by Lawrence Meyers | January 10, 2013 7:00 am
Every year I consider candidates for my own portfolio. I may add new names, add to existing names, or the reverse. This year, however, I’m rejiggering my retirement portfolio. So, each week I’m going to examine a security that I’ll consider adding to this long-term diversified portfolio.
First up: DirecTV (NASDAQ:DTV).
I’ve followed the company for several years. I think it made a stellar choice in hiring the marketing chief at PepsiCo (NYSE:PEP), Mike White, to be its CEO. That’s because the guy knows how to market a great brand, and if you’ve ever seen DirecTV’s advertising, you know why.
Yet, while the company continues to blast the doors off metrics like cash flow, it has a creeping problem with subscribers.
Note the total number of subscriber additions: 1 million in 2009, 600,000 in 2010, 700,000 in 2011. Domestically, DirecTV netted 67,000 new subscribers in the third quarter, to a total of 96,000. This was way off last year’s addition of 327,000 in Q3 and 537,000 total, and obviously well below the annual subscriber additions the company has been used to.
The question is whether this is a macroeconomic issue (as consumers are deleveraging) or company-specific. Still, while I’m concerned about the huge drop-off in domestic customers, the good news is DirecTV is constantly updating, improving and adding services, while also retaining pricing power. Average revenue per user (ARPU) is at $96.41, up from the low-$70 range just a few years earlier, but also off its high around $101.
DirecTV has been absolutely on fire in Latin America, and in many ways it still is, but the strongest growth may be in the past. While it did see 543,000 subscriber additions in Q3, that was down from the previous year’s 574,000. Still, DirecTV added 1.8 million through the first three quarters of 2012. It had been adding almost 3 million subscribers annually.
At first glance, ARPU appears to have cratered from $64.63 to $55.97 — but literally all of it was due to currency exchange rates. So, while the company isn’t blasting the doors off in Latin America, I’d say it’s certainly burning them.
But the core of DirecTV is that it’s a cash flow-generating monster. That’s a necessity because this is a capital-intensive business, and if you ever saw the episode of CBS (NYSE:CBS) TV’s Undercover Boss in which we got a look inside White’s company, you get a small idea of its complexity.
Despite those expenses, however, free cash flow has been traditionally … well … amazing. In 2008, FCF ran at $1.8 billion. By 2010, it hit $2.8 billion. Today, it’s at $1.75 billion through three quarters. That’s free cash flow, money that the company can use beyond upkeep.
And DirecTV has been using it to aggressively buy back stock for years. It repurchased $1.22 billion of it in the last quarter alone and 112 million shares so far this year, reducing share count by 15%.
Warren Buffet’s Berkshire Hathaway (NYSE:BRK.B) may have made some dumb moves lately with purchases of newspapers and scandal-ridden solar sucker play SunPower (NASDAQ:SPWR), but he has loaded up on DirecTV stock and now owns 4.89% of the company. This occurred at the same time Buffett bought a stake in Liberty Media (NASDAQ:LMCA). Obviously, he’s been having lunch with John Malone.
DirecTV trades at only 12x this year’s earnings, despite EPS forecasts of 20% growth this year and next. But hidden in there is the effect of the share buyback. In truth, the company’s operating profit (better to examine than net income because of many non-recurring charges), is up only 12%. On that metric, DirecTV seems fairly valued.
When I consider the slowing subscriber additions and the increasing competition for eyeballs from other forms of entertainment, I can’t see adding DirecTV to my retirement portfolio.
However, because of its trading patterns, I do see it as a trade. It’s the kind of stock that I would sell naked puts against and attempt to pocket the premiums. If I get the stock put to me, I won’t be upset. It’s a fine company to hold, and I’d be able to hold long enough to then sell a covered call or just hold for a swing trade.
As of this writing, Lawrence Meyers holds February naked puts on DirecTV, but has no position in any other security mentioned.
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