For quite some time, investors have been trying to handicap which cable and satellite firms would win the race for market share. That game is almost over as market share rates are holding fairly steady these days. Each of these players lose a decent number of customers to rivals every quarter, but they also convert a similar number of subscribers back from those rivals. This has led to an era of sharply-reduced spending on efforts to lure new customers (known as SAC, or Subscriber Acquisition Costs). For DirecTV, that means lower marketing spending and fewer discounted pricing offers. The net result: the firm now collects $80 a month on average from each customer, up from $75 a year ago -- and it is spending less to acquire those customers, which yields impressive profits for each subscriber.
Much more importantly, DirecTV has largely completed its internal investments in North America, so investors need not look just at operating cash flow (which does not include capital spending), and can instead focus on free cash flow, the real measure of shareholder returns. DirecTV generated $648 million in free cash flow in the first quarter, up from $340 million a year ago. For the full-year, the company is on track to generate more than $2.6 billion in free cash flow.
So what to do with all that cash? A stock buyback is an obvious move. Management has already taken the share count down from above 1.1 billion in 2008 to a recent 938 million. Based on current plans, the share count should fall below 900 million by the end of this year. So by using the projected year-end share figure, cash flow should equal about $2.90 a share, up from $2.09 in 2009. Goldman Sachs' research thinks the share count will be reduced to less than 800 million in 2011, and below 700 million in 2012. Even if sales, reported income and free cash flow grew at a snail's pace, they would still grow quite nicely on a per share basis during the next few years, if ongoing buybacks are enacted.
South of the border
Although DirecTV's North American market is largely mature, the company is still seeing dynamic growth rates in Latin America, thanks to more aggressive anti-piracy moves and still-low penetration rates. Whereas DirecTV may only add around 300,000 to 400,000 net new subscribers here in North America this year, the company is on track to add more than one million net new subscribers in Latin America. With one business (North America) largely mature and the other (Latin America) in high-growth mode, some have speculated that management may look to separate the two businesses if they will create a higher valuation as standalone entities.
Action to Take ----> Despite the impressive momentum, shares still trade for less than 4.5 times projected EBITDA, on an Enterprise Value basis. Assuming they trade up to around 6.0 times EBITDA/EV, investors are looking at a +33% gain in this stock. As the company builds on its impressive string of free cash flow results while the share count steadily shrinks and the company moves closer to issuing a robust dividend, investors are likely to start bidding up that EBITDA multiple to a level that is still a sharp discount to the long-term double-digit EBITDA growth rate.
-- David Sterman