Disclosure: I am/we are long TMUS. 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.