Charlie Ergen, the billionaire founder of Dish Network Corp. (NASDAQ:DISH), is not shy about pursuing the holy grail of the telecommunications industry. Over the next ten years, he wants DISH to become a provider of three major services, Internet, video and voice service, both on mobile devices and in the home, which is something no other firm has been able to do effectively. DISH has been laying the groundwork for this quest over the past few years through such efforts as the purchase of Blockbuster out of bankruptcy, as a path into the streaming media business, and through the acquisition of two satellite operators, in order to acquire the spectrum necessary to create a wireless broadband business. If DISH can succeed in this aggressive strategy it would transform the company into something much more than a satellite pay-TV provider.
DISH is the nation's third largest subscription-based television service provider, with 14 million customers, which represents approximately 14% of total pay-TV subscriber market in the U.S. The firm offers a variety of local and national programming, is a technology leader in its industry, and aims to provide outstanding customer service. The company owns or leases capacity on 13 satellites, and subscribers receive programming via a satellite dish and receiver. The company is based in Englewood, CO and has approximately 34,000 employees.
DISH is quite cheap, especially considering its sizeable market capitalization, and resides comfortably within our universe of the top 10% cheapest stocks, with an EBIT/EV yield of 18.3%. Below are some additional summary statistics for the company.
Developing a satellite pay-TV business is a highly capital intensive process, requiring investment in numerous assets, including satellites, scarce transmission bandwidth, programming content, subscriber equipment and its installation, advertising, customer call centers, and FCC and other government licenses. The high initial fixed costs associated with the creation of such a complex content distribution network serve as a deterrent to new startup entrants. Many argue that due to this dynamic the satellite pay-TV industry has effectively evolved into a duopoly, consisting of DISH and its larger competitor, DirecTV (DTV).
DISH's approach to the market has been to be the low cost provider of satellite TV service, which it promotes through its "everyday value" branding message, with monthly packages starting at $19.99. It seems reasonable to attribute these low prices to significant economies of scale. Additionally, the company's customers have lower levels of disposable income, and tend to be value conscious; thus, switching costs are high for these customers, which has the effect of stabilizing the company's customer churn rate. Finally, DISH boasts an established and recognized brand, which it supports and enhances through customer service and advertising.
Within the satellite pay-TV market, which has high barriers to entry due to the heavy investment required, DISH is a large, low cost service provider with significant market share and a customer base with low turnover. These appear to be the ingredients of a franchise with an economic moat. Next we turn to our quantitative output to assess DISH's economic moat, and reduce its franchise power to a single number.
The company boasts solid normalized (8-year, geometric mean) return on assets of 10.9% and normalized (8-year, geometric mean) return on capital of 19.0%, and these results place it in the 90th percentile for each of these categories, within our universe of cheap stocks. Long term free cash flow (8-year cumulative FCF) / assets is 67.9%, which places the company in the 91st percentile. DISH has also shown reasonable margin stability, with a normalized (8-yr average) gross margin / gross margin 8-yr standard deviation of 9.3, which places the company in the 51st percentile. When we take an average of these percentile scores, we find that DISH's average is 81% - just shy of the 95th percentile breakpoint of our universe - indicating solid franchise power.
In general, it appears that while the company's margin stability is merely average for our universe, normalized returns on assets and on capital are very impressive, as is the company's long run free cash flow generation record. It should be noted that these percentile scores are relative to the cheapest decile of our screening universe. This means that within this smaller universe of already cheap stocks, DISH is demonstrating durable franchise power - not bad for such a large capitalization stock.
DISH is currently profitable, generating a 11.6% return on assets, which exceeds its long run average (see Franchise Power above), and FCF / assets is also strong at 16.3%, although this metric is slightly below its long run average. Free cash flow exceeded net income, indicating the company is not using accruals aggressively, and this earns the company another point. Overall, we give the company three out of a possible three points for profitability.
Turning to our stability measures, our next component of financial strength, DISH's leverage, scaled by its assets, is increasing versus a year ago, and so we withhold a point. Its current ratio decreased by 6.4%, which signals a statistical reduction in liquidity, which also fails to earn the company a point. Finally, we review DISH's net equity issuances, scaled by assets. It turns out that over the past year DISH has been a net issuer of equity versus its asset base, which also fails to gain a point. Our quantitative stability measures give the company a score of zero out of a possible three for stability. An analyst might review the company's leverage and share issuance trends, and its liquidity situation to get more comfortable with DISH's overall stability.
Recent operating improvements
Next we review the company's recent operating improvements. Return on assets has decreased versus a year ago, which is a bad sign and fails to earn the company a point. FCF / assets increased versus a year ago, and this operating improvement wins a point. Gross margins increased YoY, which causes us to award a financial strength point. Asset turnover has increased versus the prior year, indicating a more efficient use of the company's assets, which is worth a point. In the long run, one might hope for continued increases in asset turnover, as the incremental asset base required to service a marginal customer declines, based on leveraging the high fixed start up costs of the business discussed earlier. Overall, the company scores three out of a possible four points in connection with its recent operating improvements.
On our various Financial Strength metrics, DISH scores 6 out of a possible 10 points overall. Statistically, DISH appears to be solidly profitable, and is showing multiple statistically important recent operating improvements. There are some questions around the company's stability, as regards share count, liquidity and leverage, and these would be areas for an analyst to review.
Summary and Conclusions
DISH is cheap company, with an 18% earnings yield and a single digit P/E. On this basis alone, the stock merits consideration, but it is the quantitative quality measures that set it apart.
DISH is a large capitalization company that controls almost one sixth of the national pay-TV market, and has made a significant investment in that market, which would tend to discourage new startup entrants due to the significant investment required. It is the low-cost service provider, which implies high switching costs for its subscribers, enjoys economies of scale, and it operates in what has effectively become a duopoly. These factors suggest the presence of an economic moat, and the numbers seem to support this. In particular, the company has shown strong margin growth and solid free cash flows over the past 8 years, and averages a solid score of the 81st percentile across our franchise power metrics. The company is showing solid profitability and is showing a variety of signs of recent operating improvements. The company's stability metrics raise some questions; an analyst might want to review recent changes in leverage versus assets, and liquidity ratios, as well as dilution caused by stock issuance to determine whether these trends will continue.
The stock may be cheap since subscriber growth has slowed recently, versus earlier growth rates. Charlie Ergen, however, has articulated a bold vision for the company, involving its entry into the Internet, video and voice markets at home and on the go, which he has stated could occur over the next 10 years. This would reinvigorate the franchise going forward, and stockholders would therefore get a call option on this upside potential. Even if the company does not totally succeed, the assets related to this effort have value, in particular the wireless spectrum. Some believe that these spectrum assets alone makes DISH a compelling acquisition target, perhaps for a large telecommunications company. An analyst could explore these themes, for instance by assessing the value of the embedded spectrum as part of a sum-of-the-parts valuation.
Finally, the company passed our screens for manipulation and financial distress, scoring a 3/3 for safety. The numbers are suggesting that statistically the company does not appear to be showing obvious signs that its equity is overvalued. Please refer to our web site for additional discussion of these metrics. DISH scores in the 81st percentile for Franchise Power, and a 60% (6/10) for Financial Strength, and thus its overall quality score (average of these two metrics) is 70%, which earns it a top 10 finish in our universe of the top decile of cheap stocks. DISH appears to be a cheap, safe, high quality, large capitalization franchise allowing participation in the satellite pay-TV space, and offers some upside due to the broader strategy it is pursuing.
Disclosure: I am long DISH.