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DISH's Stock Vs Its Bonds - HY Coverage On Bonds

|Includes: DISH Network Corporation (DISH)
Summary

DISH Stock has taking a multi year beating due to loss of subscriber base , stiff competition in the Pay-TV market by giants like AT&T, Comcast , and recent mergers.

DISH is trading at 6 year lows with a Moody’s downgrade in April 2018 to B1 Issuer rating and PD rating of Ba3. S&P also has the company’s outlook listed as"negative"

Against this backdrop DISH’s bond term structure seems interesting. We will analyze the Financials at high level, understand the key risks and potential upsides to make a case that there is opportunity in.

May 2022’s trading around 94 to 95 range as of Jan 21 2019.

Financials and Fundamentals

DISH hasn’t releases its Q4 earnings and under assumption they are same as Q3-18’, the financial data below shows the last 6 years of performance. The financials aim to show that the company’s margins remain strong with a strong focus on cost control. Company’s cash at hand is low however cash flow from operations and leverage ratios remain healthy near term to service debt for next 2 years.

Numbers in $ in 000s

2018 (E)

2017

2016

2015

2014

2013

Income View

Revenue

13,709,614

14,391,375

15,212,302

15,225,493

14,643,387

13,904,865

Total Cost and Expense

(11,482,042)

(12,823,610)

(12,893,041)

(13,797,121)

(12,818,936)

(12,556,686)

Add back Depreciation

716,244

817,564

921,202

963,357

1,077,936

1,054,026

Net SGA expense

(10,765,798)

(12,006,046)

(11,971,839)

(12,833,764)

(11,741,000)

(11,502,660)

EBITDA

2,943,816

2,385,329

3,240,463

2,391,729

2,902,387

2,402,205

Interest Expense

(13,039)

(63,172)

(53,141)

(494,081)

(611,209)

(744,985)

Adjust for DEBT Interest expense capitalization post 2015

(873,661)

(879,453)

(907,359)

Taxes + other expense + depreciation

(1,261,032)

(223,468)

(1,689,383)

(1,095,274)

(1,346,485)

(849,728)

Net Income (ex comprehensive income charges)

$1,669,745

2,098,689

1,497,939

802,374

944,693

807,492

EBITDA Margin

21%

17%

21%

16%

20%

17%

Gross Margin

12%

15%

10%

5%

6%

6%

IE Expense/Net Inc.

1.9x

2.2x

1.6x

1.6x

1.5x

1.1x

Cash Flow View

From Operations

2,687,645

2,779,507

2,854,247

2,459,123

2,408,131

2,309,197

From Investment’s - Cap Ex

(1,544,033)

(6,521,265)

(1,737,657)

(8,062,084)

(983,924)

(3,034,857)

FCC License acquisition /spectrum /auctions

(1,020,319)

(4,711,154)

(1,500,000)

(8,570,389)

(2,663,372)

(328,134)

Other (Equipment/Marketable Securities sales)

(523,715)

(1,810,111)

(237,657)

508,305

1,679,448

(2,706,723)

Financing Flows

(1,476,671)

(103,237)

3,153,930

(448,200)

980,267

1,851,940

Free Cash Flow (FCO)

(333,059)

(3,844,995)

4,270,520

(6,051,161)

2,404,474

1,126,280

Interest coverage ( IE/ FCO)

-262%

-23%

21%

-8%

25%

66%

Balance Sheet View

Cash and Securities

$1,865,149

1,980,673

5,360,119

1,611,069

9,236,241

9,739,404

Plug for other Assets ( which are mainly FCC licenses)

28,272,261

27,793,093

22,554,173

21,275,641

12,871,221

10,617,026

Short term liabilities

4,877,597

4,828,004

4,592,832

5,162,940

4,112,525

4,551,649

Long Term Debt + Capital Leases

13,790,114

15,134,441

15,541,736

12,221,925

13,782,313

12,596,793

Plug for Liabilities ( deferred tax , revenue, non-controlling interest etc.)

3,226,661

2,873,415

3,168,401

2,753,058

2,200,490

2,210,983

LT Debt/Total Assets

46%

51%

56%

53%

62%

62%

ST Liab/ Cash

262%

244%

86%

320%

45%

47%

Equity View

% of Convertible debt / LT Debt

21%

13%

19%

Preferred stock

0

0

0

0

0

0

Leverage

46%

51%

56%

53%

62%

62%

Shareholder Equity

8,386,949

6,937,906

4,611,323

2,748,787

2,012,134

997,005

Common Shares outstanding (diluted, A+B)

525,752

522,596

484,162

464,697

462,927

459,166

Book Value

15.95

13.28

9.52

5.92

4.35

2.17

Date

Nov-7-2018

Feb-21-2018

Feb-22-2017

Feb-23-2015

Feb-21-2014

Actual Stock Price ( after Q4 earnings release)

32.16

43.87

61.91

46.42

57.37

35

P/E ( past earnings)*

10.13

10.92

20.01

26.88

28.11

19.95

CHECK

0

0

0

0

0

Long Term Debt Rating

B1 (Moodys)

Ba3 ( Moodys)

Empirical 1yr PD for a name downgraded to B1

2.8%

Analyzing Financials 

  • As of Sep 2018, DISH’s had 12.656 million Pay-TV subscribers in the United States, including 10.286 million DISH TV subscribers and 2.370 million Sling TV subscribers. The average loss in subscriber base has been around 2% in Pay-TV but company is adding more Sling Subscribers each quarter
  • Bulk of revenue is still dominated by Pay-TV and faces competition from DirectTV which was acquired by AT&T and Time Warner Cable which was acquired by Charter Communications. That leaves DISH competing with major players like AT&T, Charter, Comcast and Verizon and smaller players like Optimum and other streaming companies like Netflix, HBO, and Sony PS3 in steaming market for Sling.
  • DISH’s business model has been to buy FCC licenses, own or lease satellites and develop DVR technology to provide Pay-TV (i.e. cable television) to individual and commercial enterprises. They have had a loyal consumer base with churn rates in range of 2% to 2.5% and ARPU of $86.29 (net profit per subscriber) which is 1% lower in FY-18’ vs. FY-17. DISH also gets lower customer reviews in Sports television options compared to DirectTV but has higher customer satisfaction in news, movies and international options
  • DISH Hopper DVR is known for its many features such as capability of storing hours of content (including HDR), add free playback and recently its announced working with Google to make it more adaptable to voice commands and home safety features
  • DISH is also trying to make strides in IoT and 5G capable broadcasting and wireless broadband services though the financial health of its balance sheet makes it less competitive and prone to slow death in next 5 years without a strategic cash rich partner
  • Recent insider transactions with buys have been reported as of Jan 2019
  • This leaves me with a neutral outlook for DISH Stock near term

Analyzing DISH's Capital Structure

  • Dish issues bonds mainly via its DISH DBS Entity. These are sr. unsecured fixed rate debt for most part ( expect Convertibles) and in event of bankruptcy may not be able to lay claims to the more lucrative FCC Spectrum license which are roughly worth 21Billion on the balance sheet. These assets are controlling interests (which DISH has capitalized and consolidated) in AWS-3, North Star entity’s to new a few important ones.
  • During 2016, DISH did an accounting change which I have readjusted to calculate true interest expense. The rationale as given in 2016 10k was mainly due to capitalizing interest expense related to wireless Spectrum acquisition and also issuance of Convertible notes to refinance maturing fixed rate debt.
  • Most notable in DISH’s debt structure is now the addition of two convertible bonds in 2016. These bonds reduce the financing costs, but dilute equity (roughly 13 shares per 1000 Par on strikes of around 68 to 85). These bonds potentially can lay claims to those Spectrum FCC assets since these are issued by the Parent though in the 10k they are listed as structurally subordinated to DISH DBS's senior unsecured liabilities.

Convertibles in Capital Structure

Notional

2 3/8% Convertible Notes due 2024

1,000,000

3 3/8% Convertible Notes due 2026

3,000,000

  •  A word of caution, DISH’s cash at hand to meet short term liabilities is deteriorating as can be seen in STLiab/Cash ratio in Table. For DISH DBS Bonds, the actual Debt/Asset ratio is are lot higher is spectrum assets are removed (> 100%). Below are the snap shot of licensees from 2017 year end

FCC Authorizations in '000s

2017

DBS

611,794

700MHz

711,871

MVDDS

24,000

AWS-4

1,949,000

H-Block

1,671,000

AWS-3

9,890,389

600 MHz

6,211,154

Capitalized Interest

2,656,075

Total

23,725,283

  •  Dish’s PV01 for a 10% moves in Interest rates is 370Million. Hence, interest rate sensitivity won’t materially eat into earnings 

  • As mentioned in its latest 10q from Sep 2018, DISH expects to deploy next-generation 5G-capable network, focused on supporting narrowband IoT. The first phase of network deployment will be completed by March 2020, with subsequent phases to be completed thereafter. They expect a $ 1 Billion cash expenditure until 2020 but post 2020 for second phase deployment a tune of $ 10 Billion. This is where they are possibly in lookout for a strategic partnership.

  • Though speculation and less probable as of now per DISH’s own management analysis , any potential talk of cash injection and partnership can cause the valuations of DISH to go up significantly

  • DISH also states that it runs impairment tests on all its capitalized FCC licenses it has acquired and that carrying value is lower than fair value.

  • As of Jan 2019, DISH’s EBITDA margins and Gross margins, interest coverage to EBITDA all indicate that it can service its debt until 2020 if it focuses on keeping costs low and not spending more on licenses. However its ability to generate free cash flows in 2019 and beyond causes me to assign negative outlook when trading this debt which can jump to default / workout if the general economy does fall into recession and loss of subscriptions accelerates more than usual 2.5% churn.

Technical Analysis

As of Jan 22nd, price snapshot of DISH Bonds (source Bloomberg)

Notes

Outstanding

Price

7 7/8% Senior Notes due 2019 (2)

1,337,469

102.18

5 1/8% Senior Notes due 2020

1,100,000

100.19

6 3/4% Senior Notes due 2021

2,000,000

101.32

5 7/8% Senior Notes due 2022

2,000,000

94.86

5% Senior Notes due 2023

1,500,000

86.56

5 7/8% Senior Notes due 2024

2,000,000

82.82

2 3/8% Convertible Notes due 2024

1,000,000

82.96

7 3/4% Senior Notes due 2026

2,000,000

87.00

3 3/8% Convertible Notes due 2026

3,000,000

85.00

The Price for 5 7/8% July 2022 vs. Stock price is shown below (source Bloomberg) as of Jan 22nd

As can been seen, similar to almost all HY names, DISH’s May 2022 took a sharp plunge when market’s sold off and have not yet recovered back to November levels. This might give some short term technical price support in near term if Q4 earnings are in line with expectations.

Some Derivative mathematics now required from CDS market (  bear with me)

  • Say we used all the Bond price data from 12/31/2018 and compared that to Bond price data as of Jan 22nd2019 to construct a CDS Spread curve, we can extract the market’s implied probability of survivals for DISH as shown below.
  • As can been seen , the market’s general selloff in December implied a roughly 8% higher probability of default than on Jan-22ndand there is further room to go down should DISH’s financial outlook improve in next 12 months

Trade Idea , Recommendation and risk management -

  • Amidst this backdrop, the only lucrative bonds where you can get a potential Mark to market gain , which gets pulled to par as long as no default scenario is materializing and still earns 5.875% coupon is the May 2022 ( USU25486AE80 ). The yield on this is roughly 7.65% and around 260bps lower than Yield on 7 3/4 2026 Bonds the June 20207 bonds. That yield pickup comes at a significantly higher default probability. Hence, longer paper on DISH’s books is akin to equity.
  • Though is a HY name and not a distressed name yet , the Converts are more preferred for longer durations since they can potentially have high recovery due to spectrum asset claims. For risk management, enter May 2022 positions with a lower bid (say around 93.5 limit and increase tick size). Watch for earnings misses. Have a strategy to sell at 90 ( bonds low in Dec 2018) and exit in case EBITDA margins are getting worse and cash from operations shows drop below $ 2 Billion mark. I think without a moderate to severe recession, chances of DISH bonds surviving until 2022 are much higher than implied by market. A potential partnership can also boost the fortunes of DISH stock holders lifting up bond prices.
  • Compare this with much riskier high dividend equity ETF strategies like say KBWY, GSBD and you get a better yield pickup for much lower volatility for 3 years out.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.