Viva Latin America

Impressive growth from DirecTV’s Latin America business boosted second quarter operating income. At the group level, DirecTV delivered operating income of just over the $1 billion mark for the first time and surprised the market on several elements of its performance. The company is expecting steady growth and stable churn, supported by new products and further capital management.

“DirecTV has repurchased almost $9.1 billion of its own stock over the last three and a half years”

DirecTV surprised the market with net additions of 100,000 in the US and 415,000 in Latin America for the second quarter. The company now has over 26 million subscribers, including 18.7 million in the US, and 5.8 million in Latin America.

Total revenue increased 12.1% to $5.8 billion on the prior comparable period, lifting operating income by 44% to $1.01 billion and net income of $543 million, up by 33%.

In the US, gross subscriber additions of 946,000 turned into net additions of 100,000 after churn stayed flat at 1.51% on average per month. The average cost of acquiring each new subscriber is still increasing and at $783 has not been higher. But the changed tactic of tougher credit checking is paying off as churn remains stable and each new subscriber is generating better returns.

The average revenue per user (ARPU) increased 5.7% to $87.90 for the quarter. This followed a 6.4% increase in the first quarter. The company has been matching the competition with a free HD DVR promotion that will continue to nudge ARPU higher over the year. The usual combination of better products and more subscribers taking a greater number of these is helping to push this crucial factor forward.

Programming expenses grew 8.4% in the quarter but as the subscriber total grows, the effect is diluted on a per subscriber basis. The extension of the NFL Sunday Ticket contract will affect this factor throughout 2010 as the company amortises the higher cost across the year. DirecTV has passed on some of that increase in a mix of higher tier pricing for Sunday Ticket packages as well as a shift down of the $99 SuperFan tier with the HD channels into the basic package. Despite the adjustments, the Sunday Ticket packages continue to be a big crowd-puller for DirecTV, so even though it is slightly less profitable on a per subscriber basis, it is still very worthwhile maintaining for promotional purposes.

DirecTV introduced two new services – Whole Home DVR and a suite of three dedicated 3D channels – that will provide a stimulus to ARPU over the coming year. The prevalence of 3D programming will blossom in the same manner that high-definition has, as consumers flock to the even better viewing experience. The take up rate will not be linear, however, and will depend on consumers’ willingness to shell out for 3D televisions. Notwithstanding the ponderous US economy, we believe the appeal of the new technology will create a new wave of spending that will underpin future growth for DirecTV’s services.

Free cash flow increased 40% to $1.41 billion for the year to date primarily due to the higher operating income, but slightly offset by higher tax payments.

So far this year, DirecTV has repurchased $2.19 billion of its stock, including $1.72 billion in the second quarter. The share repurchase scheme is in line with the company’s target of a net debt to US division operating profit ratio around 2.5 times. DirecTV has repurchased almost $9.1 billion of its own stock over the last three and a half years.

During the period, the company resolved an outstanding issue with the Federal Communications Commission that resulted in the exchange of 21.8 million Class B shares, held by Dr John Malone, for 26.5 million Class A shares. The additional 4.6 million shares valued at approximately $160 million reduced the diluted earnings per share to 42 cents per share, down from 60 cents. If not for the dilution, earnings per share would have risen by 50% quarter on quarter. The ‘Malone’ transaction has now simplified the stock structure of the business allowing for a better comparison of periodic progress.

Capital expenditure for the quarter amounted to $494 million and $1,033 million for the year to date.

DirecTV also repaid $1.1 billion of senior secured debt during the half year. The company had earlier completed a $3 billion debt refinancing at a lower average cost of debt and lengthened the maturity profile at the same time.

The daily chart of DTV shows the share price consolidating sideways between the $40 resistance and $33 support levels. The price action has pulled back from the topside resistance and is currently being supported by the 50 day moving average. This pullback has given the oscillators time to move away from overbought territory. Should the 50 day MA hold we would expect to see another test of the $40 mark. If it breaks the 200 day MA is just below at about $35 which should see some buying interest if tested.

The weekly chart shows a stock in a healthy uptrend that continues to put in higher highs. The price action is well above the 39 week and 200 week moving averages and has no overhead resistance except for the recent 52 week high of $39.89. The 39 week moving average looks to be providing support on any pullbacks.

Summary

DirecTV looks set to punch out another solid year of subscriber growth, particularly from Latin America, combined with higher ARPU after passing on programming cost increases.

The free cash flow being generated from the business is very strong and is funding the stock repurchase program. This is, of course, very supportive of earnings per share growth.

The company has aligned itself with the three top telecommunications companies in America as it looks to mitigate the threat of not having its own triple-play strategy. The compelling offering it has makes DirecTV an ideal partner for the big telcos which lack the key content and products of DirecTV.

We continue to like the prospects for DirecTV and recommend the stock as a buy for Members without exposure.