Has DirecTV Now Become a Loss Leader to Help Sell the AT&T-Time Warner Merger?

They called it a game-changer. DirecTV Now, AT&T’s virtual pay TV package, was billed by executives as a cure for cord-cutting and an enticement for the cord-never crowd. But there were doubts as to just how game-changing a 100-plus package of channels could be: Analysts initially estimated DirecTV Now would cost anywhere from $50 to $70 when it hit the market.

On Monday, AT&T chairman-CEO Randall Stephenson, while on the stump for his proposed $85 billion acquisition of Time Warner, announced DirecTV Now’s package of Internet-delivered streaming channels will be offered for just $35 a month when it launches in November.

What happened? It’s probably not coincidental that DirecTV Now, with its consumer-friendly price tag, is set to arrive just as AT&T starts the process of persuading federal regulators to approve one of the largest media mergers in history. The pricing strategy prompted industry analysts Craig Moffett and Michael Nathanson to crunch the numbers and estimate that the profit margin for AT&T would probably be all of $1 per subscriber. That’s a far cry from the estimated $60 that the satcaster makes on its traditional subscribers.

Not that prospective subscribers are likely to care about AT&T’s profit margin. If the language on directvnow.com is anything to go by, the company is going hard after the Generation Y cohort with DirecTV Now. The site promises to “hit you up later with the deets” for “TV beyond your wildest dreams” if you provide your email address to receive more information.

Currently included in the package are channels from: Disney, NBC Universal, HBO, Turner, AMC Networks, Viacom, Scripps, Starz and A+E Networks. Not officially on board yet, though sources say deals are very close to being done: Fox and CBS, which recently made a carriage deal with Google and YouTube for another planned virtual bundle.

Related Content How AT&T-Time Warner Could Usher in a New Era of Megamergers

A big bundle for $35 per month is an impressive price point considering the other products on the market. PlayStation Vue’s similar 100-channel package, for instance, costs $55 per month (on sale from $65). It also means other  entrants into the live TV arena like Hulu and YouTube will have to find a way to compete with that price point. The way for them may simply be by offering a better user experience, or finding a way to undercut AT&T on price.

“We’ve taken an approach to OTT that isn’t ‘skinny’ but does address the obstacles consumers are facing with pay TV,” Tony Goncalves, AT&T’s senior VP of strategy and business development, told Variety.

One feature DirecTV Now’s virtual pay TV competitors won’t have is the ability to bundle Internet and cell service with their TV package. Even Dish’s Sling doesn’t have that advantage.

And so one of AT&T’s big selling points for DirecTV Now is that it’s an easy bolt-on to your AT&T cell or Internet service. While the streaming experience for a lot of Americans can still be touch-and-go, live streaming architects say that, from a stream quality perspective, there is some benefit to owning more of the networks you’re sending data through. It’s also not hard to see why being able to fill your tele-needs (-communications and -vision) with one provider would be attractive to customers.

Streaming video uses an awful lot of bandwidth, though, and the days of limitless data are long gone for everyone who isn’t a T-Mobile customer. AT&T could make a DirecTV Now subscription more attractive by not counting DirecTV Now streaming against any data caps if you’re an AT&T Internet or wireless subscriber, and that’s what the company plans to do.

But in a note to investors Monday, Moffett and Nathanson dismissed the idea of DirecTV Now being “zero-rated” — that is, of data used to stream DirecTV Now not counting against a data cap if the person streaming is an AT&T Wireless or Internet customer. “The FCC’s Net Neutrality rules ban preferential treatment of owned content,” the two wrote. “One can safely assume these prohibitions would apply even if the (AT&T-Time Warner merger) successfully avoids FCC review and therefore deal-specific FCC behavioral remedies,” he said.

This all gets into the still-thorny issue of net neutrality. Bits from other streaming services flowing through AT&T’s network have to be treated the same as bits owned by AT&T. So if AT&T wants DirecTV Now or HBO Now usage not to count against its data cap, it has to extend the same courtesy to the likes of Netflix and Hulu and Amazon. And it will, AT&T says — but other companies typically have to pay to participate in this kind of zero-rating program from providers.

The issue of whether the FCC will in fact review the AT&T-Time Warner deal remains unresolved, though it’s likely that some regulator body will seek to impose restrictions of some kind on the merger, and a tougher stance on zero-rating could be one of the results.

Other than the net neutrality issue, the potential merger doesn’t seem to affect DirecTV Now. AT&T had always planned on bundling its wireless and Internet service with the product. Time Warner’s HBO has always been a premium channel offered as an add-on to an MVPD packages (generally with a free month tossed in by the provider), and Turner had already signed on to be part of DirecTV Now long before the overall AT&T-Time Warner deal was done.

But how will AT&T be able to offer so many channels at such a low price? MoffettNathanson broke the numbers down in another note to investors Wednesday morning and came to the conclusion that it could only do so by taking a loss.

And cannibalization might be a bigger problem with such a low price. The MoffettNathanson report also estimated that DirecTV Now could draw about 11 million subscribers. About 2 million of those would come from DirecTV, resulting in a chunk of missing revenue, given the possibly large profit gulf between DirecTV and DirecTV Now customers. Another 6 million could be siphoned away from more traditional pay TV providers, with the last 3 million coming from the cord-cutter/cord-never segment of the population.

That’s a healthy number of customers, but the question of whether AT&T will actually make money with DirecTV Now still looms large. It could be seen as a loss leader to help demonstrate AT&T’s consumer-friendly intentions, or it could be an effort for the telco to grab market share in the emerging market for virtual MVPD packages. Either way, it’s a risky bet. As Moffett and Nathanson observed on Wednesday, “Running with scissors might be dangerous… but it probably won’t kill you.”

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