This Entertainment Provider Could Double in Two Years
There are certain items that Americans consider indispensable. If a company can provide one of those products and generate a monthly subscription fee from its use, it creates a sustainable business model. Once this model is in place, the company can upsell its customers by offering enhancements to its basic package, and thereby drive revenue growth.
Selling an indispensable product also happens to be a great way to stay in business during a recession. During the recent economic slump, Americans have been keen to stay home rather than spend discretionary income. DirecTV (NYSE: DTV) has been one of the beneficiaries of the economic slowdown, being the purveyor of a U.S. staple: televised entertainment. That’s in addition to the fact that any time an American moves to a new residence, or just gets fed up with their current provider, there are limited options: DirecTV, DISH Network (Nasdaq: DISH), FioS service from Verizon (NYSE: VZ), U-Verse from AT&T (NYSE: ATT), and the local cable provider, such as Time Warner Cable (NYSE: TWC).
These services are arguably commodities at this point, and as technology improves, that will remain the case. The most successful company will be the one that most rapidly translates technological advances into its service, provides the best customer support, and wields a marketing sword like a samurai. DirecTV has already proved itself in these areas, and has always demonstrated that they will stay committed to them.
As for who rules the roost going forward, marketing is likely to be the primary determining factor. This is why Michael White was brought in as the new CEO after Chase Carey bolted for News Corp (NYSE: NWS). White came from Pepsi’s (NYSE: PEP) International division, where he spent twenty years helping distinguish Pepsi products from its all-too-similar rivals. The soda business simply comes down to brand loyalty, and White did an outstanding job at building and maintaining that loyalty among consumers worldwide.
He arrives at a time when DirecTV rules the market. Subscriptions have been growing at a steady clip for years. In 2009, in the midst of this recession, the company added 1.6 million net new subscribers. Turnover is a mere 1.5%, customers who choose DirecTV stay with it for the long haul.
From a technological standpoint, DirecTV distinguishes itself by offering more HD channels than its competitors (with up to 70 more coming this year). It will be beaming 3-D programming this summer, and has the largest selection of so-called 1080p, or “Full HD” movies for the cinematically-inclined. DirecTV also controls the tailgate crowd — myself included — with its NFL Sunday Ticket package (which can be viewed in HD for, yes, an additional fee). That’s just to name a few.
It’s enhancements like these that have permitted DirecTV to upsell its customers. For example, two years ago, about half of the company’s customers had the HD/DVR combination service. Now two-thirds of them do. The result is that the company’s average revenue per unit is well above its basic package, and this drives its increasing margins.
Marketing is not cheap these days, and with bundled telephony services breathing down DirecTV’s neck, the company had to increase its marketing expenditures by some +10%. Despite this, however, the company still created $2.4 billion of free cash flow last year. That takes us to the company’s extraordinary balance sheet. Free cash flow far exceeds debt service, and excess cash is pumped back into the company. That cash is used to stay on top of technological improvements, to hammer its marketing strategy home and to repurchase more than $10 billion worth of stock during the past three years.
DirecTV remains a growth story. Analysts peg compound annual growth rate at +34% for the years 2009-2012. This starkly contrasts to DISH at +14%, and Verizon at +4%. Two key ratios offer insight into this stock. The first, EV/EBITDA-to-Growth, is best used for comparing a stock with its peers. DirecTV comes in at 0.6, well below all competitors, with only DISH close at 0.8. The other, is P/E-to-Growth (commonly referred to as the PEG ratio), a value below 1.0 usually suggests a value play. DirecTV comes in at 0.5, suggesting the price could double from here before hitting its fair value. DISH’s PEG is 0.8, with all the others at 1.0 or higher.
Given its strategy, management, balance sheet, marketing skill and some quick math, the company looks undervalued. The prospect of a rise to $60 during the next two years seems achievable.