Deep Dive – $DTV: The Medium is the Message

by Enis February 25, 2014 12:13 pm • Commentary

Comcast’s bid for Time Warner Cable has led to a war of words in the TV industry.  The tie up of two of the largest U.S. cable providers has led to antitrust concerns.  It has also highlighted the race for scale in the TV distribution industry, as competitors fight with each other as well as emerging disruptors like Netflix.

Dish Network chairman Charlie Ergen has been among the most vocal figures in the industry.  Multichannel summed up his thoughts from last week’s conference call with analysts:

Dish Network chairman Charlie Ergen said if the pending Comcast/Time Warner cable merger passes regulatory muster, it could make it easier for a combination of the two largest satellite TV players, Dish and DirecTV.

“If you take the No. 1 and No. 4 [pay TV] providers and put them together, it’s hard to see why you can’t put No.2 and No. 3 together,” Ergen said on a conference call with analysts to discuss fourth quarter results. But the Dish chairman expressed some doubt that the Comcast/TWC deal would receive approval.

“This puts pressure on everybody that in a way is a bit unprecedented,” Ergen said. “…Nothing I can see is positive about this. If you are a pay TV provider and your name is not Comcast or Time Warner Cable, I don’t see anything positive.”

Ergen wasn’t proposing a deal with DirecTV and he acknowledged that both companies have taken different strategic paths – Dish has concentrated on amassing wireless spectrum and creating a broadband business while DirecTV has focused on growing its video base and boosting shareholder returns. But despite their differences, Ergen said it wouldn’t prevent a deal.

Dish and DirecTV tried the merger route in 2002 only to have it rejected by regulators who believed the deal would significantly limit competition.

As the WSJ detailed, the Comcast-Time Warner deal would create a media behemoth at the top of the sector:

If approved by regulators—no sure thing—the deal will give Comcast 30 million video subscribers, far more than the next biggest pay-TV operator, DirecTV, with about 20 million. Comcast will have an even larger advantage in broadband subscribers, strengthening its position against Web giants like Google Inc.

The major changes afoot in the media industry are a consequence of the increase in consumer choice as media consumption moves away from the simple cable subscription.

While the industry leaders position their pieces on the board, the entire media industry has actually been on a tear over the past few years.  Comcast, Time Warner Cable, DTV, DISH, Charter Communications and Liberty Media are all near all-time highs in stock price.  Of all of these leaders, DTV caught my attention for a few reasons: 

First, DTV and Comcast are the only two major media distributors that have grown earnings for each year over the past 10 years.  Analysts project 10-20% earnings growth for both companies over the next few years.  However, market participants have assigned CMCSA a higher valuation by almost every metric, even though it is already more than 3x the size of DTV in market cap terms.

DTV has a trailing 12 month P/E of around 14, compared to around 21 for Comcast.  DTV’s EV/EBITDA is 6.9, vs. 8.25 for CMCSA.  DTV is a more leveraged company (90% debt/assets vs. around 30% for CMCSA), which is one reason for the valuation discount.  All else equal though, DTV looked like the most interesting potential investment among the major media distributors.

DIRECTV has been a quiet winner in the revolution of American television over the past decade.  The company has quadrupled in value over the past 5 years, going from around $10 billion in market cap in early 2009 to almost $40 billion today.  In that period, earnings have also more than quadrupled – the stock has not gotten a boost from multiple expansion like most other stocks, since the P/E multiple has actually been close to flat since early 2009:

[caption id="attachment_36778" align="alignnone" width="600"]DTV trailing 12 month P/E, Courtesy of Bloomberg DTV trailing 12 month P/E, Courtesy of Bloomberg[/caption]

The company’s stellar earnings growth has attracted some high profile investors, including Warren Buffett’s Berkshire Hathaway, which now owns 7% of DTV after first initiating a stake in 2011, when the stock was trading in the $40s.  John Malone, the long-time media tycoon, owns about 5.5% of DTV.  So two of the richest men in the world both have more than $2 billion invested in DTV.

Granted, DTV management has expressed some concern about the changing nature of competition in the industry.  In their most recent SEC filing, executives laid out their expectations and concerns for 2014:

DIRECTV U.S. faces challenges related to the rapid advance of technology that provides consumers with more options both in and out of the home and an industry that is increasingly competitive. In addition, programming content providers are continuing to seek increased rates for their content.

        Revenue growth at DIRECTV U.S. has been generated by an increase in ARPU and growth of our subscriber base. In 2014, we expect revenue to increase in the mid-single digit percentage range driven primarily by ARPU growth. We also expect positive net subscriber additions in 2014.

        In 2014, we expect operating profit before depreciation and amortization to grow in the mid-single digit percentage range. We expect to continue to be challenged by rising broadcast programming costs; however we intend to manage the impact to our margins by continuing to capture productivity improvements, which are expected to reduce costs and improve call center performance, field operations and customer satisfaction.

        We expect total capital expenditures in 2014 to decrease approximately $300 million at DIRECTV U.S to approximately $1.75 billion, primarily due to a reduction in set-top receiver costs, as well as lower upgrades relative to initial demand volumes for the DIRECTV Genie in 2013 and a higher use of refurbished set-top receivers for new subscribers.

Subscribers.    In 2013, net subscriber additions decreased due to lower gross subscriber additions associated with a continued focus on attaining higher quality subscribers, as well as a more challenging competitive environment and a decline in aggregate subscribers across the MVPD industry. 

Going forward, DTV’s era of fast growth is behind it.  However, the stock’s reasonable valuation and large existing “hooked” subscriber base of 20 million users are of significant appeal for potential investors.  The satellite infrastructure that was necessary for DTV is a major competitive moat as well.

Technically, the stock achieved a clean long-term breakout in early 2013, cleanly getting over the $50 level:

[caption id="attachment_36797" align="alignnone" width="600"]DTV monthly chart, Courtesy of Bloomberg DTV monthly chart, Courtesy of Bloomberg[/caption]

On the daily chart, the stock found support at the $67.5 level, which coincided with the rising 50 day moving average:

[caption id="attachment_36796" align="alignnone" width="600"]DTV daily chart, 50 day ma in pink, 150 day ma in yellow, Courtesy of Bloomberg DTV daily chart, 50 day ma in pink, 150 day ma in yellow, Courtesy of Bloomberg[/caption]

Anywhere in the 65-67.50 area would be a good spot for a long position given the confluence of support and the relative valuation of DTV compared to peers and the broader market.  This stock is on our long watch list for now.