HBO Max in, Stephenson out – unless AT&T CEO agrees to DirecTV sale

Headline writers the world over are fast running out of sensationalisms to describe the torrid state of affairs at AT&T. Video subscriber losses totaled 1.36 million in the third quarter, with the operator out-doing Q2’s 956,000 cancellations. Predictably, the company’s subsequent WarnerMedia day quickly glossed over the widening cracks as the spotlight was again diverted to HBO Max, as well as the strong insinuations that Randall Stephenson’s days are numbered.

AT&T projects an ambitious 50 million domestic HBO Max subscribers in 5 years’s time, plus an additional 25 million to 40 million across Europe and Latin America by the end of 2025.

The initial plan is to invest between $1.5 billion and $2 billion in the streaming service during 2020 and about $1 billion a year thereafter. AT&T also plans to bring in a live element to HBO Max sometime within the first year, which should accelerate these projected costs somewhat, which we think the company has grossly underestimated.

All good and well, but the matter of fact is that AT&T is now guaranteed to close 2019 on below 20 million traditional pay TV subscribers for the first time since buying DirecTV four years ago in a deal the company should never have pursued.

Premium TV subscribers (covering DirecTV satellite and U-verse IPTV) declined by almost 1.2 million to 20.4 million in total, while the remaining 195,000 losses were picked up by AT&T TV Now, the recently rebranded and re-hiked DirecTV Now, leaving the latter with 1.1 million subscribers.

So how exactly does the $14.99 a month HBO Max expect to smash 50 million subs by 2023? Aside from AT&T’s run of the mill marketing campaigns to offer the streaming service free to existing HBO customers and premium video subscribers, as well as an exclusive one-year free deal with Verizon, the operator has introduced a number of features to differentiate itself.

Recommended by Humans is a backwards take on the recommendation engine aimed at attracting younger viewers through offering content suggestions from real-life social media influencers via short-form videos. The feature brings analytics to the fore so that the system is not entirely as dumb as the influencers presenting the recommendations. Once upon a time, AT&T sourced a recommendation engine from Jinni, but since Jinni has been struggling recently and looking for a buyer, we believe AT&T has since taken recommendation software and analytics in-house.

Another forthcoming HBO Max feature is called Co-Viewing. AT&T says content recommendations are skewed when a subscriber is watching with friends or family members, an apparent problem HBO Max is solving with a shared homepage. This segregates content from the main personal homepage, tailored for the tastes of the group as a whole. Neat but not revolutionary.

It speaks volumes though that AT&T TV Now was mentioned just once during the entire earnings call, with the skinny bundle cast aside for HBO Max as well as the imaginatively named AT&T TV, the Android-based platform launching early next year which we now know will run on Korean client hardware.

Despite its claims otherwise, AT&T has essentially discarded the DirecTV brand and has simplified its video strategy down to two products.

For all the positive projections around HBO Max, the dark side of the Q3 results are that AT&T has been virtually forced into implementing a three-year plan in response to the recent lambasting from activist investor Elliott Management. This will involve a separation of the Chairman and CEO roles both currently held by Randall Stephenson next year, along with the appointment of two new directors on the board over the next 18 months or so – raising serious question marks about the longevity of Stephenson’s time at AT&T. It seems the long-standing exec is being squeezed out of the telco giant after 12 years in charge.

AT&T’s three-year plan aims to achieve revenue growth in the region of 1% to 2% to offset debt accrued from the Time Warner deal and, crucially, AT&T has agreed (reluctantly) to cease from any M&A activity. Acquisitions in the other direction, however, are certainly being encouraged, with the DirecTV satellite business still top of the agenda, although AT&T’s earnings call again reiterated how the satellite business remains an important piece of its strategy over the next three years. Even so, Stephenson added, “But no portion of our business is ever exempt from a continuous assessment for fit and performance.”

The DirecTV spin off proposed by another private equity investor only a fortnight ago, Apollo Global Management, was not addressed by management during the call. Apollo has advised AT&T to fold DirecTV into Dish Network to create a new company which AT&T would retain ownership of, financed by Apollo. The private equity firm estimates AT&T would be set to generate approximately $25 billion – half the fee AT&T handed over just four years ago. With DirecTV’s subscriber base in freefall, the company should be biting Apollo’s hand off at the very prospect of a 50% return on investment.

Speaking of revenues, let’s take a quick look at Q3. Total consolidated revenues at AT&T came in down $1.1 billion to $44.6 billion, largely due to declines from legacy video and wireline services, plus substantial WarnerMedia investments. Entertainment group revenues declined by nearly $400 million year on year to $11.2 billion for the quarter, while WarnerMedia sank by some $350 million to $7.8 billion. HBO revenues were up by $175 million year on year to $1.8 billion, while Xandr, the ad tech division, saw positive momentum with a $59 million increase over the year period to $504 million.

HBO Max’s personalization features and uncompetitive price point have failed to inspire, and even offering the platform free to existing HBO customers as well as subscribers to premium video, mobile and broadband packages will struggle to plug the flow of cord cutters. We do however expect WarnerMedia to pull out the big content guns.