Does Verizon need DirecTV if AT&T buys EchoStar

Implications: Verizon’s FiOS price increase and AT&T’s EchoStar bid imply that Verizon might need to acquire DirecTV for the following reasons: 1) Margin on basic video, 2) Low penetration, 3) High capex.

Analysis: Verizon’s 12% price increase on basic FiOS television service could indicate the problems of low penetration and high marketing costs for customer acquisition.  Verizon is facing similar issues that motivate AT&T to consider acquiring EchoStar.  When AT&T attained 100,000 U-verse subscribers for its IPTV, the fiber-to-the-node (FTTN) network had 5 million homes passed for a penetration rate of only 2%.  For the third quarter of 2007, Verizon announced 202,000 net new FiOS TV customers for a total of 717,000 total FiOS TV customers.  At the same time, Verizon stated that it had gained 229,000 net new FiOS Internet customers for a base of 1.3 million total FiOS Internet subscribers.  To cover the content and marketing costs of television, Verizon needs more Internet access users to be bundled with TV service.
The FiOS Internet customers have value to Verizon because of the high margin and low cost of acquisition.  And in the long term, Verizon has savings from the fiber-to-the-premises (FTTP) compared to maintaining the copper-wire network.  Verizon estimates that for the $22.9 billion FTTP build out, the savings on the copper-wire services are $4.9 billion. In comparison, FiOS for TV has the higher costs of acquisition and content.
The net $18 billion FTTP capex has to be justified with television subscribers instead of Internet users who probably would order DSL anyway.  Verizon has either to promote the bundle of TV and Internet access or create an efficient strategy to compete for the standalone TV subscriber.  Comcast and Time Warner have declined in the net additions of standalone TV service but increased the bundled Internet access subscribers.  Verizon’s increase of the basic TV package from $42.99 to $47.99 might drive more bundled sales.  The higher price could also increase churn and worsen the problem of competing for standalone TV service.  Verizon has about 800,000 DirecTV subscribers from co-marketing bundled services.  DirecTV had a third quarter of 2007 with a 45% increase in net additions from a year-ago for a total base of 16.6 million subscribers.  The additions are coming from the lost basic video subscribers of Comcast, Time Warner Cable and Mediacom.  Verizon acquiring DirecTV could be a strategy to competing for basic video service at a low cost, and allow FiOS to be a profitable venture for high value customers of premium bundled Internet and TV.