High Definitions display a Direct TV logo Photograph by Chris Rank/ Bloomberg News
Under pressure from cord cutting and TV viewing via streaming services, both satellite operators have faced an exodus of subscribers in recent years. According to J.P. Morgan’s Philip Cusick, gaining increased scale through a combination might be the way for satellite TV to remain competitive versus other home video options.
“The video ecosystem is shifting quickly to a broadband-focused world, leaving satellite as the fastest-declining legacy TV platform,” Cusick wrote in a report on Monday. “As rural broadband buildout using copper, fiber, and wireless moves along, supported by government funding, the natural satellite TV customer base shrinks every year and eventually will struggle to justify two, or possibly even one constellation of dedicated [direct broadcast satellites].”
Holding on to satellite TV subscribers through bundling with other services like home internet or phone services isn’t an option for Dish, which lacks a wired network, and has been a harder sell for AT&T than management expected it would be when it bought DirecTV in 2014. Dish lost 10% of its subscribers last year, while DirecTV shed 6%—accelerated this year by promotional periods ending for many customers.
While merging the two satellite businesses would be simplest from an execution perspective and create the U.S.’s largest player in home TV by subscriber market share—with 31%, or 25.4 million subscribers—Cusick believes that carving just the DirecTV satellite operations out of AT&T would be value destructive for the rest of its video services. The company’s U-Verse wired TV service and streaming live-TV offering DirecTV Now would have diminished scale and negotiating power with content providers, putting AT&T’s TV unit back to square one before its DirecTV acquisition.
Cusick recommends combining all of AT&T’s TV customers with Dish, which also has a live-TV streaming service, Sling TV. The combined entity could reach a total of about $2 billion in annual cost savings, largely from an estimated $825 million reduction in programming expenses. More subscribers under one contract means greater negotiating leverage with channel owners like CBS (CBS), Fox (FOX), or Viacom (VIAB) for lower rates. Cusick models a 0.5% reduction in monthly churn—or customer defections—as subscribers could no longer switch between Dish and DirecTV, saving $600 million in annual subscriber acquisition costs. Over time, as old satellites are retired and other redundant network equipment is removed, operating expenses could come down by $200 million annually.
Cusick models AT&T taking a minority ownership stake in the combined entity, with 49% versus Dish’s 51%. With AT&T in debt-paydown mode following its $106 billion purchase of Time Warner, he estimates the transaction plus an incremental $7 billion of debt on the new company could help reduce its borrowings by $22 billion. Cusick calculates that the combined Dish/DirecTV could have an enterprise value of over $50 billion. But he’s not bullish on its prospects. He estimates that about a third of the combined 29 million subscribers will defect by 2025, and that enterprise value will decline to $48 billion in 2022.
Reducing AT&T’s stake to less than half could also reduce regulatory opposition to a potential deal. Earlier incarnations of Dish and DirecTV tried to merge in 2002, but the Federal Communications Commission blocked the deal on competitive grounds. But in a world of greater cable and broadband reach, dozens of live and on-demand streaming services, and shrinking subscriber bases, the merger should have an easier path to approval.
“It is against this highly competitive backdrop that we now believe regulators could potentially allow for the combination of satellite/DBS players due to its antiquated technology, structural challenges (inability to bundle), as well as the emergence of broadband-delivered video— which is becoming the predominant form of video consumption of late,” Cusick wrote. “So, while a combination would result in 33% share of legacy pay-TV households today, we believe trends across the broader video ecosystem will make it more justifiable in several years”
To preempt antitrust regulatory concerns about consolidation in rural areas where satellite is the only option for TV delivery, Cusick believes that long-term national price guarantees could be enough to win merger approval.
The companies haven’t said they are interested in a deal, and Cusick’s analysis is based just on the financial implications of a potential combination. “To be clear, we do not believe the companies are in discussions today, and see both regulatory and personality issues that would have to be overcome to get to a deal,” he wrote.
Dish stock was up 1.4% on Monday morning, to $37.60, versus a 0.8% rise for the S&P 500. Cusick has an Overweight rating and $40 price target on the stock. AT&T stock was down 0.9% Monday, to $32.18. Cusick also rates it Overweight and has a $38 price target.
Write to Nicholas Jasinski at firstname.lastname@example.org