AT&T to spin off Warner Media group and combine it with Discovery Inc.

With great fanfare, AT&T thundered its way into the media business three years ago with grand visions of streaming video to millions of its customers’ cellphones, etc. Now the telecom and media giant implicitly admits its mistake:  AT&T has agreed to spin off its Warner Media group and merge it with a rival content provider, Discovery Inc., the companies announced today.

[We hinted that this might happen in a recent article titled, “Verizon Explores Sale of Media Assets; Wake up Call for AT&T?”  We also chronicled AT&T’s spin off of their TV business in the article titled: Analysis: AT&T spins off Pay TV business…. Finally, we voiced our objection to the June 2018 AT&T-Time Warner deal in Analysis & Huge Implications of AT&T – Time Warner Merger.]

The transaction will combine HBO, Warner Bros. studios, CNN and several other cable networks with a host of reality-based cable channels from Discovery, including Oprah Winfrey’s OWN, HGTV, The Food Network and Animal Planet.

The new company will join together two of the largest media businesses in the country. AT&T’s Warner Media group includes the sports-heavy cable networks TNT and TBS. In addition to Discovery’s strong lineup of reality-based cable channels, the company has a large international sports business.

The new company will be bigger than Netflix or NBC Universal. Together, WarnerMedia and Discovery generated more than $41 billion in sales last year, with an operating profit topping $10 billion. Such a sum would have put the new company ahead of Netflix and NBCUniversal and behind the Walt Disney Company as the second-largest media company in the United States.

Under the terms of the agreement, which is structured as an all-stock, Reverse Morris Trust transaction, AT&T would receive $43 billion (subject to adjustment) in a combination of cash, debt securities, and WarnerMedia’s retention of certain debt, and AT&T’s shareholders would receive stock representing 71% of the new company; Discovery shareholders would own 29% of the new company. The Boards of Directors of both AT&T and Discovery have approved the transaction.

As part of the deal, AT&T will be able to shed some of its debt and get some cash and bonds that altogether would amount to $43 billion. AT&T shareholders will own 71 percent of the new business, with Discovery investors owning the rest.

The new company will be run by David Zaslav, 60, a media veteran and the longtime chief executive of Discovery, casting into doubt the future (yet again) of the top ranks of WarnerMedia. Jason Kilar, 50, who was hired to run AT&T’s media group only last year, could lose his job.

“Jason is a fantastic talent,” Mr. Zaslav said on a call with reporters following the announcement. He also praised other executives within WarnerMedia, including Toby Emmerich, the head of the film division, Casey Bloys, who runs HBO, and Jeff Zucker, the leader of CNN. Mr. Zucker and Mr. Zaslav are also longtime golfing buddies.

Mr. Zaslav said he would be looking for ways to “get the best people to stay,” but he didn’t elaborate on his plan for the new company’s management team.

John Stankey, the head of AT&T, who appeared alongside Mr. Zaslav in the news conference via Zoom, said “Jason remains the C.E.O. of WarnerMedia.” He added: “David’s got decisions he’s got to make across a broad cross section of how he wants to organize the business and who will be in what roles moving forward during this transition period.”

The companies said they expected the deal, which must be approved by Discovery shareholders and regulators, to be finalized in the middle of next year. The companies anticipate they will cut annual costs by $3 billion as a result of the transaction.  AT&T will also cut its dividend (more below).

The deal highlights the need for even large media companies to get bigger. Traditional entertainment firms are struggling to maintain their grip on viewers as the likes of Facebook, YouTube and TikTok

continue to draw big audiences. Consolidation appears to be the quickest way to buy more eyeballs — the deal could set off another round of media mergers. ViacomCBS, the smallest of the major entertainment conglomerates, is often seen as a possible target.

To compete with Netflix and Disney, both AT&T and Discovery have invested heavily in streaming. AT&T has spent billions building HBO Max, which now has about 20 million customers. Discovery has 15 million global streaming subscribers, most of them for its Discovery+ app.

The new company expects to generate $52 billion in sales and $14 billion in pretax profit by 2023. Streaming will be a big driver of that growth and is estimated to bring in $15 billion in revenue.

Our analyst colleague Craig Moffett wrote in a note to clients:

This deal makes strategic sense for each side. Discovery’s linear networks are helped by the inclusion of CNN for news and by the inclusion of TV rights to the NBA, NFL, MLB and NCAA Basketball for sports. By our math, the new company will instantly become the largest home of linear impressions, sourcing 28% of the 2020 U.S. viewing time and 24% of U.S. national advertising. Better still, it will be under-monetized, as it will generate only 20% of national affiliate fees. While we rightly worry about the long-term health of TBS and TNT, we would assume that Discovery will move key Turner sports and news content to Discovery+, to make it a broader and more attractive offering which will help
their ability to grow those more valuable impressions. Internationally, Discovery’s linear and SVOD offerings will be strengthened by the inclusion of CNN and Cartoon Network into their offerings. Simply put, Discovery+ becomes a more relevant service for a wider group of people in the world.

For WarnerMedia, they benefit from having a more natural destination for Turner’s product in a DTC world. We have noted time and time again that TNT and TBS were poorly positioned, and appeared to have no clear path forward to a DTC world. We have similarly lamented that HBO Max, while immensely attractive to U.S. audiences, were not nearly so well positioned outside the U.S. Discovery’s international footprint and focus creates both an accelerator and greater scope for HBO Max’s international rollout.

The new company will now be able to have unified conversations with the same set of global distribution partners – Roku, Amazon, Apple, wireless operators, broadband services – with greater strength and urgency. We assume that both brands Discovery+ and HBO Max will maintain separate identities but will be offered in a bundle a la Disney. In short order, the new company will be able to join the upper tier of global SVOD/AVOD players: Netflix, Disney and Amazon.

For AT&T, while the timing was surprising, the action was not. The market was never going apply a Disney-like multiple (say, by using on 2024 revenue multiple for HBO Max) that would give AT&T full sum-of-the-parts credit for the potential value of HBO Max. Moreover, AT&T’s balance sheet allowed neither the aggressive investment required for HBO Max nor the 5G wireless push (nor, for that matter, for the consumer fiber business). Ultimately, they had no choice. The die was cast even before the ink was dry on their initial acquisition.

Not at all unexpected, AT&T said its 52-cent-a-share dividend would be cut if its merger of Warner Media and Discovery is approved.  AT&T’s dividend’s health had been in question given a debt load that was exacerbated by the company’s 2018 acquisition of the WarnerMedia assets, which include TNT, CNN, HBO, and the Warner Bros. movie studio. As of March 31st, long-term debt totaled about $160.7 billion, up from $153.8 billion at the end of 2020.

In an interview with CNBC Monday morning, AT&T CEO John Stankey said “there’s been some overhang on our equity that’s been driven by the balance sheet dynamic,” notably debt. The deal will allow AT&T to “accelerate our deleveraging of the business,” he added

References:

https://about.att.com/story/2021/warnermedia_discovery.html

https://www.nytimes.com/2021/05/17/business/att-discovery-merger.html

Verizon Explores Sale of Media Assets; Wake up Call for AT&T?

Analysis: AT&T spins off Pay TV business; C-Band $23.4B spend weakens balance sheet

Analysis & Huge Implications of AT&T – Time Warner Merger

 

10 thoughts on “AT&T to spin off Warner Media group and combine it with Discovery Inc.

  1. Good summary, Alan. You predicted that they would need to sell some assets to pay for and build out their recent C-Band spectrum win. This deal makes sense.

    Probably the funniest take is from journalist Amy Maclean of Cablefax who wrote on Twitter,

    “Normally, my kids don’t care or understand my job… Today my 10-year-old is very invested in my merger coverage and is concerned that Discovery is going to try to sneak some education into his favorite Cartoon Network shows.”

    https://twitter.com/MACcable/status/1394386565049245697

    1. Thanks Ken, I hinted that AT&T would have to sell or spin off Time Warner after Verizon was said to be in negotiations to spin off their media assets. Here’s what I wrote:

      Message to AT&T:

      If the Verizon media sales go through, it should send a clear message to AT&T, which went heavily into debt when it purchased Time Warner (and to a lesser extent DirecTV). AT&T has already spun off off its TV assets. AT&T agreed to create a new company for its U.S. video business unit together with private equity firm TPG Capital. The company will be called New DirecTV and include: today’s Direct TV, U-verse TV and AT&T TV (AT&T’s OTT video service). Closing the TV units “sale” will reduce their observed rate of decline. In the most recent quarter, video revenue shrank by 9.2%. That hemorrhage will stop once the video sale is complete. Next stop is for AT&T to sell or spin off Time Warner to reduce it’s debt load.

      https://techblog.comsoc.org/2021/04/28/verizon-explores-sale-of-media-assets-wake-up-call-for-att/

  2. From Robin Hood Snacks email:
    AT&T is ditching the entertainment biz, leaving its media assets to fend for themselves. The telecom giant reached a deal with Discovery to combine their media assets into a new, publicly-traded company (name TBD). Meet the cast…

    AT&T: Famous for its phone plans, but also for buying WarnerMedia for $81B in 2018. That gave it CNN, HBO, TBS, and Warner Bros. In 2015, it snagged DirecTV.
    Discovery: Famous for reality shows like Shark Week, Extreme Makeover, and 90 Day Fiancé. Its networks: Food Network, Animal Planet, HGTV, and… Discovery Channel.
    Do you think you’re better off alone?… If the deal is approved, AT&T will get $43B — around half of what it paid for Warner (womp). AT&T’s media biz has struggled thanks to cord-cutting, streaming, and pandemic movie theater closures. In February, it sold a large stake in its DirecTV business. The Warner spin-off marks the end of AT&T’s big bet on entertainment — which ended up costing it $93B. Some big plot points:

    71%: AT&T shareholders’ stake in the new company. Discovery shareholders get the rest.
    $20B: How much AT&T and Discovery spend on content combined (more than Netflix).
    Two streaming services: HBO Max and Discovery+. TBD if they’ll merge.

    THE TAKEAWAY:
    Losing focus can be dangerous… especially in quickly-changing industries. AT&T lost more than money — it lost focus on wireless, which is going through a 5G revolution. Instead of just competing against Verizon and T-Mobile, AT&T was also competing against Netflix and Disney. Now, it’ll need to spend tens of billions to match broadband/wireless investments made by Verizon and T-Mobile to upgrade their networks. This sale would help it do that, but it has already fallen behind.

  3. AT&T & Verizon admit defeat. AT&T and Verizon’s failure to differentiate themselves through media consumption is a stark warning to all telco operators, Richard Windsor 18 May 2021

    Here is my analysis on Telco operators as Packet pushers and how they failure to differentiate themselves through media consumption.

    AT&T and Verizon’s failure to differentiate themselves through media consumption is a stark warning to all telco operators that they need to do something very special in order to avoid being packet pushers.
    First, it was Verizon that decided that it was unable to make a go of its 3rd rate media assets and sold them to Apollo which somehow thinks that it can do better.
    This did not come as a huge surprise as the current CEO of Verizon comes from a company that also struggled with media and eventually returned to its roots of selling the equipment for pushing packets.
    Verizon had already written down the majority of the goodwill attached to these assets and took a further hit when it agreed to sell 90% of these assets to Apollo for $5bn.
    Verizon failed because it lacked the depth of management to turn these assets around as well as I suspect the will of its senior executives.
    Then on Monday, AT&T announced that it would spin off its media a mere three years after paying $109bn to acquire Time Warner and saddling itself with mountains of debt.
    AT&T’s media assets will be combined with Discovery to create a separate entity of which the vast majority of the shares will be distributed to existing AT&T shareholders.
    However, AT&T wants to paint this, there is no way to escape the fact that this is an embarrassing about-face in terms of strategy and that AT&T shareholders have been paying the price for poor execution on media since 2014.
    I think that only the very high dividend yield has supported the valuation of this company.
    It is clear that both Verizon and AT&T will now focus on delivering the fastest, most reliable, and cheapest mobile network available and will compete purely on this basis.
    In effect, they are becoming commodity packet pushers and all other telcos should look at these events to decide what strategy suits them best.
    I have advocated for more than 15 years that a telecom operator has one of two strategic paths to go down.
    First, packet pusher: Here the telco focuses on being the fastest, most reliable, and cheapest provider of connectivity.
    There is some differentiation to be had by combining fixed, mobile, and maybe content connectivity but in the end, it will always come down to price.
    This means that the telco must also be the lowest-cost provider of packets as it will always be forced to compete on price.
    Scale will also be a factor here as operating leverage will also be a factor in determining profitability.
    I have always believed that this is the default route that a telco will be forced to take unless it is capable of doing something different.
    Second, Differentiation: This is where the operator decides to try and add value to its packets through the provision of services that are exclusive to its network.
    Assuming that the service is popular, then the operator would be able to charge a premium price for its packets as users would be willing to stay in order to get access to the other services.
    There are many variations of this strategy, the latest one being AT&T and Verizon’s attempts to compete in the digital media bonanza.
    Operators have also tried custom phone software, digital services, digital assistants, and so on but with very little success to date.
    The latest events are yet another example of how hard it is for telecom operators to break out of their connectivity mold.
    There are many examples of how not to execute the differentiation strategy, and so far, no one has really worked out how to compete on this basis.
    With the biggest operators who have the most resources now admitting defeat, the hill for the smaller operators to climb now appears to be much higher.
    However, the smaller operators can be more nimble and take more risks so it is not impossible that we finally see some innovation in this sector.

    https://strandconsult.dk/blog/att-verizon-admit-defeat-att-and-verizons-failure-to-differentiate-themselves-through-media-consumption-is-a-stark-warning-to-all-telco-operators/

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  6. Thanks for this superb article! Spot on with this write-up as AT&T’s venture into media was a huge mistake. I’ll be returning to read more posts.
    I honestly believe that your IEEE Techblog needs much more attention.

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