What was I thinking? Invest in a company with no dividend? A company whose only product was satellite TV subscriptions? Was I out of my mind to propose to my colleagues that we should invest in a company that faces such serious threats as Netflix, cord-cutting and piracy? I knew I would be met with a few eyebrow raises and scoffs but to me DIRECTV looked to be a wonderful value investment. DIRECTV had it all: a cheap valuation, lots of free cash flow, smart capital allocation, pricing power, and potential for future growth. Having owned the stock now for two quarters, my colleagues and clients are convinced and we believe the stock is still an attractive investment for new clients.
DIRECTV just reported its 2013 year end numbers and its results were remarkable. In the U.S., where it is clear that the market is fully saturated, DIRECTV was able to add 169,000 new subscribers and was able to raise its revenue per subscriber on a monthly basis to $111.74. Over 20 million subscribers paying $111 a month generates a lot of profit. The exciting part of the DIRECTV story is its Latin American operations. Through a number of subsidiaries and partnerships, DIRECTV has 17.6M subscribers in Brazil, Mexico, Argentina, Colombia, Chile and Venezuela. The company had a strong year, adding 1.2M new subscribers in the Latin American region in 2013. While there are challenges with currency and a lower quality customer, the opportunity for growth is huge. In the United States, close to 90% of 100M households have pay-tv. In Latin America, only 45% of households have pay-tv. Not only should the percentage increase over time but also the number of Latin American households with a TV should grow as well. This bodes well for DIRECTV.
Aside from satellite subscribers, DIRECTV is looking at ways to diversify its revenue source by offering home alarm monitoring services, a heavy focus on commercial accounts (bars ,restaurants, hotels and other establishments also require pay-tv service), and integrated advertising campaigns to its 37 million subscriber base. More importantly, the fundamentals of the business are strong. DIRECTV earned $5.42 a share in 2013, up 18% from the prior year. Analysts expect close to $6 in earnings this year and $7 a share in 2015. The stock is a bargain at 12 times earnings for that much growth. DIRECTV also generates an ample amount of excess cash. In 2013 it generated $2.6 billion of free cash flow or about $5 a share. The company could easily pay a large annual dividend but it has chosen (and rightly so) to buy back its stock. And it has bought back a lot of stock over the past few years. Over the last seven years, the company has reduced its shares outstanding by close to 60%. And it plans to continue to buy back more stock in 2014. In fact, it has authorized a new $3.5B share repurchase program.
Netflix and cord-cutting are serious threats to the pay-tv industry, but once you get past the headline hyperbole, the threat is so far just a threat. Netflix subscribers aren’t getting rid of the pay-tv packages. Netflix is a cheap way to get more programming but with internet data cap limits, you can’t replace traditional TV with Netflix. In fact, you can’t get live sporting events, news, weather and aside from House of Cards, quality first run programming in real-time without pay-tv. As for cord cutting, according to Bloomberg, the number of homes paying for TV was slightly higher in 2013 compared to 2008 and up year over year from 2012. Finally, the proposed acquisition of Time Warner Cable by Comcast, which has a big challenge to pass regulatory approval, could have positive implications for DIRECTV. If the deal is approved, the way would be paved for DIRECTV to merge with the DISH Network. The U.S. doesn’t need two satellite TV providers and the synergies from a merger of the two could be substantial.
Disclosure: Clients of Baskin Financial own shares in DIRECTV