DirecTV Now margins only 1-2%, but ads and low capex will make it work, Deutsche Bank says


Answering the rhetorical question, “how small is it?,” Deutsche Bank estimates that the profit margin on AT&T’s new virtualized DirecTV Now pay-TV service is only around 1-2 percent.

“Gross margins don’t look great,” said Deutsche Bank’s Matthew Niknam in a note to investors published Monday. “A simple analysis ($35 monthly rate less estimated content costs/sub) would indicate gross margins for DirecTV Now are no higher than single-digit percentages, significantly below an estimated ~45 percent 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.”

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AT&T said it will launch its new livestreamed over-the-top pay-TV service later this month, priced at $35 a month and including more than 100 channels from leading content companies. 

While the margins for the service are substantially lower, Niknam believes there’s longer term upside in terms of enabling new ad sales businesses. 

“We believe AT&T’s foray into OTT opens up a new addressable market (cord-cutters/nevers) near-term, and helps it build its video platform of the future,” he said.

Niknam added that low set-top costs and reduced capital expenditures must also be factored into the DirecTV Now model.

“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,” Niknam said. "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."

AT&T has announced programming deals with most major suppliers, save for 21st Century Fox, CBS Corp. and AMC Networks. Niknam believes the former two -- which include broadcast networks FOX and CBS -- will be locked up by the time DirecTV Now launches. 

“We have heard conflicting reports whether FOX has signed an agreement (CEO Randall Stephenson mentioned that FOX would be included at an industry conference last month, but no formal agreement has been reported by either company). CBS and AMC are notable hold-outs; however leaked internal documents (source: Variety) show CBS on a list of included channels, and we believe both parties are still working on a deal at the present,” Niknam wrote.