DIRECTV (NASDAQ:DTV) faces an increasingly steep uphill battle given rising programming costs, a more-competitive U.S. cable industry and stiffening economic headwinds in Latin America.
DirecTV provides satellite-delivered video services nationwide. The company targets high-end customers with a mix of exclusive content and an emphasis on sports, including the NFL Sunday Ticket, which helps the company generate the highest monthly video revenue per customer in the industry.
DirecTV Group is the second largest US pay-TV provider. Its operating divisions comprise DirecTV US, which had 20.2 million customers as of Sept. 30, 2013, and DirecTV Latin America, which has 11.3 million customers.
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DTV expects flat U.S. margins despite continued high single-digit growth in programming costs. In 2013, this was about $900 million in incremental cost, and growing to $1 billion in 2014. The following year will include a new deal with the NFL, which is expected to add at least $300 million in new incremental costs alone.
UBS analyst John Hodulik said the escalation in costs and stiff competition would put upward pressure on subscriber acquisition costs (SAC) and retention costs. The company must cut a larger and larger portion of non-programming operating costs to keep U.S. margins stable.
In 2012, DTV accomplished this partly through a 10 percent reduction in gross additions, but Hodulik expects only a 2.5 percent drop in gross additions in 2013. However, the gross additions are expected to decline 5.4 percent in 2014 as net subscribers decline in the U.S. for the first time.
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Aside from these financial issues, DirecTV faces secular challenges related to changing video-consumption habits. Video is migrating from linear programming delivered through a set-top box to an on-demand! , IP-based service delivered to both fixed and (to a much lesser extent) mobile platforms
This is especially true in the high-end homes that are the early adopters of non-traditional video—the same customers who are DirecTV's core market. Given these issues, DirecTV continues to evaluate prospects that can create "terminal value" and enable it to adapt.
The eventual resolution to these longer term issues is still unclear. The company at the recent analyst meeting suggested it would like to offer an over the top service that would focus on certain niche content (i.e., programming aimed at millennials) and/or would appeal to customers unable to get DirecTV's satellite service due to their location.
On the Latin American front, the region is a great long-term growth story, but inevitably it could hit speed bumps along the way. Hodulik currently sees one of these with the meltdown occurring in Venezuela and, to a lesser extent, Argentina.
Together, these markets represent roughly one-third of LatAm subscribers and a larger fraction of total LatAm EBITDA. In Venezuela, the official exchange rate is 6.3:1 per US$, but the bolivar is trading at closer to 70:1 on the black market. The devaluations in both countries in the near future that will hurt EBITDA generation.
Despite these headwinds, DTV aims to deliver positive net additions in the U.S. from 2014-16, along with mid-single-digit growth in revenue, 7-9 percent growth in programming cost per subscriber and high single-digit growth in cash flow before interest and taxes.
In this scenario, it is better to remain on the sidelines with DirecTV as the company faces a tough road ahead given rising programming costs and a more-competitive U.S. cable industry.
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