Should Investors Direct Their Portfolio Toward DIRECTV?

Investors with a few gray hairs may remember when DIRECTV (Nasdaq:DTV) was a controversial stock, with plenty of doubters as to whether this company's satellite-based pay TV approach could ever make hay against likes of Comcast (Nasdaq:CMCSA). That debate is long over, and the company has proven that it can generate pretty significant amounts of cash flow. That doesn't mean that the stock still doesn't offer some controversy, though, with the debates now shifted as to whether the company can withstand the evolving competition of the pay TV market in the United States and continue to grow in Latin America.

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A Little Turbulence in Recent Results
DIRECTV has definitely given investors and analysts some data points to chew on over the past couple of quarters. The June quarter saw the first quarterly net loss of U.S. subs, as the company followed a path similar to Dish Network (Nasdaq:DISH) in tightening up its promotions and credit standards.

While the September quarter saw the U.S. net sub loss reverse back to growth, there was much higher churn. Some of this was tied to a programming dispute with Viacom (Nasdaq:VIA), but it's at least worth asking whether some of this was also due to the anniversary of the company's more aggressive NFL Sunday Ticket promotion (with subscribers expecting/demanding more concessions to stay).

Then there's also the question of what's going on in Latin America. Although the Brazilian economy (and the economies of many other Latin American countries) has slowed down, pay TV is still a hot sector. Nevertheless, the company has been margin-conscious in approaching sub growth lately and adverse currency moves drove average revenue per user down by double-digits in U.S. dollars.

Can Satellite Survive the Latest Evolution of U.S. Pay TV?
DIRECTV and Dish Network have proven that they can stand shoulder-to-shoulder with traditional pay TV providers. This has been the case even as cable rivals like Comcast get more aggressive about multiple service offerings (phone and Internet) and the acquisition of content.

Now, though, the pay TV world is changing again. Verizon (NYSE:VZ) and AT&T (NYSE:T) are looking to make fiber to the home a reality, even if the pace of the roll out has been slower than originally forecasted.

Perhaps the even bigger threat, though, is in how consumers are increasingly looking to access television content. Companies like Netflix (Nasdaq:NFLX) and Hulu are increasingly offering the on-demand, a la carte options that many pay TV customers have long said they wanted. It's worth asking how much of a threat this really is to DIRECTV, given that its customers tend to be more serious TV-watchers and are more willing to pay up for advanced services, but it bears watching.

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Will Competition in Latin America Stay Rational?
As the standards of living improve in Latin America, the pay TV market opportunity continues to grow at a rapid pace. The biggest question in my mind, though, is whether the competition will stay rational, or whether there will be waves of price-cutting and subsidies designed to grab share today at the cost of long-term returns.

There's good and bad news on this front. The presence of America Movil (NYSE:AMX) as a competitor in major markets like Brazil is both good and bad news. The good news is that America Movil needs the growth of the Latin American pay TV market to help offset the flagging growth of its mobile phone business; the bad news is that America Movil is going to compete aggressively (if rationally) for customers and has a lot of capital behind it.

The Bottom Line
It may well be time for DIRECTV and Dish Network to try again to get a merger past U.S. regulators. The synergies of de-duplicating their infrastructures and marketing efforts should be significant, and regulators may be willing to accept that the pay TV market has changed enough that having one satellite provider doesn't dramatically alter the competitive landscape. By the same token, though, both companies are more than viable on a standalone basis and that may present insurmountable challenges to a merger in the near term.

If investors are willing to look past the sizable debt load of DIRECTV, the shares look as though they could still offer upside to shareholders. Mid-single digit free cash flow growth suggests a fair value in the high $50s to low $60s, and ongoing growth in Latin America, coupled with better margins in the U.S., could make that sort of growth realistic over the next decade.

At the time of writing, Stephen D. Simpson owned shares of America Movil since 2007.