This chart shows how tiny the margins will be on AT&T's new $35 streaming TV service
Harry Hamburg/APLast month, AT&T shocked the industry by announcing that the monthly price for its new streaming TV service, DirecTV Now, would be just $35.
Why was that so surprising?
Because for that price, when DirecTV Now comes out this month, it will give you 100+ channels - delivered over the internet, no cable box or satellite dish required. It's your big pay-TV bundle with its price chopped down.
It's a gamble for AT&T.
AT&T reportedly thinks that DirecTV Now will be its primary TV platform by 2020. That's likely why its willing to give up an insane amount of its profit margin to try and get out ahead of a shift toward "streaming" TV (and away from cable and satellite).
While the deals AT&T makes with networks won't be less expensive, AT&T says one way it will improve the margins on DirecTV Now is by ditching legacy equipment like satellite dishes, and drastically decreasing its customer acquisition costs.
Still, the company has said the margins will shrink. At a recent Goldman Sachs conference, CEO Randall Stephenson said DirecTV Now will have "thinner" margins than the company's current pay-TV products, but not "thin" ones. "This is a very, very low-cost customer acquisition product," he said.
But exactly does Stephenson mean by thinner?
An analyst note from Deutsche Bank's Matthew Niknam, distributed Monday, puts that into perspective.
"Gross margins don't look great," he wrote. "A simple analysis ($35 monthly rate less estimated content costs/sub) would indicate gross margins for DTV Now are no higher than single-digit percentages, significantly below an estimated ~45% for the traditional video business. But, we also believe this may be underestimating the potential for advertising revenues, which could add another ~$5/month in ARPU. With that in mind, the DTV Now (OTT) gross margin improves modestly to the high-teens, but is still less than half of traditional linear video."
Here is a chart from Deutsche Bank that shows how DirecTV Now will likely compare to linear TV:
Deutsche Bank points out, however, that when considering DirecTV Now through the lens of a return on investment, it starts to look a bit sweeter financially.
"Despite the (estimated) gross profit margins of DTV Now coming in less than half of traditional video, we believe the product screens relatively better on a return on capital perspective, as it does not require the very costly upfront spend tied to truck rolls, tech. labor, and set-top boxes at the customers' premise," Deutsche Bank wrote. "Similar to other OTT products, sign up and activation are a relatively simple (and capital efficient) process, also (likely) eliminating the need for multi-year contracts (as is often the case with traditional video) to lock in customers."
So Deutsche Bank, at least in part, agrees with Stephenson: Cutting out the legacy hardware will save AT&T some money and allow a faster clip of customer acquisition.
How many new customers are we talking about?
A recent report from MoffettNathanson estimated that DirecTV Now could snag 11 million subscribers eventually. Here's the potential breakdown: 2 million cannibalized from DirecTV, 6 million from other pay TV, and 3 million "cord-cutters."
Using competitor Sling TV's rollout as a barometer, Deutsche Bank notes that DirecTV Now could get 650,000 subscribers by the end of 2017. And DirecTV Now has several advantages over Sling in gaining new customers, including its nationwide retail distribution (for wireless) and a lower price point for the amount of channels.