AT&T: Focus On HBO

Introduction

AT&T (T) will use Time Warner’s assets (now re-branded as WarnerMedia) to propel value going forward. Among the most significant assets captured in the acquisition is HBO, the premium-cable network that is also an over-the-top affair for those wishing not to engage the multi-channel-video-programming model (i.e., cable/satellite distribution). The key to unlocking growth potential from HBO is, of course, content. AT&T has indicated that it is willing to spend to get that growth. The biggest risk factor is AT&T spending too much and yielding few hits. AT&T may also take the HBO brand to theatrical distribution as well, in a bigger way than what HBO has experienced in the past in terms of filmmaking.

Therefore, HBO is one major reason to view the stock in a positive light.

Brand Value

HBO is a jewel asset. It has the type of quality programming that consumers demand. The company has demonstrated that it knows how to develop franchise episodic assets.

HBO also has output deals that bring recent films to the small screen in the pay-tv window. Twenty-First Century Fox (FOX) (FOXA) is one of the studios that ports its movies to the network. Comcast’s (CMCSA) Universal Pictures also has a deal with HBO.

HBO has been around for a long time since the early 1970s. In that time, the company has constructed a moat of brand equity that keeps its name in the consumer mindshare in high-profile fashion.

Content Value

HBO has, as of late, generated some major hits. Programs such as Game of Thrones and Westworld hit valuable demographics in the comic-fan crowd. This means that HBO can leverage its content to create merchandising opportunities.

Besides current content, HBO has a deep library of legacy titles. Something like Sex and the City can still be accessed on the channel via its on-demand component. The company entices subscribers to stay by offering its series as a library to be used at any time.

HBO also is a leader in original films and documentaries. The company stays current by exploring events happening in the world today, whether via a non-fiction expose or a fictionalized retelling. The channel is also no stranger to hosting comedians and their concert specials, as well as sporting events and rock shows.

Earnings Power

The premium channel brings in billions of dollars in revenue and profits. It also has well over 100 million subscribers worldwide.

According to a Bloomberg piece from this past February, the business has over 140 million subscribers across the globe. In terms of over-the-top subscribers, HBO has captured 5 million customers.

Let’s now look at the full-year earnings for 2017. In summary, sales expanded by 7% to over $6 billion for the HBO operating segment. Adjusted operating income increased 14% to $2.2 billion. I’ll quote directly from the release to afford further context:

Revenues increased 7% ($439 million) to $6.3 billion, due to an increase of 11% ($532 million) in Subscription revenues, partially offset by a decrease of 10% ($93 million) in Content and other revenues. Subscription revenues grew primarily due to higher domestic subscribers and rates and international growth. Content and other revenues declined due to lower home entertainment revenues.”

Again, this is for the full year, and you’ll note that lower home entertainment sales were an offset. This is because, in addition to chasing subscriber revenue, HBO also distributes its content on other platforms/media.

Costs will probably rise over time for programming marketing. Here is another quote:

Programming costs grew 4%, reflecting higher original and acquired programming costs, partially offset by lower programming charges. The increase in marketing costs was related to original programming and HBO’s OTT products.”

The following part of the release provides more evidence for the financial/brand-value power of the service:

Home Box Office added over 5 million domestic subscribers across its HBO and Cinemax services in 2017, its largest annual increase ever. In 2017, HBO received 29 Primetime Emmy Awards, the most of any network for the 16th consecutive year, including Outstanding Comedy Series for Veep, Outstanding Limited Series for Big Little Lies and Outstanding Variety Talk Series for Last Week Tonight with John Oliver. In 2018, HBO received four Golden Globe Awards for Big Little Lies, the most of any network. Average viewership for the seventh season of Game of Thrones increased 28% year over year to 33 million viewers, a record for an HBO original series. In November 2017, HBO launched OTT services in 11 Central European countries.”

HBO isn’t standing still in this era of cord-cutting/streaming.

The Big Picture

Let’s try to imagine some strategy. AT&T has built up a successful telecommunications platform that will benefit from the introduction of great content. HBO will play a large role in this paradigm. The company will use content and platform expertise to capture value-adding customer activity.

The proverbial sky is the limit, but one of the approaches that is hopefully at the top of the list is using HBO as a platform with which to explore day-and-date opportunities – i.e., the release of a theatrical film at both the multiplex and on a digital/physical platform such as Blu-ray, or HBO. Using HBO in this manner could really grow subscription revenue, in my opinion.

HBO also could play the game of spending enormous amounts of cash to vigorously compete in the marketplace. AT&T could fund the spending and consider it an investment that will surely pay dividends in the future. In fact, this Bloomberg article hints at an increase in budget for content development, which recently was pegged at $2.5 billion. The company will need much more than that, I think, and it will probably eventually get it. If HBO can efficiently exploit the increase in budget (which is sometimes hard to do in Hollywood), then it will be able to make more bets on series/movies and perhaps can experiment with the aforementioned day/date opportunity.

One thing mentioned in that Bloomberg piece is of particular interest to me: in the section of the article titled “Sports Shorts,” you will note a cautious approach to sports-rights licensing. I know many observers might disagree with this, but I believe most media companies should focus on fictional content rather than sports games. To me, the rights for football events/et cetera have become expensive. It is better to create movie/TV franchises instead of overpaying for live events because content production can be more controlled, more tailored to a demographic; with that comes predictability as well as flexibility (i.e., in terms of releasing the content and in choosing how to market it). AT&T will hopefully retain an attitude of reservation toward sports rights and instead pump more money into HBO.

Valuation

AT&T stock is now, arguably, a different beast post-consolidation. Nevertheless, it is famous for its high dividend yield. At a little under 6%, it is a very attractive long-term capital-appreciation/income play, in my opinion, because of the combination of content and brand-equity/platform. Consumers know AT&T’s trademarks, and they know Time Warner; they will certainly become familiar with WarnerMedia. There’s a lot of growth potential here, as I see it.

Conclusion

AT&T is a buy based on content (especially HBO) and income generation. Please perform your own due diligence before engaging a transaction.

Disclosure: I am/we are long CMCSA, T.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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