The Challenges Facing A Merged AT&T Time Warner

Richard Waters in San Francisco

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When AT&T revealed its intention to buy Time Warner in late 2016, streaming video company Netflix was worth a mere 18 per cent of the combined stock market value of the telecom and media behemoths.

Since then, the number of Netflix’s paying subscribers has grown more than 40 per cent, and its value has ballooned to 60 per cent of a combined AT&T-Time Warner — a union that is now on the brink of completion, after being given the green light in a US courtroom this week.

As Judge Richard Leon remarked, channelling Bob Dylan: “You don’t need a weatherman to know which way the wind blows.”

Judge Leon’s clear conclusion — that a valid response to the rise of digital giants is consolidation among incumbents — will have far-reaching effects. The day after, Comcast tried to break up Walt Disney’s takeover of 21st Century Fox with a new, $65bn bid of its own. And what is true of the media industry today could one day become the fashion among retailers, as they try to counter online competition, or among traditional IT companies, facing the threat from a handful of new cloud computing giants.

Whether vertical integration of the kind pursued by AT&T is the right response is another matter. The history of combining distributors with producers of movies, music and television shows is decidedly mixed.

Time Warner was bought by a distributor once before — internet company AOL, at the height of the dotcom bubble. That deal was matched the same year by the acquisition of Universal by French group Vivendi, an owner of mobile phone networks. Both were predicated on the idea that new technologies, whether mobile phones or instant messaging systems, would open up new ways to distribute all types of creative output.

That proved hopelessly optimistic. Consumers still preferred the TV screen and CDs, and broadband networks were in their infancy. The question is whether — in the age of Netflix, YouTube and the iPhone — the calculation has changed.

Certainly, consumer habits have come a long way. Listening to music on mobile phones, as Vivendi proposed — or even watching entire TV shows — is now the norm.

But the challenge for vertical integrators is still to add more value than they subtract. One risk has always been that the incentives inside integrated production/distribution companies will lead them to favour in-house material, reducing their willingness to compete in an open market. Another is that they will use some services to subsidise others, devaluing parts of the portfolio.

These are abiding concerns. But they are outweighed by the imperative of finding ways to counter the new wave of direct-to-consumer, vertically integrated digital giants — not just Netflix, but Amazon, Apple and Google’s YouTube.

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For a start, bundling services together — like selling a video service to an existing wireless phone customer — has obvious defensive characteristics. It lowers customer acquisition costs and reduces churn. Selling video as part of a package of services could also be seen as a bulwark against the most fearsome digital bundle of them all: Amazon Prime, which has more than 100m subscribers.

To go on the offensive, though, AT&T will have to show that it can actually create more value from its ownership of Time Warner’s assets than either company could capture before. And it will have to do it in competition with the digital natives, which have grown up in a very different world.

Selling new video services direct to consumers, for instance, could put AT&T-Time Warner on a more equal footing with Netflix. It will be in a better position to collect information on users’ viewing habits and schedule or cross-promote shows. It will also have full ownership of the material it produces, rather than needing to negotiate for different use rights — an advantage when it comes to experimenting with new packages of digital content.

It will also have more information about consumers to compete with the digital advertising services of Google and Facebook, in part thanks to AT&T’s direct billing relationships — although it will need to tread carefully in tapping this.

There is no guarantee the new AT&T will be able to master the new techniques needed to exploit opportunities like these. But the $80bn it is paying for Time Warner will at least give it a chance to try.

richard.waters@ft.com

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