AT&T (T) reports its first quarterly results including DirecTV this week. We think the cost synergies management expects to generate from the deal over the next three years are reasonable – greater negotiating power to buy content at cheaper rates, marketing synergies, more concentrated truck-rolls to service customers, supply chain benefits from set-top boxes, less SG&A redundancies, and more.

With wireless and pay-TV markets looking saturated, buying more subscribers via acquisition and taking out costs is a logical strategy to further enhance market share and free cash flow generation. However, we believe T’s large move into pay-TV trades near-term synergies for greater long-term strategic uncertainty.

Dividend investors only concerned with the safety of T’s 5.6% dividend yield do not need to worry, but we believe the DirecTV acquisition creates an extra layer of uncertainty with regards to T’s long-term total return potential. With that said, the business is still very stable and T’s status as one of the 52 S&P Dividend Aristocrats remains very secure.

Business Overview

Prior to its acquisition of DirecTV, T’s business was fairly balanced between wireless and wireline operations. In fiscal year 2014, wireless accounted for 56% of its sales and 75% of its income (low-to-mid 20% operating margin). Wireline made up the remainder of the business. Following its $49 billion purchase of DirecTV, which gained approval earlier this year, T became the largest pay-TV company in the United States. Altogether, T has close to 75 million wireless voice/data subscribers, around 28 million pay-TV subscribers, and over 15 million broadband internet subscribers.

No company has ever had as many subscribers across each service line as T now does, which the company hopes will give it advantages in negotiating costs for TV content, selling its various services via price-effective bundles (internet, TV, and mobile on one bill), realizing cost synergies (e.g. advertising, consolidated headquarters), and more. Essentially, T hopes that its ability to provide customers with their video, data, and information needs anytime, anywhere, and on any device will be enough differentiation to drive its next leg of growth.

Unlike T, VZ is maintaining its focus on its wireless network assets, which generate almost all of its profits. However, both companies are looking to capitalize on the rapid growth of video services. Rather than make a large acquisition, VZ has instead invested several hundred million dollars and acquired AOL for $4.4 billion to build its own over-the-top mobile video services, called go90. Despite the heightened competition rippling through the saturated wireless industry, VZ remains one of our favorite income stocks in our Top 20 Dividend Stocks list.

While the telecom industry will continue to generate stable cash flows for years to come, increasingly saturated markets and emerging competition from non-traditional competitors like Netflix, Amazon, Google, and Apple are slowly changing the way T and VZ must play the game. Let’s take a look at the industry.

Business Analysis

With T’s acquisition of DirecTV, analyzing T now requires an understanding of the wireless, pay-TV, and broadband markets. Each of these markets carries substantial barriers to entry and is generally more concentrated than most other industries as a result. From spectrum licenses to network infrastructure, billions of dollars are required before a single subscriber can be secured.