There are certain items Americans consider indispensable. Any company that can
generate a regular subscription fee from these indispensable products has one
heck of a sustainable business model. Even better, a crafty company can provide
lots of different versions of its services, plus lots of add-ons to upsell its
customers and drive revenue growth. Sixty days ago, I wouldve placed a solid bet
on DirecTV (NASDAQ: DTV ) for the above reasons, and many more. However, the
companys recent earnings report hit me with a surprise. New subscriber additions
were the lowest in quite some time and have me reassessing the stock. During the
recent economic slump, Americans have been keen to stay home and de-leverage
their balance sheets. DirecTV has been one of the beneficiaries of this
development. It helps that the company is in a space with limited options for
consumers. Competitors include Dish Network (NASDAQ: DISH ), FioS service from
Verizon (NYSE: VZ ), U-Verse from AT&T (NYSE: T ), and local cable providers
such as Cablevision (NYSE: CVC ). Ive been fond of DirecTV over all the others
because the services essentially are commodities. The differentiation comes in
product mix, technological advances that translate more quickly into new
services, customer support and marketing. DirecTV always struck me as the winner
in these categories. Indeed, after Chase Carey left as CEO for News Corp.
(NASDAQ: NWS ), the company selected Michael White as the new commander. He came
from Pepsi s (NYSE: PEP ) International division, where he spent 20 years
helping distinguish Pepsi products from the competition. After explaining this
to a savvy investor friend, he asked, What is your long-term vision for DirecTV?
I answered, Conquer the entire U.S. market for distributing television
programming. They only hold 20% market share. Theres enough ground to stake out
to last for years. My hypothesis, however, forgot to take one big thing into
account: There really is viable competition in the form of telcos that also
offer internet and telephone service (DirecTV just added telephone service via
CenturyLink), and increasing numbers of consumers are cutting off their TV
service altogether, thanks to Internet content. DirecTV only added 26,000
subscribers in the quarter, compared to 100,000 in the same quarter last year,
and its a far cry from the 1.2 million added in 2010. Meanwhile, Time Warner
Cable lost 130,000 subscribers, and Comcast lost 238,000. However, AT&T added
202,000 subscribers, and Verizon added 184,000. Uh oh. But theres tons of good
news out of Latin America, where DirecTV continues its extraordinary growth
story. The company added 472,000 subscribers there. Even here in the U.S., the
average revenue per unit hit an all-time high of almost $91 per month (upselling
works!), churn still is low at 1.6%, the company continues to aggressively buy
back stock, it has $1.5 billion in cash, and it generated $400 million in free
cash flow. The problem is this is much less free cash than the company usually
generates, and DirectTV is seeing higher customer retention and acquisition
costs. This is the first real chink Ive seen in DirecTVs armor. Nevertheless,
the company trades at 13 times current-year earnings, with five-year projected
annualized growth of 23%. However, that same aggressive stock buyback inflates
earnings per share. I suggest waiting on the sidelines to see what the next
quarter or two brings. I wouldnt buy the stock here, and conservative investors
with gains might want to take profits. Lawrence Meyers has no positions in any
stocks mentioned.
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