Dish Network (DISH) operates in a basic duopoly in the satellite TV industry along with competitor DirecTV (DTV). DISH has incredibly stable cash flows, huge operating leverage, significant competitive advantages, and some huge growth opportunities (including their new Netflix competitor, the rejuvenated Blockbuster online service). Not only that, but the company is currently firing on all cylinders – operating income was up over 70% in the first half of this year (approximately 40% after excluding litigation costs), and subscriber numbers have been slowly trending up for years.
So what is this company doing trading on the magic formula list? Quite simply, over the past few years the business has grown substantially in value while the share price has stagnated along with the rest of the market. This divergence in price and value has created a great entry point for the long term investor. It’s one of the things we look for here at Gurufocus’ own Micro-Cap Magic Formula newsletter.
So just how cheap is DISH Network? Over the past twelve months, they’ve earned $2.65 billion in operating income and $3.61 billion in EBITDA. With their current EV sitting at $15.85 billion, they’re currently trading for just 4.4x EV / EBITDA and under 6x EV / EBIT.
For fun, let’s compare this to their only direct comp, DirecTV. They currently trade for over 6.2x EV / EBITDA. Let’s look at them from a couple of other metrics: DTV trades for 1.64x EV / Sales compared to DISH’s 1.2x despite DISH network enjoying higher margins and better returns on assets. In other words, DISH enjoys much better operating metrics than DTV but still trades for much lower multiples.
So what competitive advantages does DISH enjoy?
Quite simply, this is a business with massive fixed costs. Starting a new satellite company isn’t cheap – you need to build satellites, launch them, buy bandwidth (of which there is a limited amount in very high demand), market for new customers, pay for content, etc.
To justify those costs, an investor would need to have a target market of underserved consumers who would eagerly sign up for the service. In other words, if had to fight and scrape for each and every one of your customers, you’ll never be able to justify the costs of building out a satellite company.
DirectTV and DISH have already spent that money. They’ve already captured the low hanging fruit in terms of underserved customers. They’ve already acquired bandwidth and achieved the scale necessary to run a satellite TV company profitably.
No one else is going to be able to do that. DirectTV and DISH have locked themselves into a duopoly in this market. They still have to compete with cable companies, so they’ll never enjoy the elite profts you’d expect from a pure duopoly, but as they continue to leverage their fixed costs and grow their subscriber base, expect these two to enjoy high and growing levels of profitability.
Why is it so cheap?
With strong and steady profits and significant economies of scale, why is DISH trading so cheaply right now?
Easy. Dish is highly, highly levered. Their shareholder’s equity is actually negative; in other words, their liabilities outweigh their assets.
And DISH doesn’t just employ financial leverage. Their business also enjoys huge operational leverage. While they do have to spend money to acquire customers, it costs them basically the same thing to run their network whether they have one million, two million, or ten million subscribers.
With huge operational and financial leverage, DISH could be exposed to another big leg down in the economy. The bear case could go something like this: The economy enters a double dip recession that makes 2008/2009 look like a walk in the park, DISH loses subscribers in droves, and their dual forms of leverage results in massive operating losses and the brink of bankruptcy. Even if that’s a tad too bearish, a really bad recession could cause them to bleed cash for a while and easily justify today’s low prices.
Could that happen? Yes. But it doesn’t seem likely. Even during the depths of the recession, DISH basically stayed flat in customer count, and as the economy has recovered, their customer acquisition rate has accelerated.
If those trends hold, it’s not hard to envision a share price substantially higher than today’s prices. Even if DISH’s growth stalls for a few years as the economy stutters, their share price will likely appreciate on the back of their strong cash flows.