November 28, 2009 - 3:56pm EST by
2009 2010
Price: 31.60 EPS $1.35 $2.24
Shares Out. (in M): 957 P/E 23.4x 15.7x
Market Cap (in $M): 30,000 P/FCF 13.5x 16.0x
Net Debt (in $M): 7 EBIT 2,634 3,459
TEV (in $M): 34,100 TEV/EBIT 12.9x 9.9x

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DirecTV (DTV)

Investment Thesis: DirecTV is currently trading at an attractive absolute and relative valuation.  The stock is currently underpriced due to short-term technical factors.

Company Background: DirecTV is a digital broadcast satellite.  The company delivers subscription based cable television service to over 18m subscribers in NA and over 4m subscribers in LatAm.  The company charges a monthly subscription fee (ARPU) for each user and in turn pays the cable networks a programming fee per subscribers.  DirecTv also incurs significant subscriber acquisition cost (cost of cable set-top box, marketing and installation) in first year of service.  The average new add for DTV has a 1.3 yr pay-back period and average life of 5.6 years with NPV of $1,219 assuming 10% discount rate.

The company has one of the best operating metrics in the industry.  Through a combination of singing up customers for contracts, excellent customer service and up scaling customers to DVR and HDTV, DirecTV has managed to maintain the highest ARPU in video along with the lowest churn rate.  Combined these factors have helped company achieve the highest ROI in the sector


Valuation:  DirecTv currently trades at an attractive absolute valuation of 11.5% equity free cash flow yield and 4.7x EV/EBITDA.  The company also trades cheap on relative basis at 5.2x EV/SSCF* compared to peer Dish trading at 6.1x EV/SSCF.  While DirecTV should trade at a premium to Dish given DirecTV is increasing subscriber adds while Dish has been losing subscribers.



Conclusions/risks: The two primary risk factors for the sector are pricing competiton as new house-hold formation slows as well as competition from video over the internet / video on demand.  The industry has been relatively well disciplined with regards to pricing.  The second point of competition from video through internet poses a real long-term strategic challenge for the dish players.  However this is likely going to be a longer-term slow secular headwind that will play out over many years and one would need to continue to monitor developments here closely.

I believe this opportunity attractive enough to merit a 2-3% position in a portfolio.  Near-term catalysts should play out over next six months and should provide a nice tailwind.





Mispricing/Catalysts: There are several reasons why DirecTV is mispriced.  As these headwinds go away over time, they will serve as catalyst for share price appreciation:

1)      Long LMDIA / Short DTV trade: This trade has been a popular trade amongst the arbitrage community and has caused DTV to have a short interest of 27% of float compared to peers at less than 1% of float.  Once the two entities are merged by year end this trade will be reversed and should lift the short-term technical pressure on DTV shares

2)      Share buy-backs:  The company has the best capital allocation discipline in the industry.  They have reduced shares o/s by over 30% over the last three years.  The company continues to pursue an aggressive share-buy back policy and has set a target debt/EBITDA ratio of 2.5x (with likely goal of using cash proceeds to continue to buy-back stock).  Assuming company maintains its policy, at current share price, the equity fcf yield would rise to15-17% over the next 3 years despite declining ARPU and subscriber additions

3)      There is potentially opportunity for DTV to spin off its LatAm dish assets.  Those assets are in early stages of growth and would garner a much higher multiple than company average and would help unlock incremental value

4)      EV/EBITDA multiple discrepancy: While DTV trades cheaper than Dish it appears to be trading higher on EV/EBITDA multiple  This is a result of accounting distortions rather than any real economic reasons.  Since DTV is growing it's subscriber base (at very high IRR) it also has to expense subscriber acquisition costs which distorts EBITDA.  As industry matures and subscriber adds slow, this discrepancy will become clearer to shareholders


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