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 would’ve placed a solid bet on DirecTV (NASDAQ:DTV) for the above reasons, and many more. However, the company’s 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).
I’ve 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. There’s 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 it’s 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 there’s 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 I’ve seen in DirecTV’s 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 wouldn’t buy the stock here, and conservative investors with gains might want to take profits.
Lawrence Meyers has no positions in any stocks mentioned.
