Why DirecTV Is Investing Heavily In Latin-American Pay-TV

The DirecTV Group [DTV] is embarking on an aggressive strategy in Latin America that involves buying out its only satellite TV rival in the market and planning a competitive against the region’s generally fragmented and weak cable competitors.

The first part of the plan announced last week is DirecTV’s purchase of the Latin American satellite television operations of its parent company, News Corp [NWS], in a deal intended to create a single, profitable satellite TV service from what previously had been two money-losing adversaries. With many cable TV operators in Latin America struggling, a strengthened satellite TV operator would be a formidable foe.

Satellite TV operators have been consolidating in other parts of the world and the trend finally is unfolding in Latin America, said Chase Carey, DirecTV Group’s president and CEO. DirecTV Group is 34-percent owned by Fox Entertainment Group, which in turn is 82-percent owned by News Corp.

The DirecTV Group agreed to pay $579 million in cash to acquire the equity interests of News Corp’s Latin American satellite TV operations. The deal also gives DirecTV access to programming from the new partners it gains in Latin America through the transaction. That content could give DirecTV a boost in the United States, where a sizable Spanish- speaking audience exists for the industry-leading U.S. satellite TV service to tap.

DirecTV’s purchase of News Corp’s Latin America holdings still require regulatory approval in Brazil, Colombia and elsewhere in the region but those hurdles ultimately should be cleared, DirecTV management said in a conference call with analysts.

For DirecTV, the transaction will “drive down” subscriber churn and the cost of spurring them to sign up, Carey said. The combined operations could produce a bottom line in excess of 20 percent within three to four years. By next year, the consolidated Latin American satellite TV business should be cash flow positive and generating a profit, Carey predicted. The strategy is to build these Latin American satellite TV businesses and enhance shareholder value along the way.

“This is a very tough place to be and to compete,” Carey said. “We plan to compete aggressively with cable.”

Highlights of the transactions include:

• A merger between News Corp’s Sky Brasil and DirecTV Brasil. DirecTV Brasil customers will migrate to Sky Brasil but DirecTV Group would acquire the ownership stakes in Sky Brasil now held by News Corp and Liberty Media. Globo will continue in its role as the lead supplier of Brazilian programming to the platform. There were approximately 423,000 DirecTV customers in Brazil on June 30, compared to 806,000 for Sky Brasil.
• DirecTV affiliate Galaxy Mexico closing its operations and selling its subscriber list to Sky Mexico. DirecTV customers in Mexico would be offered the opportunity to migrate to Sky Mexico, which DirecTV would acquire from existing owners News Corp, Televisa and Liberty Media. Plans for the acquisition have been filed with the Mexican government.
• The purchase of Globo, Televisa, News Corp and Liberty Media interests in Sky Multi-Country Partners, which has direct-to-home (DTH) platforms in Colombia and Chile. The plan is for Sky customers in Colombia and Chile to migrate to DirecTV’s Latin American service. This transaction requires regulatory approval in Colombia. There are approximately 89,000 Sky subscribers in Chile and Colombia, where DirecTV Group would operate its DTH platforms in addition to Argentina, Venezuela, Puerto Rico, the Caribbean and the rest of Latin America. Those operations would be conducted under the newly created “PanAmericana” platform. Upon completion of the purchase of the Sky Multi-Country business, the Pan- Americana platform would have approximately 938,000 subscribers.

The surviving Latin American DTH satellite TV operations and their new ownership structures would be: Sky Brasil, 72-percent owned by DirecTV and 28-percent by Globo; Sky Mexico, 57-percent owned by Televisa and 43-percent by DirecTV; and Sky Multi-Country Partners, 100-percent owned by DirecTV.

What The Analysts Say

A big winner in the deal, at least for the short term, appears to News Corp, because it was able to dump unprofitable operations, to receive $496 million in cash and to have DirecTV assume $600 million in net debt from the three Sky operations. When News Corp’s share of the debt is considered, the value of its transaction with DirecTV is about $800 million, according to a research report from New York’s Fulcrum Global Partners.

News Corp reduced its risk by ridding itself of complicated joint ventures and the uncertainty about when they might become profitable rather than hurting its earnings-per- share performance. The impact on giant News Corp’s value will be insignificant, Fulcrum wrote. “We would rather be in News Corp’s position in this transaction that DirecTV’s,” Fulcrum concluded.

Grupo Televisa is another beneficiary of DirecTV’s spending spree in Latin America. The agreements should give Grupo Televisa an additional $25 million in free cash flow, according to a Merrill Lynch report. News Corp also agreed to expand its relationship with Grupo Televisa outside Mexico and the United States. “We view this series of transactions as extremely favorable for Televisa,” said Merrill Lynch’s research note.

DirecTV’s acquisition values each Sky subscriber in Latin America at between $800 and $850. The figure could be about $830, according to Bob Peck, Bear Sterns’ satellite broadcasting analyst.

“We expect significant cost savings to gradually materialize as subscribers in the region move to one platform,” Peck wrote to his clients last week. “Excluding one time charges, cash flow break even related to these transactions is expected in 2005.”

DirecTV expects to grow its Latin American subscriber base to 5 million during the next three to four years, compared to a combined 3.4 million subscribers for both Latin American DTH businesses on June 30. Roughly 40 percent of the estimated 100 million Latin American television households are possible customers for pay TV, and 15 million of them already subscribe to satellite or cable. That estimate leaves 25 million households ripe for picking, according to Peck.

Thomas Eagan, a satellite-broadcasting analyst with New York City-based Oppenheimer, wrote to his clients last week that he expected the purchase of News Corp’s Latin American assets to be neutral for DirecTV. Aside from the cash outlay, DirecTV also would incur one-time costs totaling as much as $220 million to cover $100 million in set-top-box expenses, $100 million in lease payments and as much as $20 million in other costs, Eagan wrote. In addition, DirecTV paid close to $840 per subscriber, well above the $500-to- $700 range he previously forecasted.

(Chase Carey, DirecTV, 310/726-4656; Richard Greenfield, Fulcrum Global Partners, 212/803-7025; Whitney Johnson, Merrill Lynch, 212/449-0695; Bob Peck, Bear Stearns, 212/272- 6665; Thomas Eagan, Oppenheimer, 212/668-5769)