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October 25, 2016

AT&T's Business Transformation: From Connectivity, to Services, to Experiences

Posted by Anurag Vardhan Sinha (View Profile | View All Posts) at 10:25 AM

AT&T's Business Transformation: From Connectivity, to Services to Experiences

Last Saturday AT&T's CEO Randall L. Stephenson announced that AT&T Inc. has reached an agreement to buy Time Warner Inc. for $85.4 billion, including the Time Warner Inc's debt and cash, the purchase is valued at $108.7 billion. AT&T has agreed to pay $107.50 a share, evenly split between cash and stock and when the deal finally closes, Time Warner shareholders will own 14.4 % -- 15.7% of AT&T shares.

This is a landmark in the history of AT&T, as with this announcement, they have transitioned from a communications company to a media conglomerate. This will result in the largest vertically integrated media company, with a combined market capital of over $300 billion (AT&T has a current market capital of $230.64 billion and Time Warner Inc. has a current market capital of $69.7 billion). With this acquisition, AT&T will be able to combine content from Time Warner, a vast library of TV and movie properties, including HBO, CNN, TBS, TNT, Cartoon Network, and the Warner Bros. film studio, home to the Harry Potter and DC Comics franchises entertainment, with AT&T's distribution network of mobile services, broadband and TV in the U.S., Mexico and Latin America.

In the last few years, the industry has been witnessing large mergers that create media behemoths out of communication companies. In 2009, Comcast acquired a 51% stake in NBC Universal for $ 5.8 billion and the deal, as a whole, valued NBC Universal at $30 billion. By 2011, Comcast bought the rest of the stakes at 'specified intervals' from GE. In 2015, Verizon bought AOL for $4.4 billion and a year later, they acquired Yahoo, the search pioneer and web portal juggernaut for $4.8 billion.

There has been resistance to such mergers as well. In 2000, WorldCom and Sprint called off their whopping $129 billion merger after the United States Department of Justice filed to block the deal. AT&T's $39 billion bid for T-Mobile was withdrawn in 2011 after the Department of Justice filed an antitrust lawsuit to block the deal. The Federal Communications Commission declined to approve Dish's proposed $29 billion merger with DirecTV in 2002. However, Stephenson has confidently cited that this deal will be approved by regulators.

The trigger for such mega mergers has come from the challenge faced by communication companies to their traditional line of business by new entrants. Being a capital intensive industry, it is estimated that in the US, communication companies collectively invests upward of $65 billion in capital expenditures annually, to provide both the access networks and the digital backbone. Since 1996 it is estimated that these companies have invested about $1.2 trillion, but they have been unable to benefit from these massive investments. Instead, the value has been largely captured by digital newcomers who have built successful business franchises 'Over-The-Top' of the communication company's networks. New age technology / media companies have skillfully utilized the concept of 'net neutrality' to decimate the entry barrier of high capital investments and forced an unequal but 'imaginary' level playing field with communication companies.

The new IP centric "Over-The-Top" (OTT) players like Google (YouTube), Amazon, Apple, Deezer, Microsoft (Skype), Spotify and Netflix have encroached on to the communication industry's traditional revenue streams, marginalizing them to the role of mere access providers. For example, Netflix competes with operators' of IPTV/cable TV services and is estimated to consume as much as a third of the total network bandwidth in the US during peak times! Or consider free calling apps like Skype, Viber and Nanu -- it is rumored that Skype alone takes away an estimated $1 billion in voice call revenue from the global communication market every day!

The communication industry responded to the challenge by consolidating, differentiating and transforming, and taking the battle into the enemy camp. In order to differentiate and transform, communication companies focused on offering newer service lines, newer ways of monetization and adoption of 'internet standard cost structures'. Innovation based on network functions virtualization (NFV) and software-defined networking (SDN) helped communication companies migrate to 'cloud standard' cost structures. AT&T undertook the ambitious Domain 2.0 strategy to convert their existing networks into an elastic, programmable, and dynamically manageable next-generation cloud/IP platforms, which can operate at internet timescales and transaction volumes. Verizon defined their SDN/NFV architecture along with industry leading OEMs like Cisco, HP, Intel, Redhat and Samsung.

The third part of the strategy was to transform themselves into technology and media companies with extensive expertise in distribution. The current set of mergers and acquisitions point to the communication industry's zeal for transformation. Since these mergers and acquisitions are cross sector or cross industry, they do not attract the level of regulatory interference as in the case of a horizontal- same sector M&As.

It is interesting to note that the two traditional competitors -- AT&T and Verizon have taken a non-competitive approach towards creating their own version of integrated media companies. Verizon's investment in AOL and Yahoo will help them compete with technology rivals like Facebook and Google for advertising sales online, while AT&T seems to be betting on pay TV and movies, with acquisition of DirecTV and Time Warner Inc. Combining Time Warner's content along with the backbone, reach and customer base of AT&T and DirecTV, it can take on potential technology competitors like Netflix, Dish, Comcast and Sling TV. AT&T has already started flexing its muscles by offering 'zero rating' or exempting DirecTV streaming video and U-verse app. from data caps on AT&T mobile internet service. It was estimated that Netflix had spent over $5 billion on acquiring content this year. AT&T can choke their plans by raising prices or refusing to license content to online services that compete against them.

Management guru Peter Drucker advised, 'Plans are only good intentions unless they immediately degenerate into hard work.' The biggest roadblock that AT&T and the communication industry in likely to encounter will be the integration of the acquired companies and synthesis of a common culture. Time Warner's $165 billion AOL acquisition in 2001 is a case in point. Organizational incompatibility, negative financial synergy created due to the 'dot-com' burst, and failure to realize synergies, ended the merger with the separation of the two companies.

AT&T is taking on $40 billion by way of bridge loans to finance the Time Warner deal. It has already added to its debt by financing the DirecTV deal last year and the spectrum auction in 2015. Independent analysts' estimate that AT&T's debt will grow to as much as $170 billion if the deal is approved, making it one of the most indebted companies, and adding to its execution level pressure.

It will be interesting to see if the acquisition of Time Warner Inc. by AT&T and NBC Universal by Comcast will trigger a new wave of consolidation, forcing 21st Century Fox, AMC, Discovery Communications and Scripps Networks to seek alliance of their own.

AT&T's Business Transformation.jpg

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