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November 05, 2009

DirecTV Comes Through with Free Cash Flow as Prior Worries Recede

When I first read the DirecTV press release I was worried the stock would trade down. I saw the results as mixed with a few negatives offsetting plenty of positives. I sure was wrong. As the conference call concludes, the stock is up 6.1%.

I think part of the gains relate to ongoing takeover speculation as DTV approaches the closing of its merger with Liberty Media Entertainment (LMDIA). LMDIA owns 54% of DTV. The deal dramatically reduces LMDIA's John Malone's influence and simplifies the corporate structure. It also sets up a spin-off of the rapidly growing DirecTV Latin America unit. That step is widely expected and makes DTV an easier and more attractive merger candidate for AT&T. AT&T exclusively sells DirecTV service in the telco channel and is already accounting for the bulk of DTV's new subscribers. With telco TV subscriber additions slowing but telcos still needing TV as part of the bundle in the battle with cable, DTV looks like a better and better acquisition candidate.

Getting back to the earnings report, the negatives were a slight miss in net subscribers on higher monthly churn, and modest shortfall in EPS and EBITDA. Upside came from a rebound in ARPU growth and higher than expected share buybacks and free cash flow. EPS of 37% were two cents short of estimates. The ARPU improvement was important as a weak 2Q09 ARPU had made investors skittish.

The misses were minor and besides takeover speculation, it seems that investors are taking away the fact the DTV still grew revenues and EBITDA by 10% and 8%, respectively. The EBITDA number is depressed by charges from repatriating money from Venezuela and foreign exchange. In the US, revenues grew 9% and EBITDA was up 11%. Compare that to flat to low single growth at cable and telco competitors and you have to be impressed.

Even better, DTV is providing the street with the capital allocation strategy it desires: heavy share repurchase. Share buybacks are now suspended until the closing of the LMDIA merger (shortly after 11/19). But expect a big announcement by the end of the month on a repurchase for 2010 likely to be 10% or more of the shares outstanding.

Net debt stands at $3.9 billion against EBITDA of over $5 billion in 2009 and estimates for greater than $6 billion in 2010. Even with new debt coming on board when the merger closes, the balance sheet is in superb shape and free cash flow continues to grow as subscriber growth moderates.

I still like the DTV story but prefer to play it through LMDIA which will create a stub of Starz Entertainment that I Think remains undervalued by about 30%. Via LMDIA I get that upside plus the good DTV story.

Disclosure: LMDIA is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts.

Posted by Steve Birenberg at November 5, 2009 02:17 PM in DTV