DirecTV: A Low Risk Merger Arbitrage Play

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Feb 18, 2015

Last year, AT&T (T, Financial) announced its plans to acquire DirecTV (DTV, Financial) for $95 per share. The acquisition is likely to close in first half of this year pending regulatory approval. DirecTV's shares are currently trading at $87.47 providing an excellent merger arbitrage opportunity. I believe DirecTV offers a good low risk opportunity to investors who want to benefit from price discrepancy between DirecTV's current price and AT&T's offer price. Further, given DirecTV attractive valuation and growth rate, even if this deal doesn't goes through DirecTV shareholders will be rewarded in the long term. Last quarter, legendary investor Warren Buffett (Trades, Portfolio), who is also a long time shareholder of DirecTV, added 1,353,468 shares of the company to his portfolio. He now hold 31,353,468 shares of DirecTV. His recent purchase is an indication that the company remains undervalued at the current levels. The company's shares are likely to gain whether the company's merger is successful or not. Here's a look.

Scenario I: If AT&T and DirecTV's merger is successful

Under the terms of merger agreement, DirecTV shareholders will receive $95.00 per share, comprised of $28.50 per share in cash and $66.50 per share in AT&T stock. The stock portion will be subject to a collar such that DirecTV shareholders will receive 1.905 AT&T shares if AT&T stock price is below $34.90 at closing and 1.724 AT&T shares if AT&T stock price is above $38.58 at closing. If AT&T stock price at closing is between $34.90 and $38.58, DirecTV shareholders will receive a number of shares between 1.724 and 1.905, equal to $66.50 in value.

AT&T shares are trading at $34.71 currently. At the current prices DirecTV shareholders are likely to get $28.50 per share in cash and 1.905 shares of AT&T which will be worth $66.12. That implies a total value of $94.62 or 8.18% upside in the next five months (transaction is likely to close in 1HFY2015). In fact, at the current share price of DirecTV, this transaction will be profitable for its shareholders as long as AT&T's share price is above $30.96.

Scenario II: If AT&T and DirecTV's merger is unsuccessful

But what if the deal doesn't go through? There have been some worries around the deal's regulatory approval after FCC halted review of the proposed merger in October last year. In my opinion, even in this scenario DirecTV's share are set to outperform given the company's strong fundamentals.

DirecTV has an impressive track record of revenues and earnings growth. The company's revenues have grown 76% from FY2011 to trailing 12 months (TTM) ended September 2014. In the same period, its EPS has grown 56% from $3.47 to $5.43.

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Source: Gurufocus Value Screens

Despite its impressive growth, DirecTV's shares are trading at a discount to its peers like Time Warner Cable (TWC, Financial) and Comcast (CMCSA, Financial) (CMCSK, Financial).

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Source: Gurufocus Value Screens

Going forward, the company is likely to continue posting strong results in the U.S. and Latin America. In the U.S., the company continues to generate mid-single-digit revenue and earnings growth due to the positive effects of disciplined price increases and improved penetrations of its Genie HD DVR, coupled with the positive impact of its disciplined approach to both new gross adds and cost management. In Latin America, Sky Brasil drove the company's revenue growth of 10% in the last quarter, led by continued subscriber growth and strong local currency ARPU growth. In fact, DTV Latin America's local currency ARPU grew 15% in the last quarter, which helped it increase its local currency revenue by 28%.

Sell side analysts are expecting the company to report an EPS of $5.92 in FY2014 and $6.20 in FY2015. This implies the company is trading at 14.10 times its FY2015 EPS which appears low given the company's track record of top and bottom-line growth. So, I believe the stock represents a good buying opportunity irrespective of whether the company gets acquired by AT&T or not.