* Malone to take DirecTV off Murdoch's hands. It has been widely reported that Liberty Media (LINTA) and News Corp. (NWS) have reached a deal to trade Liberty Media's 19% interest in News Corp. for News Corp.'s 38% interest in DirecTV plus some cash and assets. This will effectively cement the Murdoch family's control over News Corp., and put DirecTV under the control of Liberty Media, which also owns QVC, the Discovery Networks and STARZ.
* The trade is really a mixed bag for shareholders. We think that DirecTV would gain significantly more from a close alliance with News Corp. than from anything Liberty Media can offer it, which dampers our long-term competitive outlook for the platform. However, the company is in the midst of a cash flow inflection, and Liberty's less aggressive tendencies are likely to improve the outlook for this metric over the more visible future.
* Liberty makes DirecTV look less dynamic. Liberty will use DirecTV to help its programming. News Corp. would do the same, but News Corp.'s experience with other DBS platforms gives us greater confidence this would be mutually beneficial. Malone will have an incentive to invest in broadband and interactive in so much as it can help QVC and STARZ, but Fox has sports, news and reality programming which could be recast to help DirecTV maintain its position as a differentiated multichannel offering.
* Results in 4Q06 are also likely to send a mixed message. DirecTV is benefiting from HD growth and aggressive efforts by its telco bundling partners to offset cable's push into voice. Results could not be worse than last year's fourth quarter, so gross and net add comps should be positive. However, execution issues exist. One only needs to talk to a DirecTV HD DVR user to find a user that has had problems, so results are likely to be less impressive than they should be.
* DTV is no longer inexpensive and is beginning to look overbought. DirecTV is at our $24 price target, and trading at 24.0x 2007E FCF and about 15.0x 2008E FCF. Even with the potential for upside from a less aggressive steward, this is no longer a discount valuation. Moreover, the stock has recently had several positive catalyst, not the least, inclusion in the S&P 500. We believe the potential for less-than-stellar results in 4Q06, and investor discomfort with being a minority shareholder in John Malone's world could put downward pressure on the stock.
* We value DTV at $24 based on a DCF analysis. Our price target is based on 14.4x 2009 UFCF discounted at 10.0% for an EV of $27 billion, or $1,750 per 2006E sub. Our $3.0 billion valuation for DLA is confirmed by a similar analysis, which uses a terminal multiple of 40.0x and a discount rate of 14.5%. At our $24 price target, excluding DLA, DTV is trading at 6.0x 2007E EBITDA, 21.0x 2007E EPS, 28.0x 2007 FCF and $1,750 per 2006E sub.
We view investment in DirecTV as moderately speculative.