When it comes to communications mergers this year, it's all about the bundle.
Attention will focus on federal regulators this year as they now have not one but two major communications mergers to consider. So far, chances look good that AT&T and DirecTV will be allowed to consummate their $48.5 billion proposed merger.
The best thing that AT&T and DirecTV have going for them going into the regulatory review of this merger by the Department of Justice and the Federal Communications Commission is that together the companies could act as a stronger competitor to big cable. And by big cable, we're talking about the soon-to-be even bigger Comcast, which is looking to buy Time Warner Cable for $45 billion.
It's true that AT&T and DirecTV compete directly against each other for paid TV subscribers in almost all of AT&T's U-verse footprint. But the fact that DirecTV only offers TV service and doesn't offer broadband or home phone services will likely help the companies convince regulators that it's worth losing one pay TV competitor per market in order to allow for a stronger AT&T to compete against cable.
"We expect the greatest regulatory focus [on the AT&T/DirecTV deal] will be the merger's potential impact on pay TV prices," Paul Gallant, an analyst with Guggenheim Partners, said in a report Monday. " But in the end, we suspect AT&T's enhanced ability to attack cable -- plus an attractive set of merger concessions from the companies -- will lead the FCC and DOJ to approve the merger."
Biggest hurdle: prices for pay TV
The biggest barrier to this merger in the mind of regulators will likely be the fact that DirecTV and AT&T compete in the pay TV market. The concern will be what their merger will do to pay TV prices, which have been riser faster than inflation year after year.
"The industry needs more competition, not more mergers," John Bergmayer, senior staff attorney at public-interest group Public Knowledge, said in a statement. "The burden is on AT&T and DirecTV to show otherwise. The most obvious concern is that customers in U-Verse territories would lose a video competitor, though the transaction would have nationwide effects."
In most of AT&T's U-verse TV cities, DirecTV also competes. In those markets, Gallant said the biggest factor for regulators will be looking at how concentrated the market is in terms of competition. In many cases, the number of competitors will shrink from four to three.
On its own, this is a somewhat troubling fact that will likely weigh heavily on regulators' minds. In 2001, satellite TV provider Dish tried to buy DirecTV, but the deal was blocked by regulators for this very reason.
"The merger [of AT&T and DirecTV] will further concentrate an already highly concentrated market," Gallant said. "And the fact that pay TV prices continue to rise faster than inflation is a perennial sore spot in Washington."
Don't forget the bundle
This is where the so-called "bundle" could play to AT&T and DirecTV's big advantage. Today, DirecTV only sells pay TV services. But most consumers don't buy just standalone TV services. Many prefer the cost savings associated with buying services as part of a bundle. In this respect, Gallant reasons that AT&T and DirecTV could pitch this merger to regulators as being pro-competitive, since together the combined companies will have a stronger product offering to compete against cable operators.
Most of DirecTV's pay TV customers are in rural markets where AT&T does not offer its TV service. DirecTV doesn't offer a broadband or telephony service. So when competing against cable companies, which offer TV, broadband and telephony, DirecTV can't really compete. In many markets, cable has 50 to 60 percent of the market, despite the fact that satellite TV has been in the market competing for 20 years.
Meanwhile, AT&T, as a relatively new entrant in the TV market, does not have the same robust TV offering that either satellite or cable has. It often pays more for content than entrenched cable operators. A combined AT&T and DirecTV could offer a better cost structure when it comes to acquiring content, which could keep prices in check.
What's more, AT&T has a wireless offering, which is something that cable companies don't yet have. Combining AT&T's 4G wireless and broadband networks with DirecTV's satellite network means that AT&T could move video off its broadband network onto satellite in places where it makes sense to free up additional bandwidth faster Internet speeds over its wireline and wireless networks.
Another thing that AT&T and DirecTV are likely to point to when it comes to competition in the pay TV market is the fact that more distributors doesn't necessarily lead to lower prices. Gallant notes in his report that despite the fact that the FCC reduced local franchising barriers so phone companies could compete with cable and lower pay TV prices for consumers, the new video entrants end up paying more for programming. As a result, the phone companies have offered video service not as a money making endeavor, since the margins on that service are so small, but because they must do so in order to effectively compete at all with cable.
If regulators approve the Comcast and Time Warner Cable deal, as it seems likely they will do, an AT&T/DirecTV combination could serve as a powerful counterweight in many markets.
Execs say they're confident
AT&T's and DirecTV's executives recognize there will likely be skeptics to their plan. But they still feel confident that the deal will pass regulatory muster. AT&T, which has been down this road of acquisitions many times in the past, seems to have learned its lesson from its failed 2011 merger with wireless competitor T-Mobile.
"The first thing Mike (White, DirecTV CEO) and I began discussing regarding the transaction was achievability from a regulatory perspective," AT&T CEO Randall Stephenson said during a conference call Monday with investors and analysts. "We each did extensive analysis and really took a deep dive. And when we peeled back the onion, we saw how DirecTV and AT&T could go to market."
Stephenson said the companies identified what they thought would be the biggest areas of concern for regulators and they have tried to proactively address those issues in hopes they can win approval for the deal.
For instance, AT&T has already offered a few concessions that could be added as conditions for the merger. For instance, it will commit to offering a standalone wireline broadband service with download speeds of at least 6 megabits per second in areas where AT&T already offers its wireline services. The company has offered this concession twice before in order to get previous mergers approved. The first time was in 2005 when AT&T merged with local provider SBC. And it made this promise again in when AT&T bought local phone and broadband provider BellSouth. The company has not been under any obligation to sell standalone DSL service since 2009.
AT&T also said it will expand its footprint for broadband to cover 15 million more people than it does today. These new markets will mostly be in rural areas, where the government has been trying to promote the private sector to build more Internet access. Additionally, AT&T said that it will also expand its all fiber network to 25 additional markets. The company already offers the all-fiber network with 1Gbps download service in Austin. And it said last month it will expand the service to 100 additional cities. The new 25 markets will be on top of that.
Finally, AT&T also said that as a condition of the merger it will commit to adhering to the FCC's 2010 Net neutrality rules, which were thrown out by a federal appeals court in January. AT&T would honor the 2010 Open Internet rules for three years.
This is an important concession given that the FCC has just introduced a controversial proceeding that will begin the process to reinstate these rules. What makes this concession important is the fact that Comcast in its merger with NBC Universal already committed to follow these rules. And the company has agreed to extend the rules even further if its given approval to buy Time Warner Cable.
What all this means is that the FCC can win a victory when it comes to Net neutrality and protecting the openness of the Internet, simply by approving these mergers.
What about Sprint/T-Mobile?
Even though it may seem like mergers are all the rage this season, the outlook for the FCC approving a wireless merger between Sprint and T-Mobile is still unlikely. It would be difficult for a Democratic-administration DOJ to approve all three deals. And there are likely enough competitive reasons to keep the third and fourth largest wireless competitors from merging.