On the morning of September 9, 2019, people in Dallas woke up to a fiery letter from Elliott Management proclaiming that it had invested $3.2 billion in AT&T, and that it demanded changes. Despite several huge mergers and acquisitions, most notably DirecTV and Time Warner, the stock price was below when the last CEO, Ed Whitacre, left the company.
Since during the same time the overall stock indices have been up significantly, it was only a matter of time until someone showed up with ideas of how to propel the stock price. In addition, the ideas, like selling underperforming assets, reducing the cost structure, and simplifying the organization are hardly novel—and much easier to conceive on a spreadsheet than to deliver in the real world.
It should come as no surprise that AT&T is trying to sell non-core and underperforming businesses to reduce its debt load—again, easier said than done. For example, in order to drive efficiencies and lower costs, many non-core businesses are running on the same network that is performing well. Offerings like Digital Life, which was a bet on the part of AT&T and did not pan out, are hard to sell because they integrally use AT&T’s fixed and mobile assets for connectivity. Any buyer would be joined at the hip to AT&T for many years, and ultimately would find it unprofitable to create a network replicating AT&T’s or to switch to a different provider just to have a different choice.
Elliott spent a lot of time decrying the long-lost opportunities with the delayed rollout of 4G, but did not talk about AT&T’s 5G leadership, where the company clearly learned from what happened in past. AT&T has improved its margins substantially through its global SDN leadership and wireless margins, which are superior to those of Verizon. AT&T has also consistently reduced its headcount by 5,000 to 10,000 people per quarter. The entire increase in profitability in the last five years has come from cost reductions, not from increases in revenue, which is part and the source of the problem. The shift towards SDN and merger-related efficiency gains have led to significantly fewer employees and costs. What it also means is by leveraging the same infrastructure for more and more tasks, it both becomes cheaper to provide and harder to break apart.
The wireless industry has exited its hypergrowth phase as it has reached higher penetration. T-Mobile, with the help of some cash and spectrum from AT&T when the TMUS-T merger failed and (more importantly in the long run) low margins allowed the company to rampage the wireless marketplace. Due to strategic investments in network, T-Mobile’s cost structure became closer to the level of Verizon and AT&T, allowing it to compete at a 38% gross margin level against their 48% to 53% gross margin level. If AT&T or Verizon would lower their wireless gross margin to 38%, lower prices, and add in some goodies, customers would flock to them as well. Wall Street would crucify the AT&T or Verizon management for it because the Street is looking first and foremost for profitability.
With the DirecTV acquisition, AT&T underestimated the secular trend away from linear television towards on-demand viewing and overestimated the importance of the fact that 70% of data usage is video content. Being a distributor, AT&T realized too late that content creators were not partners but competitors for the same viewers. Ever-increasing rates for content and a dwindling number of viewers puts linear television distributors between a rock and a hard place when it comes to profits. Dish is very clear about it, and that’s why Dish is looking toward entering the wireless space in search of safe harbor. We can argue about the wisdom of Dish’s decision, but we can be sure that Dish is not interested in doubling down on linear television by combining with AT&T’s DirecTV when Dish is focusing on diversifying its business. The logic of that combination looks great in a spreadsheet, but not in the real world.
As AT&T realized that content providers are the actual controllers of the fate of distributors, the logic of having a network and content would prop up the sagging distribution business. AT&T bought the best content creator money could buy. After a lengthy battle with the government, AT&T won and merged Time Warner into the company. While AT&T and Time Warner were in a government-imposed holding pattern, the rest of the world continued to evolve, giving Disney and others valuable time to execute on their strategies of disintermediating distributors—may it be DirecTV, Dish or Netflix—and launching their own video on-demand services.
As an aside, when people talk about regulations having an impact on the business, this is a prime example. The government lawsuit and hold on AT&T and Time Warner lasted for more than 18 months, and in that time, the competitive environment became even tougher for AT&T. The tough battles for distribution rights and rates, as well as content creators making their own content exclusive to their video on demand service, is a testament to that battle.
AT&T entered the Mexican market with the same premise that while wireless in the U.S. has topped out, there is still a lot of growth opportunity in Mexico. With Telcel holding 80% market share and the Mexican government eager to have another viable alternative to Telcel, opportunities for profit are significant. The company integrated two weak companies, and turned AT&T Mexico into a challenger, expanding the network significantly. This investment is an expensive but necessary prerequisite for success. Now, AT&T is executing its strategy despite the Mexican government being much more friendly to Telcel than it has been in the past.
AT&T has made some mistakes, but no one can assail the company’s overall vision. However, as is always the case, it’s about the execution. As Elliott engages more with AT&T, it will realize that its good ideas for easy fixes are anything but easy. At the same time, AT&T will probably accelerate some divestitures of non-integrated assets, allowing Elliott to declare victory and move on as it has done several times before. Or, will this approach by Elliott be the opening gambit in a much longer and more significant reshaping of one of America’s oldest companies? The next few months should be interesting.
Roger Entner is the founder and analyst at Recon Analytics. He received an honorary doctor of science degree from Heriot-Watt University. Recon Analytics specializes in fact-based research and the analysis of disparate data sources to provide unprecedented insights into the world of telecommunications. Follow Roger on Twitter @rogerentner.
"Industry Voices" are opinion columns written by outside contributors—often industry experts or analysts—who are invited to the conversation by Fierce staff. They do not represent the opinions of Fierce.