MorningWord 10/24/16 – Cross promotional. Deal mechanics. Revenue streams. Jargon. Synergy.

by Dan October 24, 2016 9:40 am • FREE ACCESS

About 10 days ago I called AT&T wireless to ask why my family plan was about $100 more a month than current offerings from Sprint (S) and T-Mobile (TMUS). This was after I saw my data usage spike near our 30 gigabit a month limit, from what I could only assume was excessive video streaming from the kids. AT&T’s customer service’s answer was fairly predictable, trying to up-sell me to a higher data plan. But in response to competitor pricing the overall answer was similar to the one they have been giving for nearly a decade (and Verizon’s), that their network is superior than the others.

There has likely been hundreds of millions of dollars spent on adverting in the last decade to either assert or debunk the network superiority mindset among consumers. But I suspect a large part of AT&T’s customer base’s loyalty has more to do with a sort of Stockholm syndrome dating back to the release of the first Apple iPhone in 2007 than any network superiority. For the first three iterations of the iPhone, consumers in the U.S. could only buy the device with a contract through AT&T.  In the years since, Verizon (VZ), S & TMUS have used aggressive promotions around new iPhone launches to woo customers back from AT&T. That has caused greater customer churn than AT&T might like and considerable pressure on pricing.

Back to me and my bills… apart from telling me their service was superior to their competitors (sigh), the sales guy suggested that I bundle my wireless plan with Direct TV (remember AT&T closed their $48.5 billion buyout for DTV in 2015) and reduce my wireless bill by, wait for it… $100 a month.

Which brings me to the big news over the weekend that AT&T is now attempting to buy Time Warner (TWX) for $85 billion to gain video content through properties like HBO and CNN. If the deal is allowed to go through it will be weighed down with considerable consumer protections and initially the bundling of Wireless & Wireline service, Cable via DTV and content offerings through Time Warner will result in lower prices for consumers, despite the long term implications of a vertically integrated monopoly behemoth.

When AT&T completed their DirectTV acquisition last year, CEO Randall Stephenson said:

Combining DIRECTV with AT&T is all about giving customers more choices for great video entertainment integrated with mobile and high-speed Internet service

In Saturday’s press release announcing the TWX deal, Stephenson said:

The future of video is mobile and the future of mobile is video

AT&T is desperately trying to differentiate their offering from their main competitor VZ who has been messing around with acquisitions of old skool internet assets like AOL & Yahoo to spin a wider web, on the web. That has many onlookers skeptical of Verizon’s diversification strategy, but with a combined price of $9.5 billion of the AOL and YHOO, this approach offers far less risk than AT&T’s.

So what to do with these stocks?  Many pundits are placing a late 2017 closing probability of about 50%. It might make sense for TWX holders to collar their stock, sell and upside call near the $107.50 purchase price and buy a downside put or put spread. For those who remember TWX’s refusal of Fox’s $80 billion in 2014 (stock and cash which NYT’s suggest would have been worth about $70 billion) saw the shares decline from the high $80s to the low $70s immediately after:

TWX 3 yr chart from Bloomberg
TWX 3 yr chart from Bloomberg

AT&T stock has declined 15% from its July highs. But if I owned the stock, and wasn’t worried about the acquisition news, the 5.25% annual dividend yield is attractive, and it might make sense to routinely sell upside calls against the stock to add yield as it unlikely that the stock will sniff the mid $40s again until there is greater clarity (in early 2017) about the deal’s approval. A routine (maybe 2 months out, 5% out of the money call selling plan) could add additional yield and a small buffer to the downside.

As for me, I own neither, but as a consumer I suspect if the deal is approved (not likely) I will pay less for all of my digital needs initially. Just as it did for wireline, wireless, texting, wireless data and (finally!) cable… pricing will be a race to the bottom, and streaming content may be the last bastion of hope to maintain an acceptable offering price if a company like AT&T can materially reduce their costs to cross sell these products. I’m not holding my breath, despite a great presentation 😉