Earnings season, TMT consolidation and the threat of FAANG

The threat of technology is most acute in the TMT spaces because these are pure information industries where the Internet upends incumbent business models. So it is interesting to see how well the sector is doing during earnings season. In thinking about the longer-term, I want to focus on Verizon, AT&T and Comcast.

TMT is now a sector

The key driver in the TMT sector is the Internet and high-speed data transfers. When the original Internet bubble popped, people at sell-side firms talked a lot about technology, media and telecom or TMT as one space. But it wasn’t one space and the nascent attempts at consolidation failed, most spectacularly in the case of the AOL Time Warner merger.

Basically, the synergies in the TMT space were not robust enough to  justify the level of consolidation we are now seeing. But in the last several years, high speed Internet connections and massive amounts of cheap cloud-based have made the Internet a reliable and cheap medium to deliver information content, whether written, audio or digital. And so, a whole host of companies have formed or been transformed into competitors of the largest TMT incumbents.

This is what FAANG is all about. Because the FAANG companies already have scale and deep customer penetration, they can ramp quickly into adjacent TMT spaces and steal customers from incumbent businesses in those verticals. Mergers- both of the horizontal variety and for vertical integration – are key defensive moves for incumbent businesses to  thwart off competition from FAANG-style companies.

Google and set-top boxes

Let’s take Google for example. Google Fiber started in 2010 and was designed by the company to bring ridiculously high-speed fiber-to-the-premises service in the United States. After Google restructured to bifurcate its business lines into nascent plays and existing lines of business, Google Fiber moved over into the Alphabet suite of nascent business lines. But the experience Google has developed in search has carried over.

Just recently, I began testing Google’s OTT live TV service YouTube TV. And it’s good — really good.  What stuck out for me was the user interface, search and the DVR capabilities – all of which come from different lines of business.

On the user interface, arguably Google’s experience with Android has been useful. But Google’s Google Fiber experience has helped it understand set-top boxes very well. And so, while Google Fiber has been put on hold, the experience from that venture carries over into Google’s YouTube TV live TV interface.

On search, YouTube TV beats other live TV services I have tried –  Hulu, FuboTV, Sling, PlayStation Vue – hands down. Wouldn’t you expect this? Google is all about search.

And then on the DVR, Google has gone with an unlimited DVR functionality that is front and center in its UI — meaning I have the option of saving unlimited amounts of content for up to 9 months, pretty much as soon as the program or individual episode data screen pops up on YouTube TV. And Google gives me the option of recording an individual episode or all future shows. There’s a lot more goodness there I haven’t mentioned.

The one thing I would point out is that Google’s unlimited DVR functionality is in direct contrast to even Hulu, which limits you to 50 hours of content and charges you for the privilege of more. The reason I mention this is that it shows how a company not wedded to the incumbent business model can use its strengths to disrupt an industry. Companies like TIVO, for example, should feel threatened. And the existing live TV providers like Verizon and Comcast get a lot of money from making people pay extra for DVR functionality.

Verizon’s earnings

I think the AT&T and Verizon earnings report show why consolidation is happening in the TMT sector and will continue to happen. When you are threatened by FAANG, it pays to spread your business lines across different spaces within the TMT sector. For example, when you look at Verizon’s earnings, the standout was mobile wireless, not fixed line, business or residential.

Verizon Communications stock rose Tuesday after the telecom services provider reported second-quarter adjusted profit and revenue that topped expectations, as the company added more new wireless subscribers than expected.

The company said adjusted earnings were $1.20 a share, up 25% from a year ago, with revenue rising 4% to $32.2 billion, topping consensus estimates. A year earlier, the wireless service provider earned 96 cents a share on sales of $30.55 billion.

Analysts expected the company to report earnings of $1.14 a share on sales of $31.78 billion for the period ended June 30.

“While some of the revenue beat was due to the revenue recognition (accounting) standard, Verizon appears to also be benefiting from customers stepping up to higher-priced wireless plans and increasing average connections per account,” Wells Fargo analyst Jennifer Fritzsche said in a report to clients.

That’s why Verizon bought out Vodafone.

AT&T’s earnings

On AT&T, here’s what we see:

Despite that AT&T’s earnings and full year guidance raise, analysts remained unimpressed. Jonathan Chaplin of New Street Research said the numbers impressed because expectations were low going in.

“There’s not one piece of this business that you can look at and say it’s doing really well,” Chaplin said on CNBC’s “Closing Bell.”

AT&T has been losing subscribers to its traditional television packages as more consumers cut the cord and opt for cheaper streaming services. Subscriber growth for its DirecTV Now streaming service has continued to help offset declines in satellite subscribers and legacy service revenues. In wireless, both AT&T and Verizon have been losing shares of postpaid subscribers, or customers who pay a monthly bill, to cheaper rivals.

This quarter marks the first financial report since a district judge approved AT&T’s highly contested $85.4 billion acquisition of Time Warner in June.

Why the difference in tone?  One reason is that revenue fell 2.1% to $39 billion, missing estimates for $39.4 billion. But, more than that, AT&T is leveraged to the areas of content and content delivery under greatest threat from the FAANG companies. The message AT&T sent after the earnings announcement was about being in direct competition:

Whether it’s Netflix, Amazon, Google, Disney or Comcast, everybody is now pursuing the same thing; ‘How do you deliver great media and entertainment experiences to our customers?’

-AT&T CEO Randall Stephenson

Final thoughts

Comcast comes out on Thursday. I will be interested to see how they make out because they are even more leveraged to FAANG competition than AT&T. At least AT&T has a wireless business.

I think Verizon is making some of the best moves in this space by incumbent TMT companies. But I don’t think they can escape the downward pressure on margins in their residential business. And also think that wireless is a mature business without a whole lot of top line growth.

Overall, I expect revenue in the TMT sector to shrink because most of these businesses are mature and high-speed access means more competition and lower margins. Defensive mergers will continue to dominate headlines as incumbents try to forestall the inevitable.

On the FAANG side of things, Google is making some great moves in the TMT space that should begin to add meaningful topline revenue. I think Netflix will need to get into live TV content delivery business like Hulu if it wants to continue to grow. Amazon is always a wildcard. Apple has been slow to react and may miss its window of opportunity. I don’t see Facebook as a player here and wonder where their growth will come from.