Robust DirecTV Puts Pressure On Cable

By | August 4, 2003 | Feature

By Jimmy Schaeffler

Hughes Electronics [NYSE: GMH] and its satellite TV unit DirecTV are proving the validity of their newest subscriber-based business model that focuses on better, rather than more, customers. The latest batch of evidence was revealed when Hughes and DirecTV reported second quarter financial results July 16, when just about every financial metric indicated improvement.

The positive results caused Hughes’ stock price to rise and close at $13.78 on July 30. In fact, the only financial measurement that still is a burr in the Hughes/DirecTV corporate saddle is subscriber acquisition costs (SAC).

Overall the Hughes/DirecTV data indicate positive signs ahead for direct broadcast satellite (DBS) services. At the same time, cable TV operators in the United States continue to grapple with issues such as churn among digital cable subscribers, subscriber management mediocrity, and effective marketing of “bundled digital” services to consumers.

Since current DirecTV President Roxanne Austin took over from Odie Donald in mid-summer 2001, she has worked on three key projects. First, she streamlined the company in a cost-cutting move. Second, she is preparing the company for its sale to News Corp [NYSE: NWS]. Third, she has successfully implemented a business model based on cultivating “quality subscribers” who pay more per month for services and are the least likely to churn. This business model targets credit-worthy subscribers, rather than welcoming subscribers of just about any credit level.

Positive Results

A conference call featuring top executives from Hughes and DirecTV last month showed that both companies appear to be on track. The call featured Austin; DirecTV Chairman and CEO Eddy Hartenstein; Hughes President and CEO Jack Shaw; Hughes CFO Mike Gaines; Hughes General Counsel and Executive Vice President Larry Hunter; Hughes Investor Relations Vice President Jon Rubin; Hughes Network Systems President Pradman Kaul; and DirecTV Latin America President Larry Chapman.

Shaw expressed optimism as he highlighted a 40 percent rise in operating profit, between the second quarter of 2003 and the same quarter in 2002, that reached approximately $325 million for Hughes as a whole. Based on the company performance, Shaw offered guidance that the company’s revenue would reach an impressive $9.7 billion-$9.8 billion for 2003.

Additionally, Hughes announced that it had settled a dispute for approximately $360 million with Boeing [NYSE: BA] over the sale of the Hughes satellite manufacturing facility during 2000. Hughes agreed to cover any “unresolved claims” arising from the transaction.

Also worth noting is that the launch of Spaceway’s first satellite was pushed back from late 2003 to the first quarter of 2004. Hughes Network Systems also revised upward its DirecWay unit subscriber level to 166,000 North American residential and small office/home office (SOHO) customers at the end of June. Plus, HNS’ set-top box division shipped 750,000 units during the second quarter of 2003, versus 512,000 units for the second quarter of 2002, to mark a 50 percent increase year-over-year.

Key DirecTV Data

Austin spoke about four key DirecTV benchmarks that looked particularly positive – revenues, net subscribers, operating profit before depreciation and amortization, and cash flow. Particular attention has been paid to better managing DirecTV’s expenses, which has resulted in better margins and cash flows. For Hughes company-wide, second quarter revenues rose more than 8 percent to $2.4 billion, versus $2.2 billion a year earlier. Net income was particularly impressive, at $21.6 million for the second quarter of 2003, versus a loss of $155 million for the same quarter in 2002.

During the second quarter, DirecTV brought in a better than expected 181,000 net new subscribers. This gain is important because it does not include subscribers that are primarily controlled by DirecTV’s rural franchisees, Pegasus [Nasdaq: PGTV] and the National Rural Telecommunications Cooperative (NRTC). Because of the net new subscriber performance during the first half of 2003, DirecTV raised its year-end subscriber guidance to 900,000, up from prior guidance of 800,000 to 850,000. The 181,000 net additional subscribers were the result of 633,000 gross additional subscribers signed during the quarter. Austin attributed this success to the addition of many new local-into- local (LIL) markets, a new customer marketing campaign and ramp up for the NFL Sunday Ticket package.

These benchmarks are particularly good news for shareholders of News Corp. and its Fox Entertainment [NYSE: FOX] unit because they would benefit from the rising value of DirecTV if the proposed acquisition of Hughes and its business units proceeds as expected.

The second quarter of 2003 marked the second consecutive quarter in which DirecTV was cash flow positive. It also marked the third consecutive quarter of holding subscriber churn at 1.5 percent or less, and the seventh quarter in a row of improved year-over-year revenues. The reduced churn is impressive because of DirecTV’s March 2003 price increase of a couple of dollars per basic package. Overall, DirecTV generated second quarter revenues of $1.8 billion. The company’s operating profit rose to $201 million, compared to $61 million a year ago.

DirecTV’s SAC for the second quarter came in at just shy of $600. That number means the typical subscriber becomes a profitable customer about ten months after first subscribing. The SAC for the first half of the year now stands at $565. DirecTV rationalizes this higher SAC by noting new subscribers with several set-top boxes are less like to churn and create higher ARPU (average revenue per unit).

And EchoStar?

EchoStar Communications [Nasdaq: DISH] will hold its second quarter analysts’ conference call Aug. 13, when industry observers can compare if DirecTV’s performance is reflective of an industry-wide trend for improving performance in the U.S. DBS industry. EchoStar also made news last month by forging an video/high-speed Internet alliance with regional telephone company SBC Communications [NYSE: SBC], which is providing $500 million in debt financing to EchoStar. The companies also agreed to collaborate through a marketing and management agreement. The new agreement would: 1) add marketing muscle to EchoStar’s business, 2) cause EchoStar to cede service of the customers signed up by SBC to the telephone company, and 3) position the companies to deepen their relationship down the road. If EchoStar Chairman Charlie Ergen wanted to sell his company to a big telephone operator in the future, the deal with SBC could be viewed as the first mile in what certainly would be a long road.

And The Numbers, Please…

DirecTV’s ARPU rose during the second quarter because more set-top box were deployed per household, there was a price increase, and local-into-local markets were added. ARPU for DirecTV now stands at a multichannel industry leading $60.90 a month, which produces revenue of more than $704 million a month, or roughly $8.5 billion a year. DirecTV’s subscriber base now stands at 11.56 million. The overall DBS industry has roughly 20.4 million subscribers, or 22.7 percent of the almost 90 million U.S. multichannel subscribers. EchoStar’s total DBS subscriber base is an estimated 8.82 million, or roughly 43.2 percent, leaving DirecTV with the remaining 56.8 percent of DBS subscribers.

DirecTV’s market share is shrinking slowly, month-by-month, as EchoStar gains more new subscribers faster by remaining the low-priced provider for budget-conscious consumers. That same share was less than 40 percent about 18 months ago. That trend should continue during the third quarter, traditionally the slowest quarter of the year, and the fourth quarter, generally the strongest.

DirecTV added an estimated 275,000 net new subscribers in the second quarter (including NRTC subscribers), versus EchoStar’s estimated 350,000 for the same quarter. Together, second quarter 2003 net new additional subscribers for both DirecTV and EchoStar reached an estimated 625,000, which is 175,000, or 22 percent less, than the 800,000 subscribers added by both companies in 2002. This gap indicates a slowing of U.S. DBS growth but not as much as many analysts had projected. As a result, cable still needs to look backwards as it runs up a steep, competitive multichannel hillside.

Jimmy Schaeffler is a subscription TV analyst at The Carmel Group, a consultancy based in Carmel-by-the-Sea, Calif., (http://www.carmelgroup.com). The company specializes in telecommunications (e.g., cable, satellite, broadcast and wireless), as well as computers and the media. He can be reached by e-mail, jimmy@carmelgroup.com, or by telephone, 831/643 2222.

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