In the battle for television viewers against traditional cable companies, the country's two-leading satellite cable providers have been engaged in a low-grade war these past years. With each passing quarter, either DirecTV (NYSE: DTV) or Dish Network (Nasdaq: DISH) scores a direct hit. Both fighters benefit while the industry is still expanding. But we may be getting closer to the end of this boxing match. DirecTV is landing its punches each time, while Dish Network can only bob and weave.
The numbers tell it all
While the entire market for satellite cable TV was growing, both of these firms were able to steadily boost subscribers and sales. But now the market is growing at a far slower rate, so any further gains are increasingly coming at the expense of each other.
Second-quarter results show a clear trend emerging: DirecTV picked up another 100,000 net new subscribers (and another 450,000 subscribers in Latin America), while Dish Network announced on Monday evening it had lost 19,000 subscribers. Analysts had been expecting Dish Network to add 100,000 subs, yet surprisingly shares have barely budged in Tuesday trading on that downbeat news.
But that may not last. That's because DirecTV has really hit its stride and is poised for massive free cash flow generation, while Dish Network looks set for a continued string of noisy quarterly results. For example, the Q2 shortfall was associated with the expiration of a two-year promotion plan that went into effect in 2008. Monthly churn for the past three months appeared to be about 1.8%, which translates into a 5% churn on a quarterly basis. That means Dish Network needs to add many new customers just to offset defecting ones. And they couldn't do that in the second quarter. As that 2008 promotion is still impacting results, third quarter results could be equally messy.
Curiously, Dish Network's co-founder, Chairman and CEO, Charlie Ergen, left on vacation and chose not to attend the company's conference call, which seemed to be an exercise in confusion. Kaufman Brothers' Todd Mitchell thinks highly of management but notes that their goals don't often jive with those of the investment community. "We believe DISH might be better off as a private company, because, in our view, that is how it is run, largely without concern for the consistency of quarterly results or a strong effort to communicate with investors. We believe the disorganized nature of yesterday's earnings call was not reflective of management's operating acumen," he wrote in a note to clients.
Meanwhile, DirecTV continues to execute its game plan without a hitch. Gone are the days of +15% to +20% annual sales growth, yet management has settled the company into a solid groove of +8% to +10% annual sales growth with an increasing focus on cash flow.
Rising profits are the result of a largely completed expansion of its North American technology base. DirecTV generated more than $1.4 billion in free cash flow in the first half of 2010, up more than +30% from a year ago. Free cash flow could approach $3 billion this year and approach $3.5 billion next year.
Since the company now generates far more cash than it needs, much of the cash flow is being returned to shareholders. The company bought back $3.5 billion in stock during the past three quarters and just announced plans to buy back another $2 billion in stock. Management has already taken the share count down from more than 1.1 billion in 2008 to a recent 908 million. By that math, annual free cash flow per share now approaches $3, up from $2.09 in 2009.
Goldman Sachs' research estimates 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 those ongoing buybacks are enacted.
Might a dividend be next? Probably not before 2011, as management wants to wait to offer a dividend until gross debt is less than 2.5 times EBITDA.
As an added kicker, DirecTV is still seeing dynamic growth rates in Latin America, thanks to more aggressive anti-piracy moves and still-low penetration rates. Whereas DirecTV should only add around 500,000 net new subscribers here in North America this year, the company is on track to add more than 1.5 million net new subscribers in Latin America. (The North American business is still five times larger). 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 it will create a higher valuation for them as standalone entities.
In effect, DirecTV is firing on all cylinders while Dish Network stumbles. That trend should become even more pronounced in the quarters to come, as DirecTV generates solid free cash flow to keep sopping up stock, even as its Latin American division continues to grow at a fast pace. For Charlie Ergen and Dish Network, damage control is the order of the day.
Action to Take --> Investors can look to buy shares of DirecTV, short shares of Dish Network, or do as my colleague Amy Calistri shows, perform a pair trade. In any business, it's always wise to bet on the strongest fighter. And in this fight, DirecTV is leading with jabs while Dish Network is leading with its chin.