The pay TV industry is subject to technological innovations, consumer habits, and household penetration. With phone and cable providers offering three-way package deals of Internet, television, and telephone service, satellite TV companies have a questionable future ahead of them. As the largest satellite TV provider in the U.S., DirecTV Group (DTV) has made a point of investing in service improvements, as well as market expansion throughout Latin America. Yet the question remains: Will investment guru John Burbank's (Trades, Portfolio) recent share acquisition pay out in the long term, or will it fall flat under competitive pressures?
Keeping the Momentum
With 20 million households under its wing, DirecTV provides satellite television service for a large portion of the U.S. population, and subscriber rates are trending positively. The company's vast geographic reach into rural regions of the country, as well as its high-quality service deals, has been attracting customers over the past years. In addition, an operating margin growth rate of 17.1% is evidence of DirecTV's significant customer base, and good management. The company’s large coverage area, which will expand in 2014 and 2015 due to the launch of two new satellites, attracts programming creators seeking to earn large profits, although these may raise their price demands over time. Nevertheless, the company’s efficient service limits the ongoing capital investments and has helped generate strong cash flow.
Its aggressive bidding power has allowed DirecTV to obtain content rights to popular programming, like the National Football League’s Sunday Ticket package. And consequently, the company’s U.S. subscriber rate doubled in the past year, while average revenue per user grew $6 to a current $102.37. Furthermore, the firm’s successful efforts to seek out a higher-paying subscriber base has allowed it to increase package prices, as well as lease, HD and DVR equipment service fees. In return for these price bumps, this company will soon be the first pay TV operator to offer next-generation 4K ultraHD video services nationwide, which will significantly upgrade the sound and video quality of its content.
Of Latin American Presence and Market Competition
Despite DirecTV’s growing U.S. subscriber base and technological innovations, the satellite TV provider still faces strong competition from phone companies. Verizon Communications Inc. (NYSE:VZ), AT&T Inc. (NYSE:T) or Sprint Corporation (NYSE:S) offer customers an integral package of wireless internet, television and phone service, posting a real threat to the firm’s one way offer. Also, with viewer habits tending towards online video programming, DirecTV faces the tough challenge of retaining its subscriber base in the long term. Another downside is that this company offers premium content, but has little control over what it airs. The current NFL deal, for example, expires this year and prices for a contract renewal could spike, hurting 2013’s outstanding revenue growth of 28.50%.
Latin America seems to be DirecTV’s big bet for the future decade, given its 93% stake in Sky Brazil, 41% in Sky Mexico and full ownership of PanAmericana. In total, these businesses cover 17 million households in the Latin American continent and reel in 20% of the company’s overall $29.7 billion revenue. The firm sees this emerging market as the potential growth driver, and has therefore invested heavily in constructing terrestrial wireless networks. Nevertheless, the sky is far from clear on the local competitive front, with Brazil’s America Movil’s recent acquisition of cable operator Net Servicios now as the main threat. Additionally, Venezuela’s currency devaluation which is expected to repeat itself in 2014, could affect DirecTV’s margins (3.5% of international revenue stems from Venezuela).
Although the current EBITDA growth of 34.40% and returns on capital of 60.60% are very tempting for a short term investment, I feel somewhat bearish about DirecTV’s long-term future profitability. However, with the company trading at a 21% price discount relative to the industry’s average, this might be a good time for shareholders looking to gain high returns in the short term.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.