AT&T May Have Had a Terrible Holiday Season

By Evan Niu, CFA Markets Fool.com

AT&T may soon be the new owner of HBO. Image source: HBO.

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The fourth quarter is a busy time for wireless carriers, since mobile devices like smartphones and tablets are popular gifts, in addition to the fact that many companies have major product launches in the fall. Unfortunately for AT&T (NYSE: T), it might have sat on the sidelines as rivals poached an increasing number of customers. At least that's what Cowen and Co. Equity Research thinks in a recent research note shared with FierceWireless. After surveying postpaid subscribers, the analysts noted that AT&T was the most common answer when asked which company was their previous carrier.

Ma Bell has been bleeding postpaid subscribers every quarter for the past two years, and it's largely fine with that. AT&T is decidedly trying to focus more on its most profitable customers and doesn't mind losing less profitable customers to rivals. The company lost 268,000 postpaid subscribers in the third quarter, but was still able to expand its wireless segment's EBITDA margin to hit a record 50.1%. While postpaid subscribers are generally more profitable than prepaid, many of the lost postpaid subscribers were using low-end feature phones that don't generate much in the way of data revenue.

A textbook response to "disruption"

I'm the first to say that the word "disruption" gets thrown around too much these days, and I wouldn't say what's currently happening in the domestic wireless market qualifies as disruption. It's not as if rivals are pioneering some new technology that threatens incumbents; they're just competing incredibly aggressively, and mostly on price.

That being said, it is interesting that AT&T is responding to these competitive threats in much the same way that incumbent companies do when facing potential disruption: retreating upmarket. It's almost like a textbook example. Ignoring lower-end customers is a risky strategy, though, since they contribute operating profits in absolute dollar terms, even if they dilute margins in percentage terms. More importantly, what will AT&T do when rivals come knocking for those more lucrative customers?

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The irony is that AT&T says the goal of its proposed merger withTime Warner(NYSE: TWX)is to "disrupt the existing pay TV model," yet it may be making a classical mistake with its core telecommunications business.

Bigger and better things

Instead, AT&T has been focusing more on its media ambitions. That includes both trying to grow its new over-the-top (OTT) DIRECTV Now service, which launched just a few months ago, as well as working to get its blockbuster acquisition with Time Warnerapproved by regulators and shareholders (Time Warner's special stockholder meeting to vote on the deal is scheduled for Feb. 15, 2017, and the proxy can be found here).

What potentially happens from here is rather predictable. If the deal goes through, AT&T will attempt to use various forms of content services that it owns as a way to differentiate from rivals, ideally exercising pricing power with those high-value customers. There are some ways that competitors can respond to AT&T's controversial zero-rating strategy, but there should be little doubt that AT&T will become much more powerful if the deal gets the blessings of all necessary stakeholders. So what if it loses some low-value subscribers in the process?

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Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool recommends Time Warner. The Motley Fool has a disclosure policy.