The 80/20 View: WarnerMedia, AT&T, and the end of the media/telco tie up

The announcement last week that the telecommunications giant AT&T would be spinning off its WarnerMedia portfolio into a newly listed entity alongside Discovery has seemingly marked the end, at least for the time being, of the appetite of telecommunications companies seeking to diversify into ownership of the content that flows through their pipes.

The deal between AT&T, WarnerMedia and Discovery in a nutshell

The arrangement is relatively straightforward. AT&T will spin off media brands such as CNN, HBO, Warner Brothers, AT&T Sportsnet and Turner into a newco combined with the media assets of Discovery Inc. This will create a business with a reasonable suite of assets across cinema, production, television, streaming, reality/non-scripted and sport. Warner will get a bunch of cash and will receive 71% of the equity in the new business.

Operating forecasts on the arrangement from the companies provided project a US$52 billion annual revenue business with US$14 billion in annual earnings. Merging the WarnerMedia operation with Discovery is forecast to save US$3 billion in reduced operational and administrative expenses.

What is unclear is how the newco will differ in the way it operates to WarnerMedia under its current CEO Jason Kilar.

So why is AT&T selling WarnerMedia, and why did it buy it just a few years ago?

AT&T announced it was buying Time Warner in the third quarter of 2016, with the deal only passing regulatory approval in Q2 of 2018. Which means for all intents and purposes, AT&T has only owned the WarnerMedia assets for less than three years.

The rationale for the buy was relatively straightforward. AT&T is primarily an infrastructure-based business that exists in a highly competitive, price-dominated environment. Seeking an edge against Verizon, T-Mobile and Sprint, AT&T felt that if it owned a suite of content creating assets, it could use these to differentiate its core mobile consumer offering; and it believed that a combination of mobile user data and high volume media assets would give it a viable offering in the advertising world, particularly around digital video.

The latter is a similar play to Verizon buying the old Oath/Yahoo/AOL business (of which they have also divested), but the former sought to use content as a way of boosting mobile subscribers and as a way of holding existing ones. Content was thought of as something that could be bundled or leveraged to strengthen the value proposition of the core mobile service.

The divestment of the media brands into a newco is somewhat of an acknowledgement that this approach is no longer an attractive one for AT&T.

Firstly, the entertainment business has undergone seismic shifts in the past 18 months alone and WarnerMedia has been hit as hard as anyone. COVID has impacted the Warner Brothers film business more than any other event, and the advent of streaming has impacted the economics of pay TV.

Secondly, Warner has been trying to move into streaming by launching HBO Max. The challenge has been two-fold: one of timing (too late) and one of volume (not enough). In the world of streaming services, an eight-figure usage number is no longer enough, 100m is the threshold. HBO Max is hovering around 40-45m, no mean feat, but a long way back from Netflix and Disney+.

Thirdly, the current media environment is a debt hungry one. Content is expensive and the market is supply driven. Add to this investments in infrastructure, technology and M&A, plus the expense of carrying existing debt, and entertainment and media is a hungry beast. For a business like AT&T, which is huge cash generating business, WarnerMedia was an anomaly and one that could threaten its 36 plus year history of increasing dividends when combined with 5G infrastructure costs across plant and spectrum which are hitting at the same time. The big question amongst insiders during the AT&T WarnerMedia period was whether WarnerMedia had sufficient funds to realise its strategic vision and compete with Netflix and Disney who have a higher historical comfort with debt.

So what are the implications then?

Implication 1: For the time being this is the end of the mediaco and telco tie-up

In the space of just over five years we’ve seen two of the largest telcos invest in and divest media assets they had purchased in an attempt to own not only the communication pipes but a part of the content that flowed through them.

It leaves Comcast and NBC Universal as the last of the “synergy” mega-bundles, and as TV distribution moves from network and pay TV signal based to direct to consumer, there’s a reasonable case to suggest the entertainment assets within Comcast (NBU and Sky) could be better served as their own entity. Or, merged with another similar business. Comcast’s growth is coming from its booming consumer fixed line internet and wireless business, which is growing at double digits.

Whatever happens, it appears unlikely that a telco or infrastructure pipe based business (mobile, pay TV, broadband) will have either the free cash, appetite for debt, or suitable targets to acquire a meaningful media company.

Implication 2: ‘Big’ isn’t big enough in 2021

Media has become a big game, a game where the likes of WarnerMedia (and NBCU) are stuck in a world where they’re big, but not big enough.

Let me explain. As you can see here, we have 3 tiers of global mediaco scale. Tier 1 is Netflix and Disney, the largest players. Tier 2 is WarnerMedia/Discovery, NBCU and Vivendi. And Tier 3 is Newscorp, ViacomCBS and Lionsgate/Starz.

Yes, these are all multi billion dollar companies … but Netflix and Disney are streets ahead of the others when it comes to both valuation and streaming progress. However, this doesn’t tell the full story.

When you add the large technology platforms, all of sudden no media company seems very large. Facebook and Google in particular are directly competing with media companies for engagement and advertising revenue, Apple and Amazon compete against them for programming and creative work.

User scale and content depth is critical. It would be reasonable to expect the likes of Disney, WarnerMedia/Discovery, NBCU, Vivendi, ViacomCBS, Newscorp and Lionsgate all looking at options around M&A over the next 12-24 months.

Implication 3: More tie-ups will be needed

The notion that CBS and NBCU could become one entity ten years ago would have seemed absurd, yet right now it’s a smart idea. Sure, it would require one of them to lose their linear network assets in the US to pass regulatory scrutiny, but in the modern media world the network game is barely a sideshow.

NBCU and ViacomCBS have been late to streaming, but combined they have a reasonable amount of content and rights. For either to be competitive in the current landscape, they cannot continue as is.

Another option is the WarnerMedia/Discovery newco acquiring NBCU from Comcast. This would create an entertainment house that will rival Disney across entertainment. And provide a springboard to make HBO Max a legitimate threat to crack 100 million users.

Just a few years ago this would have seemed unlikely to pass competitive approval – but with a new focus from regulators on technology companies and a case to be made that prohibiting incumbent media company mergers would create less competition, these tie-ups have more chance of occurring than not.

But with only so many assets available, it needs to happen fast. Especially with technology companies generating over $250 billion of EBITDA over the last 12 months and looking for places to invest these earnings.

Implication 4: Australian media companies are not immune from these movements

It’s reasonable to assume Nine Entertainment Co and Seven West Media have been looked at by their overseas counterparts.

Nine Entertainment, in my view, is particularly attractive to Disney and WarnerMedia as it contains a successful and scaled streaming business in Nine’s Stan, as well as a national TV network in Nine. Seven would find NBC Universal an attractive partner, as it provides access to depth of content and may require a local partner for its streaming ambitions.

The other potential is News Corp and Seven. It’s unorthodox but Seven could provide News Corp with a way to get SkyNews on Free-To-Air TV, as well as a way to generate an advantage in sports right through joint FTA/Pay/Streaming/on-demand bidding.

Whatever happens, it’s hard to see how there can be so much movement in the global media world and the local environment remain as is.

Ben Shepherd is the general manager of Thinkerbell. The 80/20 View is a regular column on Mumbrella.