How the WarnerMedia and Discovery merger will impact streaming

Morningstar Analyst Michael Hodel joins Yahoo Finance Live to discuss the state of streaming following the announcement to merge WarnerMedia and Discovery.

Video transcript

AKIKO FUJITA: Welcome back to Yahoo Finance Live. We are continuing to watch some of those trading names in this session one day after the big merger announcement between WarnerMedia and Discovery. Netflix, Amazon, Disney all trading higher. Comcast lower, though. That's one of those names that's been speculated about whether, in fact, this new deal is likely to force their hand into, uh, being a bit more aggressive on the content side as well. Amazon-- of course, we got that announcement or at least those reports this morning that suggest they may be looking to acquire MGM.

Let's bring in Michael Hodel. He's the analyst for Morningstar. Michael, it's been a busy few days for you, I imagine. But, you know, as we look to the headline today at least in terms of Amazon potentially being interested in MGM, is this the kind of move that you think is likely to be accelerated as a result of, uh, AT&T's moves as well as Discovery?

MICHAEL HODEL: Yeah. I think so. I think that the firms that own content, that produce content are realizing that they need to have a solidified position for reaching consumers directly. And so if you have maybe a hole in your content lineup, you're going to be looking for ways to fill that. I think that's a big piece, uh, behind the WarnerMedia and Discovery deal that we saw yesterday is the two firms complement each other reasonably well, um, on the scripted and non-scripted side of the business.

You mentioned earlier that Comcast might be interested in coming into the marketplace as well, participating in some of this M&A activity. We've long thought that Comcast and WarnerMedia would-- or NBC Universal within Comcast would fit together really nicely but a few pieces that would have to be spun off to meet regulatory approval but that the two companies would complement each other really well. So, you know, we don't think it's highly likely that Comcast will get into a bidding war here for WarnerMedia. But it's a possibility that I don't think you can rule out that as these players look to move pieces around to ensure that they have the reach that they need to build a platform for the long term, that these firms might start to look in more places.

ZACK GUZMAN: And Michael, I mean, we're all seeing AT&T shares down today, under pressure here as we kinda dig into maybe the impact of them cutting their dividend down. I mean, what do you make of that and the way that that was kind of, uh-- you know, it took a while for, I guess, the market to focus in on it. But what do you make of the reaction here as we're seeing it in day two of digesting the news?

MICHAEL HODEL: Yeah. I think the reaction is understandable. There's a large percentage of AT&T shareholders who are in the stock for the dividend, and AT&T has defended that dividend until yesterday, essentially. As recently as our analysts day in March, saying that they were committed to a stable dividend. So I can understand that a large percentage of investors would be disappointed and wanted to exit the stock at this point.

But from our perspective, the dividend cut's actually the right move for the company. I think when you look back over the last five or six years, one of the real disappointments for AT&T is that they haven't been able to defend the stock. They issued a lot of shares to buy DirecTV and then Time Warner, which increased their dividend commitment. In the process, they also added a lot of debt to the balance sheet that made the debtholders and even shareholders uncomfortable with the level of leverage on the company.

And so the firm's ability to come in and defend the stock when the yield on its shares pushed up into the 6% or 7% range was very limited. They did do a buyback at the start of 2020 but had to shut that down when the pandemic started. So I think that by pulling back on the dividend, prioritizing the balance sheet a little bit more even than they have over the last couple of years, and giving the firm some financial flexibility, they'll have the ability to have a much more solid foundation for the next decade or two decades to invest in the business where they see opportunities and also to defend the stock if it sells off and the yield on the shares starts to push back up and into the, you know, 5%, 6% , 7% range, and it becomes very clear that they can improve their cost of capital by borrowing rather than issuing shares.

AKIKO FUJITA: Michael, it's been a span of few weeks. We have seen Verizon, our parent company, unwind their content business, and now you've got AT&T doing the same. I mean, it felt like for a while there was this, um, betting on, essentially, you know, be able to increase their reach for digital ads by building out the content. I mean, is that-- you know, maybe not fair to call them experiment. But do you think that the verdict is already out that that partnership simply doesn't work because of the expensive proposition on both sides, the telco side as well as the content side?

MICHAEL HODEL: Yeah. I think there's a lot of reasons why-- excuse me-- why content and distribution don't marry up all that well. A big part of it is on the regulatory side. I think your ability to draw information from the telecom side or the-- or cable network side and use that information to better target ads is very limited. If a Verizon or an AT&T try to do that to improve their ad targeting by pulling information from their wireless business or their broadband business, I think you'd quickly have public outcry. You'd have regulators stepping in and really questioning that move. And so I think it's really difficult to find an informational advantage for putting the two [INAUDIBLE], the content side and the distribution side, together.

But even strategically, you look at what AT&T is doing with WarnerMedia. I think it makes a lot of sense to spin WarnerMedia out because over the last couple of years, as AT&T has tried to build up HBO Max, they've really focused on the AT&T wireless customer base.

By separating out HBO from AT&T, now HBO is free to go seek partnerships as widely as possible so they can build as wide of a platform and as wide of an audience for HBO Max as they possibly can, which then has the-- the impact of bringing in the best content creators. If you don't have the ability to reach a wide audience, you're not going to attract the best content creators. So I just think strategically it makes a lot of sense to spin the media business out of the core distribution business, separating Warner Media from AT&T.

ZACK GUZMAN: Yeah. And, Michael, I mean, I guess yesterday we were having this conversation about people out there topping out at maybe four streaming services that they would want to pay for. If you kinda believe that, I imagine-- if you look at the competitive landscape right now, who's on the outside looking in here?

If things are getting scooped up as rapidly as this, two back-to-back deals here potentially in this space, I would assume that that puts pressure on Apple here to get their act together maybe on scaling things up. Who has the most pressure facing them now?

MICHAEL HODEL: Yeah. I-- I don't know necessarily that I would agree with the contention that there's only going to be four streaming services long term. I think there's still a lot of, uh, consumer preference that's yet to be established.

You bring up Apple. I think Apple's in an interesting position. They've dabbled in content creation, but they also have a great media aggregation device with Apple TV, so maybe you could see Apple trying to create a wrapper type service of becoming more content agnostic and bringing a wide variety of streaming services together, you know, almost like reaggregating the bundle. That's a possible way that Apple could approach the market that would then help the more fringe content creators find an audience.

But I do think that your premise that there's going to be a handful of dominant platforms is right. And you look at-- obviously, Netflix is the runaway lead right now. And Disney Plus, you know, disappointing numbers recently but still doing very well in terms of building up their base. And HBO Max we think has done a great job too of capitalizing where they can in the pandemic and bringing movies onto that platform to really broaden the appeal of it and bring people in. Is doing a great job too.

So then outside of those three platforms, I don't think there's really any consensus or a clear-cut number four player. Maybe Amazon but, you know, Amazon's-- they-- they're such a behemoth. They can do whatever they want. If they choose to push even deeper into content, they could do that. I view them more as a wildcard, uh, in the platform war.

AKIKO FUJITA: And, Michael, finally, where does this leave somebody like a Facebook or Google? I mean, you talk about why these telcos got into the content business in the first place. The reality is Google and Facebook dominate the digital ad space. Do you see them looking to seek out in many ways to beef up content more aggressively?

MICHAEL HODEL: You know, I don't know if they necessarily need to beef up their content. I think if you look at what Google is doing with YouTube TV and the YouTube platform, really trying to find ways of bringing tools for advertisers to reach audiences wherever those audiences happen to be. I think that's the best strategy for Google going forward more so than trying to push into content.

You know, Google did start to push a little bit into content, and they've pulled back on that. So I think that's the right approach where you're just trying to build the advertising tools to help people that are trying to get a message out, reach audiences wherever they can find them. I think that makes the most sense, um, when you have already dominant positions in digital advertising like they do.

AKIKO FUJITA: Michael Hodel, Morningstar analyst. Good to talk to you today. Thanks so much for your time.