AT&T/Discovery deal highlights companies’ focus on 5G, streaming

AT&T’s planned spinoff of WarnerMedia into a new company that will merge with Discovery in 2022 illustrates how heightened competition and secular trends accelerated by the coronavirus pandemic are driving growth investments in 5G infrastructure and streaming, says Fitch Ratings. Media companies are aggregating content via M&A to create more formidable competitors in fast-growing direct-to-consumer (DTC) streaming services, while telecommunication (telecom) companies are investing heavily to strengthen wireless technology and high-speed internet access.

Fitch affirmed AT&T’s (BBB+/Stable) and Discovery’s (BBB-/Stable) ratings after the WarnerMedia transaction was announced. Credit ratings of issuers in telecom and media incorporate the effects investments have on financial and business profiles. Cash flow for these sectors is generally solid and expected to improve in 2021, supporting capital allocation decisions for most issuers. If M&A increases leverage and issuers exhibit a willingness to prioritize debt reduction over shareholder returns, until leverage declines to a level consistent with ratings, ratings could be affirmed.

Discovery’s leverage will increase significantly due to the transaction but the merger will result in substantially greater scale and distribution platforms as it creates the world’s second-largest media company, behind Disney (A-/Stable). Moreover, Fitch expects the company to use FCF to pre-pay debt so leverage declines below Fitch’s negative rating trigger within 18 months of the transaction’s projected July 2022 closing.

Scale and content investment are critical components of media companies’ long-term viability and DTC platforms will play a large role. Media M&A may continue as companies look to diversify, rebalance or consolidate assets. Discovery’s merger with WarnerMedia will provide a more diversified portfolio of intellectual property and distribution platforms to better compete against Netflix, Disney, NBCUniversal (A-/Stable) and ViacomCBS (BBB/Stable). The combined entity, however, will still trail Netflix and Disney+ in terms of subscribers, with an estimated 35 million DTC subscribers as of March 31. Netflix had 208 million and Disney+ 104 million as of the same time period.

For AT&T, the spinoff will facilitate deleveraging, given an expected $43 billion of debt relief and a lower dividend, and will refocus AT&T on its core competencies of wireless and wireline communications. Fitch downgraded AT&T in March, due to increased leverage stemming in part from borrowings to fund C-Band spectrum bids.

The convergence of telecom and media assets due to changing media consumption patterns and alternative distribution platforms is no longer a strategic focus for some telecom companies and those that acquired media assets are divesting them. AT&T acquired DirecTV in 2015 and Time Warner in 2018. AT&T announced the formation of New DIRECTV in a shared-control venture with TPG Capital in February, prior to its announcement about WarnerMedia.

Verizon (A-/Stable) recently announced an agreement to sell its media businesses to Apollo for $5 billion. The divestiture should be slightly deleveraging, given Verizon’s commitment to deploy excess cash flow towards debt reduction. Verizon increased debt materially in late 2020 and early 2021 to help fund more than $45 billion in C-Band spectrum bids. Telecom companies bid more than $80 billion in the auction to enhance 5G coverage and data capacity.

Comcast (A-/Stable) maintains a large media business facing industry-wide threats. The pandemic disrupted film and television content production and NBC Universal’s linear cable network bundle is secularly challenged due to cord cutting and DTC streaming competition. Comcast continues to build out its DTC offerings.

The secular trends accelerated by the pandemic that are now influencing investment strategies include work-from-home and demand for home-based entertainment, which increased demand for reliable high-speed internet access. Subscriptions for streaming services were already growing but reached a record during the pandemic. Fitch Ratings