DirecTV Now In Liberty Media's Hands: Analysts Play Out the Scenario

As I posted last week, the Wall Street Journal has reported that News Corp. (NWS) was getting very close to concluding its much discussed talks to sell its 39% stake in DirectTV (DTV) to Liberty Media (LINTA) (LCAPA). That has triggered a flurry of analyst speculation on what Liberty’s John Malone might do with DirecTV once the deal is closed.

The latest to weigh in on the subject is Deutsche Bank’s Doug Mitchelson. This morning, he raised his rating on DirecTV to Buy from Hold; he also increased his price target on the stock to $30 from $22, and raised his earnings estimates for the company.

Mitchelson lays out a multi-part thesis for owning the shares. One, he thinks the company could become a leader in providing high-definition content. He notes that in mid-to-late 2007, the company will launch two new satellites which will given the company the capacity for 150 national high-def channels and 1500 local high-def channels, “likely placing DirecTV in the highest capacity position of any pay TV company.”

Meanwhile, he also thinks that once Liberty gains control of DirecTV, the company will take a more aggressive approach on its capital structure, levering up the balance sheet by as much as $9.5 billion to $13.5 billion and using the proceeds for share repurchases and “potentially a sizeable special cash dividend.” He also thinks a change of ownership could lead DirecTV “to more aggressively consider and pursue strategic alternatives including a merger with Echostar (DISH) or sale to an RBOC or private capital group.

Mitchelson raised his 2006 EPS estimate for DirecTV to $1.03 a share from 96 cents. He reduced his 2007 estimate to 86 cents, from $1.31 - that assumes the company pays out a $10 billion cash dividend, or about $8 a share. With no dividend, his estimate $1.21. For 2008, he’s now at $1.33, down from $1.62; assuming no dividend, he sees $1.70.

On an interesting but more minor point, Mitchelson also wonders whether DirecTV’s set-top box strategy could change: one consequence of Rupert Murdoch’s control of the company is that DirecTV gradually began phasing out the use of TiVo (TIVO) set-top boxes in favor of hardware built by NDS (NNDS), another company Murdoch controls. Mitchelson wonders if “Direct might be interested in re-emphasizing TiVo other third party providers” with a change in control.

While we’re on the subject of DirecTV, I dug back into my pile of research not-quite-blogged from last week, and found a couple of other tidbits that I want to pass along on the company.

Craig Moffett, from Bernstein Research, who is bearish on DirecTV, says there are three common scenarios for what Malone would do with the satellite broadcaster:

- He could merge DirecTV with EchoStar. Obvious risk: regulatory approval - a deal to merge the two companies was struck down as anti-competitive in 2002.
- John Malone could tender for additional shares. Moffett says that John Malone has been quoted saying the current stock price is already too high; if true, buying more seems unlikely.
- Liberty could lever up DirecTV to pay a special dividend. Moffett says DirecTV is “unquestionably underleveraged,” and obviously Deutsche Bank’s Mitchelson thinks so as well. He does note that levering up would result in big cuts in earnings estimates for a company which has been running up on positive earnings revisions.

Douglas Shapiro, an analyst with Bank of America, theorizes that Liberty’s desire not to run afoul of the Investment Company Act of 1940 - in other words, to avoide being treated as a mutual fund - could drive the company to raise its stake in DirecTV to above 50%. One way to do that, he says, would be for DirecTV to buy back enough stock to push Liberty’s stake above 50%; after that Liberty could “contemplate taking in the minority shares.”

DirectTV shares closed today up $1.21 to $25.49 - a gain of 5%.

DTV 1-yr chart: