AT&T (T) recently announced a mammoth plan to combine its content unit ‘WarnerMedia’, with Discovery Inc. Warner Media includes marquee television channels like HBO, CNN and Warner Bros, while Discovery Inc. includes the world famous Animal planet, TLC, and Discovery Channel. This $43 billion merger paves way for one of Hollywood’s biggest studios to compete with media giants like Netflix (NFLX) and Disney(DIS). According to the financial times report, this deal would create a new business (separate from AT&T) that is likely to be valued at $150bn including debt of the combined companies.

Deal Structure: Discovery +WarnerMedia

Strategy of the merger: To be able to invest in more original content for streaming services and enhance programming options across global linear pay TV and broadcast channels. 

Details about the merger:

• AT&T (T) to spin out its media business WarnerMedia to merge into Discovery (DISCA) via dividend or an exchange offer or a combination of both.
• Discovery to contribute 100% of its business.
• AT&T will receive $43bn in combination of cash, debt securities and WarnerMedia’s retention of certain debt. 
• AT&T shareholders would receive stock representing 71% of the new company while Discovery shareholders would own 29% of common equity.
• Transaction expected to be tax-free to AT&T and its shareholders.
• The deal is expected to close in the middle of 2022.
• Discovery President and CEO David Zaslav will be the new CEO of the merged company  consisting of 13 board members (7 appointed by AT&T and 6 members from Discovery)

The Takeaway (post merger)

• New business to be valued at $150bn including the debt.
• HBO and HBO Max together contribute around 64 million subscribers worldwide while Discovery adds about 15 million paid subscribers.   
• AT&T and Discovery combined have already spent a $20 bn per year on content (more than Netflix’s $17bn per year)
• The new company has a goal to reach up to 400 million streaming subscribers across the world from the current 80 million subscribers.
• HBO Max plans to launch a cheaper ad-supported version of its services in the coming weeks which is likely to attract more subscriptions at lower monthly plans and Discovery + already offers an ad-supported version to its viewers.
• The New Company is likely to have an estimated combined revenues of $43.8bn in 2021 going up to $52bn in 2023.
• Revenues from Linear segment are likely to contribute to over 50% of the overall 2021 revenues at $22.3bn 
• While the Direct-to-Consumer (DTC) segment and the content segments add in $10.2bn and $15.2bn respectively to the overall combined company’s estimated revenues for 2021.  

Exhibit 1: Post-merger estimated revenues of the Combined Company (2021-2023e)

Data as on 18 May/Source: Company Financials, Credit Suisse estimates

Netflix sees its subscribers slipping away to competitors although continuing to be a major streamer

An established player, Netflix, still dominates the streaming services sector with over 200 million subscriber base globally. Amazon and Disney+ add up to the top three streamers. With WarnerMedia and Discovery making this giant merger, this combination could make it to the “Big 4”.  While Netflix still holds majority market share in the Subscription Video on Demand (SVOD) realm, the company is now steadily losing portions of its market share to its competitors. Their subscriber slip started in the year 2020 itself, when Netflix faced fresh competition with the rise of newcomers like HBO max and Peacock.

Exhibit 2: User Subscriptions of streaming companies

Data as on May 2021, Source: Company Financials 

Additionally, Discovery has radically shifted from a low bar relative to niche streaming to now a full media conglomerate trying to take on bigger rivals like Netflix in the race to global subscription streaming. It is clear that post the merger if HBO Max in combination with Discovery + focuses on media pure play with the ability to produce high quality content, it is likely to succeed in the global streaming business.

Exhibit 3: Market share of top Streaming Companies (Jan-March 2021)

Data as on April 2021, Source: JustWatch.com

What does this merger mean to the AT&T investors?

AT&T is known to pay good dividends to its shareholders; however it’s likely to “reset” the dividends once the deal goes through. It plans to lower the dividend payout ratio from 60% to around 40%-43% (Which is a percentage of net income paid to shareholders in dividends) based on an annual free cash flow of about $20bn. Technically, this implies less of an immediate payout to shareholders. However, this deal is likely to free up money for AT&T to invest in 5G and its other broadband initiatives, which will contribute to long term growth of AT&T and its investors.

In Conclusion:

Post the merger, the new company is likely to differentiate itself from top streaming services like Disney+ and Netflix by offering a combination of both news and sports on top of its entertainment properties which will see an increase in its customer base and market share in the streaming realm.