"There are some very large companies soiling themselves today," T-Mobile (NASDAQ: TMUS) CEO John Legere said as he signed off a conference call announcing his company's acquisition of Layer3 TV.
Layer3 offers a streaming television service similar to AT&T's (NYSE: T) DIRECTV NOW or Dish's Sling TV. T-Mobile plans to use Layer3's technology and content contracts to launch a nationwide service sometime in 2018. Management was light on the details of the forthcoming product, repeatedly saying what it isn't going to do, but never quite saying what it will do during the conference call discussing the acquisition.
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T-Mobile is clearly going after AT&T with this move. Following the acquisition of DIRECTV, AT&T is now the nation's largest pay-TV service provider, boasting over 25 million customers. AT&T has been aggressively bundling its TV and wireless services in order to bolster subscriber numbers for both services. T-Mobile thinks it can provide better value and choice to customers with its upcoming product.
What does T-Mobile bring to the table?
Layer3 TV is currently confined to a handful of U.S. cities, and T-Mobile wants to bring its technology nationwide. Supporting those efforts is T-Mobile's brand, in which it's built a ton of equity over the last five years or so. T-Mobile also has the necessary infrastructure to support a nationwide service -- 16,000 retail locations and over 70 million pre-existing customers.
What's more, T-Mobile is interacting with and selling to its customers on a regular basis. It sells tens of millions of new devices every quarter, presenting opportunities to educate and sell a TV service.
T-Mobile also offers a nationwide wireless broadband service. While customers can stream T-Mobile's planned product over any internet connection, changes in net neutrality rules could cause some hiccups on third-party internet providers.
But that's no different than AT&T or Verizon Communications (NYSE: VZ), the latter of which plans to launch a similar streaming TV platform next year as well. In fact, both have more customers than T-Mobile.
AT&T has proven the strategy is viable, amassing over 1 million subscribers for DIRECTV Now in about one year. AT&T's success has come at the cost of its traditional pay-TV products, but AT&T says it's not a cannibalistic product. T-Mobile isn't attached to a legacy video product like AT&T or Verizon, so if the strategy works as it does for AT&T, it should be able to scale the product relatively quickly.
What do the economics look like?
T-Mobile doesn't plan to make any changes to its outlook for 45% to 48% compound annual growth in free cash flow from 2017 to 2019. In other words, it expects the operations of its TV service to be cash flow neutral during the first couple years, or it will otherwise find a way to make the capital spending fit into its framework.
By comparison, DIRECTV Now appears to be a big loss leader for AT&T, especially when bundled with its wireless service. The entertainment division at AT&T is seeing declines in EBITDA and EBITDA margin as a result.
There are several other platforms streaming TV over the internet with razor-thin margins or who are possibly taking a loss. Sling TV's $20 per month plan includes ESPN and ESPN 2, which might account for almost half the consumer price alone. YouTube launched a $35 per month TV service filled with expensive sports programming as well, hoping to make a profit with superior ad targeting. Each service is attached to a parent company that can support its capital intensive operations.
T-Mobile plans to offer a low-priced option, but management says it's most focused on delivering the best value to customers. That leaves room for higher-priced services aimed more at traditional pay-TV services. That's a much larger market, with nearly 100 million households subscribing to cable or satellite television (compared to about 4 million for over-the-top streaming TV). T-Mobile notes 40 million of those households have separate internet and TV service providers, and those are the low-hanging fruit for its service, which it can bundle with wireless.
That's where T-Mobile hopes to make the economics of its television service work. Not necessarily on the low end, but with a value play that can win over customers from traditional pay TV. That just so happens to be one of AT&T's biggest customer bases.
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