Discovery deal is best hope to rescue AT&T — Raynovich

AT&T
Discovery board member John Malone said, “I believe we are creating real value for shareholders and a legacy investment for my grandkids.” (Monica Alleven/Fierce Wireless)
Raynovich

AT&T and its CEO John Stankey are taking some dramatic steps to rescue AT&T from a decade of poor financial decisions that have left the company laden with debt and underperforming assets for shareholders. This week’s announcement to spin off media assets is the right decision.

As I wrote about here in 2019, AT&T has been eating itself with debt. The only question is whether Time Warner was a worse decision than the disastrous DirecTV deal, in which AT&T took on $50 billion in debt to buy an asset that later resulted in a large loss. This week’s announcement to spin off WarnerMedia caps a disastrous acquisition spree by previous AT&T CEO Randall Stephenson, who drove the deal to buy Time Warner for $85 billion in 2016. AT&T spent years battling the U.S. government to win the deal, finalizing it in 2018.

AT&T (T) will sell its WarnerMedia to Discovery (DISCB) in a deal valued at $43 billion as it spins off media assets and creates equity in a new company formed by the merger of Discovery and WarnerMedia. AT&T shareholders will receive 71% of the equity in the new company, giving them a ticket to redemption. The deal will close by the middle of 2022. It will create a separate, as-yet-unnamed media company headed by Discovery CEO David Zaslav.

Misguided Media Ambitions

AT&Ts media strategy, guided by Stephenson, was misguided from the beginning. Many experts (including this one) pointed out that the company’s poor understanding of media businesses and its byzantine bureaucracy were not likely to help guide a massive vertical integration of media and distribution. In addition, past examples of giant telecom companies marrying distribution with content have a long history of failure, including AT&T’s own experiment with vertical integration under Michael Armstrong in the late 1990s, which also ended in failure.

The bottom line is that the content always grows faster when it’s not part of the distribution network. Netflix may be the best example – where media innovation is  allowed to flourish outside of a distribution network. This is a view held by cable and media kingpin John Malone, who is widely regarded of the architect of Discovery and a member of its board.

“I am delighted to fully support this transaction, without asking for or receiving a premium for my high vote shares,” Malone said Tuesday in a statement. “I believe we are creating real value for shareholders and a legacy investment for my grandkids.” Malone also called the deal “logical.”

Malone was a key benefactor of the deal. He owned 6.2 million Discovery Class B shares, giving him a total of 26.5% voting control — the most of any single owner. In forming the new company, he is agreeing to give up voting control for common equity in the new media company that will result in the merger of WarnerMedia with Discovery (“DiscoveryWarner” ?).

Follow what Malone says. This is the best move for AT&T shareholders because it focuses on reducing AT&T’s debt level which has risen to dangerous proportions. The company has an astounding $168 billion in long-term debt, with an equity value of only $207 billion, making it a highly leveraged operation with limited growth (AT&T has been growing at under 5% for years).

The deal gives the company some upside by taking in some cash and giving it exposure to a newly created media giant second only to the Walt Disney Co. (DIS) in annual revenue (the new company is expected to generate $52 billion in 2023). This will allow AT&T to focus on what it really should do – be a communications company delivering broadband and 5G.

RELATED: AT&T’s spin-off of WarnerMedia frees up money for 5G investments

“For AT&T shareholders, this is an opportunity to unlock value and be one of the best capitalized broadband companies, focused on investing in 5G and fiber to meet substantial, long-term demand for connectivity,” Stankey said in a statement.

Capping the Telco Pivot on Media

The deal culminates a trend toward AT&T and other telecom companies in divesting media assets. AT&T’s sale of WarnerMedia comes shortly after it sold its Crunchyroll anime business to Sony for $1.175 billion in December 2020 and spun off its DirecTV business in an arrangement with investment firm TPG Capital in February 2021. It also follows the sale by Verizon (VZ) of that company’s media business, which includes AOL and Yahoo, to Apollo Global Management early in May 2021 for $5 billion. Verizon initially paid nearly $9 billion to acquire AOL and Yahoo.

The overall trend here is key: Dump media assets so the company can invest in 5G, which is expensive — a trend that my firm Futuriom has been predicting for years. The quest for media riches was a pipe dream for the telcos. For AT&T especially, the controversial 2018 merger with Time Warner has turned out to be a bust.

The new cash is sorely needed after AT&T spent tens of billions of dollars in 5G spectrum and now needs further investment to roll out 5G infrastructure. AT&T will get a cash infusion as well as a 71% stake in the new media company. In addition, AT&T is getting $7.6 billion in cash from the newly hatched “New DirecTV,” along with the spinoff taking debt that AT&T accumulated.

Less Debt, More Capex for AT&T

AT&T’s latest media sales reflect its determination to reduce its sizable net debt of $168.9 billion as of March 31, 2021, which has had investors grumbling. By selling its media assets, AT&T will shorten the timeline planned to reduce the debt, allowing for an increase in capital spending. According to the Wall Street Journal, capex will move to $24 billion next year from an estimated $18 billion in 2021.

By Futuriom’s reckoning, AT&T’s capex has fallen over the last three years, while spending by rivals T-Mobile US (T-MUS) and Verizon has crept upward, as shown in the chart below:

Raynovich chart

AT&T has fresh impetus to step up its capex. Having spent $27.4 billion to acquire 80 MHz of spectrum in the Federal Communications Commission’s 5G “C-band” spectrum auction earlier this year, AT&T must now spend on deploying those resources. That includes equipping millions of points of presence (PoPs) worldwide, as well as installing fiber to connect 5G cells and to provide backhaul in 5G networks.

AT&T still owns some media assets, including Xandr, an online advertising company AT&T acquired for reportedly over $1 billion in 2018. But it’s likely we’ll see a change there too. AT&T’s priorities have shifted back to the core of its business — providing communications networking, wired and wireless. The telco is leaving the likes of “90 Day Fiancé” in more capable hands.

AT&T shares fell dramatically on the news, dropping about 10% since the deal was announced on Monday morning. This reaction is peculiar to me, because the direction of the company has changed significantly, toward reducing debt and returning the focus to mobile communications. The debt burden was simply too large, given AT&T’s history of execution in media, and shareholders are now much better off with a company that can focus on what it does best — communications infrastructure — while owning a stake in a new media company run by folks that know what they are doing.

R. Scott Raynovich is the founder and chief analyst of Futuriom. For two decades, he has been covering a wide range of technology as an editor, analyst, and publisher. Most recently, he was VP of research at SDxCentral.com, which acquired his previous technology website, Rayno Report, in 2015. Prior to that, he was the editor in chief of Light Reading, where he worked for nine years. Raynovich has also served as investment editor at Red Herring, where he started the New York bureau and helped build the original Redherring.com website. He has won several industry awards, including an Editor & Publisher award for Best Business Blog, and his analysis has been featured by prominent media outlets including NPR, CNBC, The Wall Street Journal, and the San Jose Mercury News. He can be reached at [email protected]; follow him @rayno.

Industry Voices are opinion columns written by outside contributors—often industry experts or analysts—who are invited to the conversation by FierceTelecom staff. They do not represent the opinions of FierceTelecom.