That the pay TV industry is getting tougher every day is nothing new, but cable operators and satellite TV providers’ profits have been decreasing slowly, calling for a change in the traditional operating scheme. They year 2012 was an especially difficult one for DISH Network Corp. (DISH, Financial), as it reported declines on several aspects of its balance sheet. However, management is fixed on making fiscal 2014 a different story and has initiated several moves to boost profits and expand the company’s reach. And many investment gurus seem convinced about the upside potential, as George Soros (Trades, Portfolio) and Stanley Druckenmiller (Trades, Portfolio) recently bought large amounts of Dish shares. Let’s see what this firm has in store for the future.
A Shifting Landscape
Over the past few years, Dish has been trying to readapt to the ever-changing consumer habits of the pay TV industry. Ever since the spin-off of its set-top box business, excess satellite capacity, and additional investments into the Echostar Corporation (SATS, Financial) in 2008, the company has been searching for new ways to gain market share and jump from its position as the third-largest pay TV provider, becoming a more equal rival to DirecTV (DTV, Financial). While the traditional pay television model will remain profitable for the foreseeable future, Dish’s recent acquisition of wireless spectrum covering the U.S. reflects the company’s aim of expanding its business operations. In fact, the firm has entered into negotiations with Sprint Corporation (S, Financial) to offer a wireless broadband service for mid-2014. This deal should help the company level its competitive disadvantage with cable operators, many of which are offering triple-play service packages, including television, broadband Internet and phone service.
Nonetheless, the firm’s current scale has benefitted negotiations with content producers so far, given its nationwide service and low expenses required for equipment installations. In fact, the company’s 14.1 million customers were tempting enough for The Walt Disney Company (DIS, Financial), which set aside its initial differences with Dish last week, in order to roll out its innovative deal with the satellite provider. The agreement will allow Disney’s “WATCH” apps, as well as a vast array of ESPN programming to be streamed on-demand to Internet connected devices for Dish’s subscribers. Not only will this system attract the much needed younger 18 to 34-year-old audience, but since the $20 to $30 monthly fee charged for the service is much lower than that of cable operators, the company could gain more strength as an industry player.
Financial Outlook
Looking forward, Dish should be able to hold its customer base somewhat flat for the next five years, although the content deal with Disney will surely show a positive trend. While the core television business will grow at a moderate 3% annual average rate until 2018, with revenue growing at 2.3% ($13.9 billion), increasing programming costs will likely pressure profitability to some extent. Moreover, the company’s $5 billion investment in the wireless business could be a major risk, if the planned service execution fails to jump start. Nevertheless, I feel bullish about Dish Network’s long term future, as management has shown strong commitment to keep up with the industry’s changes and adapt its business model to customers' needs.
Furthermore, the company’s operating margin of 9.7% is relatively healthy and free cash flow has maintained its levels since 2012 (at approximately $1 billion), thereby allowing for a high return on equity of 82.64%. Nevertheless, the stock’s trading price of 35.5x trailing earnings is far above the industry average of 16.8x, making this investment a pricey matter. While the firm may be overvalued, I think investors should consider the profit boosts that could derive from the latest agreements with Disney and Sprint.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.
