DirecTV: Higher CapEx Pushing Out FCF Ramp

Key points from Kaufman Bros. analyst Todd Mitchell's recent note to clients reviewing DirecTV's (DTV) 4Q06 earnings. (For a full-length version of this report, click here).

Higher spending will negatively impact 2007 FCF. DirecTV's 4Q06 results were impressive. Sub metrics were better than expected across the board, and the message was reinforced by 2007 guidance. However, higher activity means higher spending, pushing out DirecTV's FCF ramp. We estimate consolidated FCF will be flat in 2007 at $1.2 billion. We do not think multiple expansion is warranted, despite the sharp turnaround in operating results in 4Q07.

Strong sub growth reversed a long deceleration. DirecTV saw its first positive gross add comp in a year and churn dropped to less than 1.6% after four quarters at 1.7% to 1.8%. As a result, 275,000 net adds were up 38% from 200,000 a year ago. Higher growth came from a strong consumer offering and growth in the direct channel. Management attributed lower churn to a number of factors, but a swing of this magnitude can only reflect a change in policy.

Growth was garnered at a relatively high ROI. Total SAC per gross add of $626 was about $30 less than expected. DirecTV saw a tremendous amount of upgrade activity and said it deployed more than 500,000 HD DVR. ARPU rose nearly 7% to $80.70 on growth in HD and DVR service and a strong comp for Sunday Ticket. With a 5% increase in total subs, this translated into a 12% increase in revenue to $3.8 billion.

Increased activity is driving higher capital spending. DirecTV reported 4Q06 EBITDA of $876 million, up from $442 million in 4Q05, with growth due entirely to the capitalization of CPE costs. Without this, EBITDA would have been $468 million, up just 6%. In 2006, DirecTV capitalized $1.1 billion in CPE expense, for total capital expenditures of $1.8 billion. As a result, 2006 FCF for DirecTV U.S. was $545 million versus $535 million in 4Q05. Consolidated FCF was $1.2 billion, up from $283 million due to a favorable tax situation.

DirecTV expects similar trend to continue in 2007. Guidance is for flat gross and net adds in 2007, with churn down to 1.5% from 1.7%. APRU is expected to grow 6% and revenue 12%e. Higher programming costs will be offset for no change in premarketing cash flow margins. SAC is expected to be stable at the low end of $650 to $700, and EBITDA and operating income are expected to grow 20%. Capital expenditures are expected to be $2 billion in 2007, up from $1.8 billion in 2006.

We think Consolidated FCF could be flat in 2007. We now forecast gross and net adds to be flat in 2007 at 3.8 million and 820,000. We look for DirecTV revenue to grow 12% to $15.6 billion, EBITDA to be up 23% to $3.97 billion. We expect capital expenditures of $2.0 billion, and a 70% increase in FCF to $928 million. We expect consolidated revenue to grow 15% to $17.0 billion, with DLA contributing $1.6 billion. We project consolidated EBITDA of $4.05 billion, a 21% increase from 2006, but think consolidated FCF could be flat at $1.2 billion if DirecTV pays any cash taxes in 2007.

Stock has had a good run, and further upside is speculative. Shares of DTV have more than doubled in the past 12 months and are no longer cheap. Our price target of $26 is based on 17.5x 2010E UFCF discounted to PV at 10.7% Alternatively, at $26 DTV is trading at 28.0x 2007E FCF, and 19.0x 2007 EPS, while we estimate the 2006 to 2010 CAGR for FCF is 25%, and 18% for EPS, in line with current multiples. There maybe some further upside from a recapitalization of the balance sheet, but that is a different issue.