AT&T Buys DirecTV: Some Macro and Micro Thoughts

A few thoughts on the day after the big merger announcement:

Unlike the Comcast-Time Warner Cable-Charter proposed deal, AT&T's purchase of DirecTV "would eliminate a choice for pay-TV customers in some markets." In those areas where AT&T offers U-Verse service, a consumer likely has a choice of four competitive providers: the incumbent cable operator, Dish Network, DirecTV, and AT&T. If this merger goes through, the four choices go down to three and the new company includes one of the giant providers (as opposed to a combination of two of the smaller ones). While antitrust is far from my area of expertise, it appears that this is exactly the same outcome that doomed AT&T's attempted acquisition of T-Mobile.

While having AT&T and DirecTV under the same ownership would appear to facilitate bundling services for consumers (e.g., in non-U-Verse areas the combined company could offer phone plus DSL plus DBS plus cellphone), unless the DirecTV brand goes away, it would still appear to be the sort of shot-gun marriage that all current and prior telco-DBS "synthetic bundles" are and have been. It's not an elegant solution and "people are abandoning DSL in droves, and buying cable broadband".

When I've read of DirecTV's strong cash flow, but otherwise difficult strategic position (a TV-only provider in an increasingly bundled bustiness) and how AT&T could really use the DirecTV cash to fund its dividend, the story sounded suspiciously like Viacom's 1994 acquisition of Blockbuster to fund the acquisition it really wanted, Paramount Pictures. How did that one work out? Not that well.

Would AT&T apply the DirecTV brand to U-Verse video offering? Maybe that's a better idea. As AT&T's press release on the deal states: DirecTV is "the premier pay TV brand with the best content". The U-Verse brand is probably meaningless. Why anyone has a brand with a hyphen in it is beyond me. It is clunky and not web-friendly (the URL for the service is uverseonline.att.net, although u-verse.com does redirect to it -- why have consumers wonder if they include the hyphen or not. DirecTV's URL is simply directv.com).

This deal should seem like a homecoming for Dan York, DirecTV's chief content acquisition executive. It was just 2 years ago that he left that same role at AT&T.

Programming savings will not be as easy to come by as they are in a typical cable acquisition. DirecTV's distribution rights may be limited to its single DBS system and, if that's the case, would not have the right to simply add AT&T's systems to its affiliation agreements (and take advantage of DirecTV's greater purchasing power). Comcast, by comparison, would very likely have the right to do exactly that with the Time Warner Cable systems. It is always simpler if one does not have to negotiate. DirecTV already has relatively low programming costs as it is a giant pay-TV distributor; the programming cost savings would largely come for the much smaller base of AT&T U-Verse customers.

Could the NFL allow DirecTV to sell Sunday Ticket on U-Verse as well as DBS, but not provide it to other distributors? That could be interesting, but it would have to be negotiated. It is very unlikely that DirecTV would have the right to extend Sunday Ticket to additional platforms under its current (and expiring) deal. Would give U-Verse a leg up that it has never had before, but only a limited footprint in which it could take advantage of it. It would be an odd decision for the NFL: Sunday Ticket would be available from two providers in a minority of the country and one provider in the vast majority of the country. That's not an obvious thing to explain to consumers.

NFL Sunday Ticket is clearly on AT&T's mind. From its 8K filing about the deal: "The parties also have agreed that in the event that DIRECTV’s agreement for the 'NFL Sunday Ticket' service is not renewed substantially on the terms discussed between the parties, the Company may elect not to consummate the Merger, but the Company will not have a damages claim arising out of such failure so long as DIRECTV used its reasonable best efforts to obtain such renewal."

Packaging differences: Would DirecTV try to make the DBS and U-Verse packages of services more similar. Or would the combined company enjoy the dealmaking flexibility of having good-better-best on 2 different platforms and now have more ways to split the baby. In any event, the companies say they don't plan any large packaging changes.

Other perspectives:

• VideoNuze's Will Richmond is not a fan of the backward-looking deal.
• Howard Homonoff sees more work for the federal communications bar.
• Multichannel News's Mike Farrell sees 5 reasons the merger might not fly.
• The Diffusion Group's Joel Espelien thinks that AT&T needs DirecTV to have TV Everywhere video content for its wireless and broadband customers. I think he's totally off-base. TVE is a small portion of video content online and not even used by most pay-TV customers.
• Deadline's David Lieberman thinks Peter Chernin and over-the-top video is the key to the deal. I would tend to doubt that.

Intel Media Lessons

Word has come out that Intel Media, which has hired some 300 people to work on its over-the-top (OTT) cable service competitor, is now looking to Samsung and/or Amazon to assist in the business. That doesn't look good for the first true OTT competitor to cable.

What have we learned here:

1. To compete on the high end of the multichannel television business, you need to have all the channels. Having any significant gaps in the lineup means your product isn't meeting the expectations of consumers for a super-premium service. So, Time Warner Cable's Internet restrictions with some programmers, even if a super-premium service provider has networks 1-15, gaps in the coverage of networks 16-50 are problematic. TWC CEO Glenn Britt made these restrictions public at the Cable Show in June.
2. To compete in the low end of the market, a new entrant must find a way to get more favorable pricing from programmers and there is little reason for the programmers to support such an effort.
3. If the programmers require Intel to meet minimum subscriber guarantees, that creates additional risk for Intel to enter the business beyond the expense of creating the distribution system and marketing it. Perhaps the programmers are unwise to do this -- after all, if Intel doesn't launch, then the multichannel distribution market (buyers of programming) is less competitive than it is otherwise, and that's not good for the programmers (sellers of programming). On the other hand, the programmers all risk annoying/jeopardizing their relationships with the current customers by selling to an OTT provider -- this is new territory and this threat/potential threat has been recognized by distributors for at least a decade. If programmers are going to antagonize their core customers, they might reasonably expect that Intel makes it worth their while. Additionally, there may be incremental costs to distribute their service over the Internet -- programming costs, creating a separate feed with separate advertising, etc.
4. The opportunity to compete with the multichannel incumbents may be smaller than Intel thought when they first pursued this effort. In the last year, it appears that the multichannel subscription television business has peaked, at least in terms of number of subscribers.
5. Perhaps an executive with experience outside the US was not the best choice to lead this business. The media and television businesses are still highly provincial as opposed to international. All of the problems that Intel has encountered were well known to me and likely dozens of other people with long histories in the US multichannel business. For clarity, I don't know Erik Huggers at all and have never heard anyone speak ill of him in any way -- my point is based solely on his CV. Having lived in the UK, I can say that its television marketplace is very different from that in the US in a number of ways -- the huge role of the public broadcaster (BBC), the national orientation of the media as opposed to local, the dominance of DBS (BSkyB) over cable in market share, the requirement that facilities-based Internet providers wholesale their infrastructure to competitors.
6. Any OTT video service faces the potential threat that limits on the amount of data a typical home broadband customer might consume could make using the video service (or using it extensively) impossible or cost prohibitive. This uncertainty certainly (pun intended) makes a big investment in a new business more problematic.

I'm sure there will be a more direct over-the-top competitor to multichannel subscription television someday, but that day looks further out now than it did a few months ago.

Updated (30 October 2013): According to Peter Kafka at AllThings D, Verizon is in talks to take Intel Media off of Intel's hands.
Updated (21 November 2013): According to Reuters' analysis, For Intel, Hollywood dreams prove a leap too far.
Updated (26 November 2013): According to Bloomberg, Intel is asking for $500 million for Intel Media/its OnCue assets

Virtual MSO - A Look at the Opportunity

On the heels of the Needham analysts Laura Martin and Dan Medina's report "The Future of TV" (.pdf link) come stories about Apple and Google planning to offer something that sounds like a virtual MSO -- a plan to offer a bundle which includes live channels direct to end users over the Internet. As my friend and former colleague Will Richmond notes, this story has flared up many times over the past year or so, with Sony, Microsoft and Intel famously among the potential cable disruptors.

Hopefully new virtual MSOs will not represent a new path into the home for poltergeists.

The Needham report provides an exceptionally clear-eyed look at the television ecosystem and makes a few points that I had not seen made as clearly anywhere else. It also provides a useful context to consider the opportunity for a so-called "virtual MSO".

• Multichannel television is about 85% penetrated to households.
• Most of the popular cable networks are controlled by a relative handful of major programming companies (Disney, Time Warner, CBS, Viacom, Fox, Discovery, Comcast/NBCU, Scripps, A&E and AMC).
• The programmers bundle their channels together for sale to distributors.
• To the extent that programmers are willing to sell their services to new providers, they will expect the new provider to carry all of their channels in the "basic" package and pay full "rate card" prices.
• The existing multichannel providers have
• superior pricing on content, and
• less restrictive packaging terms, and
• a much more substantial local advertising sales business which can take advantage of the local avails that cable networks provide with their service, and
• their own pathways to their customers, so they can provide a consistent service quality. 
• The major programmers are not interested in seeing cable as a whole become unbundled. It is not unusual for a programmer to require that a new distributor sign up many other third party cable networks as a condition of an affiliation agreement with a major programmer. 
• Some programmers have restrictions in their affiliation agreements with current distributors that do not allow them to sell their services to over-the-top providers (or provide disincentives if they were to do so).

So, where does this leave our potential virtual MSO?

• Entering a possibly saturated market.
• Signing on to higher content costs.
• Receiving little or no packaging flexibility.
• Having a minimal ability to offset content costs with advertising.
• Being dependent upon a third party (the consumer's ISP) to deliver the service with acceptable quality.
• Being dependent upon that same ISP to provide the consumer with service with no bandwidth cap so that the substantial use of the service (i.e., watching television) does not require the consumer to spend extra on its ISP service.
• Likely having to launch without some popular channels.

Some of the issues the new entrants will face are temporary, but some are more fundamental. With scale, the new entrants will likely improve their content costs and advertising sales businesses. The packaging restrictions limit creating a significantly different content offering. The service quality and bandwidth cap issues look thorny.

Not surprisingly, given these difficult tasks, the virtual MSO business is only being stalked by companies with deep pockets -- Google, Intel, Microsoft, Sony and Apple fit that bill. Perhaps they are willing to run this business on little, or no, or negative margins for a good period of time to establish it.

That list of potential entrants dovetails nicely with the only obvious unimpeded opportunity for the virtual MSO: to improve the television interface. I think are opportunities in this and I am not alone in this feeling. Apparently Intel has made progress on this front. The incumbent distributors' widely deployed set-top boxes with their grid-style electronic program guides are not especially helpful for consumers navigating hundreds of channels. The widely deployed set-top boxes with DVR storage in the consumer's home have limited capacity, are subject to failure and can rarely be accessed outside of the consumer's home, often they can only be accessed on the single set to which the box is connected.

The skills that some of these new potential entrants have also dovetail nicely with this opportunity: Apple makes great interfaces, Google is the leader in running the sort of enormous data centers that a cloud DVR would require, Microsoft has some of Apple's advantages and some of Google's (both to a lesser extent). Sony still makes great consumer devices and Intel's chips undergird systems for all of these players. For each, that's a good start.

However the intersection of the opportunity and the constraints may be small. It doesn't make sense to make a first-class interface and launch it with a low-end product. Meanwhile launching a high-end product with uneven quality of service and lacking some top channels might also be problematic and the threat of future bandwidth caps doesn't help.

Fundamentally, to sort-of channel Steve Jobs, if you can't offer a product that is much better than what is out there already, why are you doing it?

At the same time, the multichannel interfaces are a moving target. It is clear that the distributors know that their interfaces are not-so-good and that the DVR would be better placed in the cloud than in the consumer's home. Comcast's new X2 guide software, unveiled at last month's Cable Show, is working on both of these issues. Other distributors are making similar efforts, like Cox's FlareWatch product/experiment (see my prior post).

The launch of iPad apps, led by Time Warner Cable and followed by many other distributors, are another way the distributors are updating their interfaces and, this also suggests another path for Apple, Google, Intel and the others.

These apps have been ported to devices beyond the iPad. In the case of TWC TV's app, it is available on portable devices such as the iPhone, Android phones and tablets and the iPod touch, but it is also available on the Roku, a television-connected box and Microsoft's Xbox game console and is rumored to be coming to the Apple TV. Clearly Time Warner Cable is more interested in making its service more available and hence more useful to consumers than protecting the revenue stream from additional set-top box rental and additional outlet charges.

But isn't carrying the cable operator's app on an Intel-powered box a tiny victory for Intel or Apple compared to the huge win of creating a virtual MSO?

Perhaps it is, but looking at Intel's issue more broadly, the creation of the virtual MSO seems much less important. Intel does not have a strategic need to distribute video content. Intel does have a strategic need to sell more of its chips, which by and large are not used in cable set-top boxes, nor in the Apple TV or Roku boxes. Similarly, Apple and Sony are primarily in the business of making consumer devices.

If the operators will create apps for the boxes of Roku, Apple, Sony and Intel, it would not appear that there is the same need for these companies to create their own services competitive with cable, particularly if they are essentially relegated to providing me-too services.

Under this scenario:

• The multichannel operator wins by making its service available on more devices, which inevitably will compete to make their boxes and interfaces more attractive, reducing the distributors' dependence on expensive proprietary set-top boxes which much be purchased, inventoried and supported and whose software tends to evolve slowly. The interface is still controlled by the operator since it has to authorize the subscriber (and no software developer would release an app that the operator won't authorize).
• The consumer benefits by having the option to buy a relatively inexpensive Internet streaming box (some Rokus cost as little as $50) and not having to rent a cable box (effectively $14.25 monthly for me on Time Warner Cable's system in Manhattan -- see picture below).
• The consumer electronics company has an easier time getting its box into a consumer's home.

1 additional outlet costs almost as much as HBO

To the extent that there is a more promising virtual MSO opportunity available down the road, Apple, Sony, Intel or whomever can then use its installed base of boxes to jump start that business. Famously, Apple did not make the first MP3 player or smartphone, they waited until what they could make was a material improvement on the state of the art.

While the Google TV box could employ the same strategy, that may not be sufficient for the company. After all, Google is primarily a services provider rather than a device provider, it is already in online video via YouTube and it has the deepest pockets of all. As the Diffusion Group notes, Google's search expertise could be bring a new paradigm to television navigation. Also, Google's experience serving up more relevant advertising might give it a leg up over the incumbent cable ad sellers, once it had meaningful scale, of course.

Another view, not inconsistent with mine: Jeff John Roberts, GigaOm

Inferences from the DirecTV-NFL Sunday Ticket Price Cuts

According to Bloomberg News, DirecTV is cutting the price of the out-of-market NFL Sunday Ticket package by 40% to existing customers ($200 instead of $325) and giving it away free to new customers.

What does this mean?

1. It is unlikely that DirecTV is paying for Sunday Ticket on a per-Sunday-Ticket-subscriber basis. That sort of structure would make a retail price cut extraordinarily expensive. Most likely DirecTV pays the NFL a flat fee or a share of the revenue with some aggregate minimum.
2. Competition among distributors continues to heat up. NFL Sunday Ticket may be the only marquee exclusive service in the multichannel marketplace. DirecTV clearly sees more to gain by using it to lure or retain subscribers than to increase average revenue per unit (ARPU). Sweet introductory offers are basically a form of price discounting (in this case the sugar is added programming value rather than a per se lower price). The flashing light is the warning that distributors' margins will continue to go down.
3. For all the discussion of the consumer appeal of a la carte, bundling is more powerful. New DirecTV customers are getting NFL Sunday Ticket as part of their bundle. Since only about 10-15% of DirecTV customers usually buy the package, that would suggest its appeal isn't that broad. Yet, here it is, front and center of a subscriber acquisition strategy.

Another wrinkle is that customers who want mobile, online and HD access to Sunday Ticket, whether they are new or existing customers, will pay $100 extra (last year that premium was $60). That's counter to the usual TV Everywhere approach where mobile and online access is included in the package as added value. The programmer charging extra for HD programming has also disappeared from the multichannel landscape. Mobile, online and HD fees may not be part of the NFL's flat-fee, yet. It seems that between the NFL and DirecTV they don't know how to value that TV Everywhere added value. As Mike White, DirecTV's CEO put it in an interview with Bloomberg “Charging for digital rights is an experiment. There aren’t great models in how you get your price elasticities right there. We’re all learning what will the market bear in terms of digital rights.”

Once they do, look to see mobile added to the bundle. As for charging extra for HD, at a time when the sets are 69% penetrated to households -- that just seems odd.