The $3.2 billion position Elliott Management Corp. has taken in AT&T may sound like a significant stake. But in the context of AT&T’s $270 billion market cap, it’s probably not enough to scare management into making the kind of strategic and operational changes the activist hedge fund is demanding unless elements of the board and other large investors join the crusade.
But it’s hard to argue with Elliott’s critique of CEO Randall Stephenson’s M&A moves over the past decade that are at the heart of its brief against management.
AT&T’s $48.5 billion acquisition of DirecTV in 2014 was premised (rationalized?) on the need for scale in distribution. At the time, AT&T’s U-verse wireline pay-TV service had 5.7 million subscribers. DirecTV’s satellite service had 20.4 million. By combining the two, Stephenson argued at the time, AT&T would have the largest number of pay-TV subscribers, giving it the clout to drive down programming costs by negotiating more favorable carriage and retransmission deals with the networks.
It never really worked out that way, however. By the time the deal closed, in 2015, linear pay-TV in general had begun to hemorrhage subscribers as over-the-top streaming services grew rapidly. In buying a satellite service, moreover, AT&T bet on the weakest technology platform for the future. It was clear, or should have been, at the time that the future of the business was going to be over-the-top and interactive (i.e. on-demand), where wireline providers who could deliver broadband and video over the same technology platform were better positioned.
AT&T tried to compensate by offering bundles of wired broadband and satellite video, but that was more workaround than strategy. It tried another gambit with the launch of the over-the-top linear DirecTV Now services (now called AT&T Now), but that left AT&T dependent on other providers’ networks and broadband subscribers to reach beyond its own wired footprint, negating much of the original strategy.
AT&T’s $104 billion acquisition of Time Warner in 2018 was an even more questionable move.
Once again, the deal was premised on scale, but also on the supposed value-creating magic of combining content assets and distribution capability.
“Media has moved into an environment where scale is essential,” AT&T’s John Stankey told CNBC shortly after the deal closed. “Somebody in the legacy media space will build a platform of scale and get to 70 million to 80 million subscribers. We’d like it to be us.”
It was that same strain of magical thinking, however, that drove AOL to its calamitous acquisition of Time Warner two decades earlier. That misadventure destroyed so much value and wealth that it should have disabused anyone — especially anyone associated with Time Warner — of the notion that “synergy” from combining “pipes and content” could create value.
But like medieval alchemists who persisted in trying to convert base elements into gold despite centuries without progress, the dream of pipes-and-content never seems to die despite repeated failures.
Even predating the rise of AOL and the internet there is a trail of wreckage and value destruction resulting from efforts to combine intellectual property assets with the physical infrastructure of distribution.
In the early 1980s, as the VCR was transforming in-home entertainment, Japanese consumer electronics makers bought into the notion that combining their hardware empires with the content people played on those devices would magically create new value. Thus, Matsushita, the majority owner of JVC, which owned the patents on the VHS format, acquired Universal Studios, and Sony, which developed the Beta VCR format, scooped up Columbia Pictures.
Both deals turned into losers for the buyers even if the sellers saw temporary windfalls.
Despite their symbiotic relationship, the businesses of producing and distributing media content are fundamentally different and there is little reason to regard them as compatible.
Content is valuable in proportion to its popularity. And its popularity is proportional to the scale of its distribution. In most cases, content creators and owners benefit most from reaching the largest possible audience across the largest number of platforms. The more competition there is among platforms to deliver the content, the higher the prices content owners can charge for the rights to deliver it.
From a distributors perspective, on the other hand, content is simply a cost center to be minimized. It generates no revenue that accrues to them.
Those interests are fundamentally at odds. And the inherent conflict doesn’t get any easier to resolve by putting them under the same roof. If anything, it gets harder.
There are certain circumstances where owning the content they distribute does add value for a distributor, primarily where exclusive content has strategic value.
Netflix, for instance, derives value from creating and owning content for its platform because exclusive content drives new subscriptions. It can justify forgoing a larger, off-platform audience for its content because for now, at least, it derives more value from exclusivity.
Apart from HBO, however, none of the Time Warner content brands AT&T now owns are in the business of cranking out exclusive content. AT&T can, and no doubt will use the facilities of Warner Bros. and the Turner networks to start producing content exclusively for its streaming platform. But if you’re going to start from scratch with a new business model anyway, why pay a premium to acquire those assets in the first place?
There is no magic in putting two fundamentally incompatible businesses under one roof, any more than mixing lead with other elements can produce gold. There are certain circumstances where it makes strategic sense to produce content in-house exclusively for your own platform. But even there, those circumstances are not forever.
At some point, Netflix’s new subscriber growth will slow to the point where it can no longer justify the cost of capital to keep producing exclusive content. Then it will have to start making decisions about how exclusive it wants its content to be.
The AOL-Time Warner merger was a bonfire of magical thinking. Yes, the pipes are fatter today than in the days of dial-up AOL, and the devices are more plentiful. The the problem then wasn’t merely a technological one, or one that technology can fully fix.