U-verse is the Regulatory Key to the Proposed AT&T/DIRECTV Merger

AT&T ‘s proposed $48 billion acquisition of DIRECTV is based on two simple business facts – 1) AT&T has broadband but needs a stronger video product to compete with cable; and 2) DIRERCTV needs a voice and broadband product to compete with cable. By combining services the can save money on customer service, back office and an estimated $1.6 billion in annual programming costs. On the surface, it seems like a merger that will create a stronger competitor to cable systems everywhere. So what’s the regulatory concern?

The first issue is that AT&T has a video offering with its U-Verse service. U-verse is a state of the art high-end fiber to the node (FTTN) service that also offers video, much like Verizon’s FiOS. Thus in markets where U-verse operates, video competition will be reduced. But this is not an insurmountable hurdle.

AT&T/DIRECTV will argue that consumers will still have two other options in those markets – DISH and the local cable company, not to mention OTT services such as Netflix, Hulu and Amazon Prime. Moreover, mobile broadband speeds are approaching the point where they will be able to offer a competitive video service in the foreseeable future.  In necessary, AT&T could also a third party to market U-verse to ensure it competes with DIRECTV – much in the way Time Warner allowed Road Runner to market its internet service after the AOL merger.

The second issue is that content providers will likely object on the grounds the combined entity will have disproportionate buying power. But we don’t believe this will be a significant regulatory issue. The buying power of the combine entities is roughly 26 million homes. This is well below the 30% informal market share screen used for identifying disproportionate media buying power. And it’s certainly well below the buying power of a combined Comcast/Time Warner merger.

The third and largest hurdle to FCC approval is the FCC’s analysis of merger’s medium to longer-term impact on broadband deployment in the US.  And this issue is far more complicated.  This is because building out U-verse is very expensive. The current U-verse business model is dependent on a combination of revenue from voice, video and data subscriptions. In many areas AT&T cannot justify it even with these three revenue streams that total an average approximately $106 per month. If AT&T acquires DIRECTV, they would be able to get video subscribers from DIRECTV, a much more economical system for video broadcasting.  U-verse would lose the video revenue stream and it would be harder to justify additional U-verse build-out. Moreover, any additional build-out might be done cheaper and with less capacity as it would not need to offer speeds sufficient to support a robust video offering. AT&T’s ability to save on these U-verse capital expenditures is undoubtedly one of the primary benefits of the merger. But it’s also one of the potential problems from the FCC’s perspective.

The FCC’s mission, to a large part, is to facilitate the deployment and adoption of advanced communications services. But if AT&T acquires DIRECTV and is incentivized to slow U-verse build-out, that goal is undermined.  And it is significant. U-verse uses the most advanced communication technology and is run by one of the country’s largest telecom behemoths. This is at a time when the FCC is already on the defensive due to a perception that landline Internet speeds in the US are slower than other countries and putting the country and an economic disadvantage. Moreover, if the FCC approves an AT&T/DIRECTV merger, they will be hard pressed to deny a merger between DISH and Verizon, potentially creating an opportunity for them to reduce investment in their FiOS system. A slowdown of U-verse deployment, not to mention a slowdown of FiOS deployment, would put a massive dent in the country’s broadband growth. Is this what the FCC Commissioners want to see happening on their watch?

For the AT&T/DIRECTV merger to succeed, it likely will need to offer significant evidence that it will not slow its investment in new broadband deployment, particularly U-verse.  AT&T is emphasizing its potential savings on programming savings when, the regulators’ eyes are going to be on the potential CapX savings that could slow the country’s broadband deployment.