I was getting my usual fix of financial news a few days ago when randomly, I decide to take a quick look at DirecTV (DTV). This name has popped up quite a few times among various hedge fund managers' holdings. Warren Buffett holds it as well, through Todd Combs and Ted Weschler. This is the first stock bought by Todd Combs and/or Ted Weschler that passes the US$1bn dollar size threshold, which Warren revealed it in his recent annual report. For this one, I definitely regret that I did not do more work on this stock earlier.
And what did I find? I don't claim to be an expert on the America media industry, but DTV definitely piques my interest
.. In fact, DTV is a rather typical Buffett stock. Ladies and gentlemen, this is a "cannibal". What does that mean? Basically it is a company which uses large proportion of their cashflow to buy back their stock. One of Charlie Munger's tips for investment success is to look for "cannibals".
DTV is a satellite TV provider in the USA and Latin America. It also owns a 42% interest in Game Show Network, a network dedicated to game related programming and internet interactive game playing. That is a small part of the business and not so significant. Pay TV in the US is very competitive and have multiple players including: Cable TV, Telcos and Internet TV. The cable infrastructure, telco fiber optic line and internet penetration are all well developed. Pay TV penetration is also very high, at ~90%. Whereas in many parts of Latin America, Pay TV penetration is still growing from a low base. Some stats on their US and LatAm business below.
| |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
| DTV US Subscribers ('000) |
16,831 |
17,621 |
18,560 |
19,223 |
19,885 |
20,084 |
| ARPU (US$) |
79.1 |
83.9 |
85.5 |
89.7 |
93.3 |
97.0 |
| DirecTV US Revenue |
15,527 |
17,310 |
18,671 |
20,268 |
21,872 |
23,235 |
| DirecTV US operating profit |
2,402 |
2,330 |
2,410 |
3,290 |
3,702 |
4,153 |
| DirecTV LatAm subscribers ('000s) |
3,279 |
3,883 |
4,588 |
5,808 |
7,871 |
10,328 |
| Latam ARPU (US$) |
48.3 |
55.1 |
58.0 |
58.0 |
62.6 |
57.3 |
| Latam Revenue |
1,719 |
2,383 |
2,878 |
3,597 |
5,096 |
6,244 |
| Latam operating profit |
159 |
426 |
331 |
623 |
916 |
955 |
As expected, their US business is fairly mature. Number of subscribers have been growing at low single digits. The management has been focusing on increasing ARPU, which translated into higher revenue growth compared to subscriber growth. This is unlikely to persist for long. Their LatAm business is where the excitement is. Just a flavor of how the LatAm Pay TV market is like:
(i) Brazil Pay TV penetration - 36%
(ii) Argentina Pay TV penetration - 62%
(iii) Venezuela Pay TV Penetration - ~40%
(iv) Colombia Pay TV Penetration - 31%
However, LatAm is only 1/5 of their revenue as of end 2012 but is growing strongly.
| Income Statement (US$m) |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
| Revenue |
17,246 |
19,693 |
21,565 |
24,102 |
27,226 |
29,740 |
| Broadcast Programming and other |
(7,346) |
(8,298) |
(9,064) |
(10,074) |
(11,655) |
(13,028) |
| Subscriber service expenses |
(1,240) |
(1,290) |
(1,525) |
(1,681) |
(1,911) |
(2,137) |
| Broadcast operation expenses |
(323) |
(360) |
(341) |
(350) |
(389) |
(414) |
| Subscriber acquisition costs |
(2,096) |
(2,429) |
(2,773) |
(3,005) |
(3,390) |
(3,397) |
| Upgrade and retention costs |
(976) |
(1,058) |
(1,092) |
(1,169) |
(1,327) |
(1,427) |
| General and admin expenses |
(1,095) |
(1,243) |
(1,457) |
(1,445) |
(1,576) |
(1,815) |
| Depreciation and amortization expenses |
(1,684) |
(2,320) |
(2,640) |
(2,482) |
(2,349) |
(2,437) |
| EBIT |
2,486 |
2,695 |
2,673 |
3,896 |
4,629 |
5,085 |
| Other income, gains and losses |
26 |
55 |
34 |
69 |
84 |
140 |
| Liberty transaction and related gain |
0 |
0 |
(491) |
67 |
0 |
0 |
| Financial income |
111 |
81 |
41 |
39 |
34 |
59 |
| Financial expenses |
(235) |
(360) |
(423) |
(557) |
(763) |
(842) |
| Profit before Tax |
2,388 |
2,471 |
1,834 |
3,514 |
3,984 |
4,442 |
| Tax |
(943) |
(864) |
(827) |
(1,202) |
(1,348) |
(1,465) |
| Net Profit |
1,445 |
1,607 |
1,007 |
2,312 |
2,636 |
2,977 |
| EBIT
Margin |
14.4% |
13.7% |
12.4% |
16.2% |
17.0% |
17.1% |
| Net Margin |
8.4% |
8.2% |
4.7% |
9.6% |
9.7% |
10.0% |
| Programming Cost/Revenue |
42.6% |
42.1% |
42.0% |
41.8% |
42.8% |
43.8% |
| Subscriber acquisition/Revenue |
12.2% |
12.3% |
12.9% |
12.5% |
12.5% |
11.4% |
| Upgrade and retention/Revenue |
5.7% |
5.4% |
5.1% |
4.9% |
4.9% |
4.8% |
My main concern here is that margins are at a historical high. While the management has displayed great talent at milking their US business, competition in US Pay TV industry seems to be getting worse. Programming costs are expected to continue climbing and so will upgrade and retention costs as cable companies shifts to HD.
| (US$m) |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
| Net CF : |
3,645 |
3,910 |
4,660 |
5,206 |
5,185 |
5,634 |
| Capex : |
(2,692) |
(2,229) |
(2,071) |
(2,416) |
(3,170) |
(3,349) |
| Acquisition: |
(348) |
(204) |
(134) |
(617) |
(11) |
(16) |
| FCF |
605 |
1,477 |
2,455 |
2,173 |
2,004 |
2,269 |
| Stock repurchase |
(2,025) |
(3,174) |
(1,696) |
(5,111) |
(5,496) |
(5,175) |
| Cashflow from debt issuance/repayment |
(220) |
2,437 |
972 |
3,655 |
2,990 |
3,690 |
| No. of shares (diluted) |
1,202 |
1,114 |
989 |
876 |
752 |
644 |
| Recurring EPS |
1.20 |
1.44 |
1.51 |
2.64 |
3.51 |
4.62 |
Their LatAm Pay TV business is definitely one of the attractive selling point of this company but that is not all. This is a massively cashflow generative business. Even after plowing cash back into the company for capex and acquisition, free cash flow is almost equal to net profits. This is a cash cow! What is even more interesting is what they have done with all that cash. Between 2007-2012, DTV produced about US$11bn in free cash flow, but they have done back US$22.7bn worth of stocks. The total number of shares have almost fallen by half in the same period of time. The result of this? EPS growth greatly outpacing revenue or net profit growth.
| (US$m) |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
| Equity |
6,302 |
4,631 |
2,911 |
(194) |
(3,107) |
(5,434) |
| Total Debt |
3,395 |
5,833 |
8,010 |
10,510 |
13,464 |
17,528 |
| Total Asset |
15,063 |
16,539 |
18,260 |
18,423 |
18,423 |
20,555 |
| Debt/ Asset |
22.5% |
35.3% |
43.9% |
57.0% |
73.1% |
85.3% |
| EBIT/Interest |
10.6 |
7.5 |
6.3 |
7.0 |
6.1 |
6.0 |
| Debt/EBITDA |
0.8 |
1.2 |
1.5 |
1.6 |
1.9 |
2.3 |
This rapid shrinking of the shareholder base while great, should not be expected to continue at a similar pace in the future. Over the last six years, DTV has greatly levered up its balance sheet to fund its share purchase. The debt to asset ratio climbed from 22.5% to 85.3%. Equity has become negative. While this may seem somewhat scary, EBIT/Interest ratio and debt/EBITDA ratio are still within safe limits. The management targets a debt/EBITDA ratio of 2.5x. Doing something like this will be very dangerous for a business with volatile margins. Historically, DTV does experience some volatility in their margins and there is a possibility of margin compression given the competitive landscape. Overall, I believe their debt levels should be manageable. The management has just approved a US$4bn stock buyback scheme and is committed to fund stock buyback from their free cashflow.
Analysts are projecting ~10% top line growth over the next few years. As of the closing price of on friday, DTV trades at a trailing PE of 12x. FCF yield is estimated to be about 7%. Compared to 10-yr Treasuries at 2% this is definitely quite attractive even though the stock has climbed quite a fair bit. Let's see if there is a pullback to give me a better entry.
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