AT&T Is Doubling Down on the Bundle

AT&T (NYSE: T) surprised Wall Street when it reported 329,000 postpaid phone net additions in the fourth quarter. Management says it owes a large part of that number to its record low fourth-quarter postpaid phone churn of 0.89%. Moreover, that low churn is the result of its bundling strategy, packaging wireless and video together to save customers money.

CFO John Stephens says AT&T added over 700,000 phone customers who bundled their wireless service with video in the fourth quarter. That seems to be primarily driven by AT&T's offer to save customers $25 on DIRECTV Now for Unlimited Choice subscribers. DIRECTV Now subscribers grew by 368,000 in the quarter, its best quarter yet.

"We believe very strongly that combining video with our mobile product is a really important element, and you will see us continue to do that," CEO Randall Stephenson said on AT&T's fourth-quarter earnings call. In fact, with increased competition from T-Mobile (NASDAQ: TMUS), Sprint (NYSE: S), and Verizon Communications (NYSE: VZ), Stephenson says the company will "probably take it to new and different levels."

Everybody wants to bundle

AT&T isn't the only carrier looking to bundle its wireless service with a video service. Both T-Mobile and Sprint introduced their own bundles last fall. T-Mobile One subscribers now get free access to Netflix, and Sprint's unlimited customers get Hulu. Verizon is actually the only major carrier that doesn't include a free streaming service subscription with its wireless service. AT&T subscribers get free HBO.

Stephenson says the moves by T-Mobile and Sprint are "an indication that [AT&T's] having success."

The benefits of the bundle are clear. AT&T's management says it's the second-biggest driver of customer retention after customer satisfaction. T-Mobile CFO Braxton Carter explained, "To the extent that you can bundle more in, the retention characteristics in a multibundle situation are very different versus a single-product situation." And that's shown up in churn rates across the board, not just for AT&T and not just in wireless.

AT&T is also bundling its home internet service with video and seeing positive retention results. DIRECTV satellite subscribers that also subscribe to AT&T's Fiber internet service churn at half the rate of those that don't bundle. As Fiber rolls out to more markets, AT&T has an opportunity to win more subscribers through bundling.

Impact on margins

Management is very upbeat about the profit potential from bundling. "Bundling allows us to have profitability from that combined account," Stephens said on the earnings call. "It also creates higher value, lifetime value, for each of those customers." While the customers might be profitable, they're not as profitable as they once were.

EBITDA margin for AT&T's entertainment group, which includes its home internet and television businesses, fell 170 basis points to 19.1%. That may be due in large part to the influx of DIRECTV Now subscribers taking advantage of AT&T's generous $25 off bundle. AT&T notably changed the discount to $15 in the middle of the quarter.

Meanwhile, AT&T's consumer mobility segment suffered a similar drop in EBITDA margin as service revenue continues to decline. Management says it expects service revenue growth to turn positive at some point this year on the back of improved subscriber retention.

AT&T's shrinking margins don't compare well to Verizon's, which saw EBITDA margin improve nearly 3 percentage points last quarter. And remember, Verizon isn't using a bundling strategy. (Verizon also produced lower churn than AT&T.)

So while the bundling strategy appears to be working in adding additional subscribers, those subscribers are less profitable than they once were. Of course, it's much better than losing subscribers and not growing at all.

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Adam Levy owns shares of Verizon Communications. The Motley Fool owns shares of and recommends Verizon Communications. The Motley Fool recommends T-Mobile US. The Motley Fool has a disclosure policy.