When Rupert Murdoch’s News Corp. took over Hughes Electronics Corp., big changes and a new attitude were promised at the satellite television company, whose name was changed to DirecTV Group Inc.
Little over a year later, there’s no doubt about the big changes. But is DirecTV headed in the right direction or is it spinning off into orbit?
Under News Corp., which owns a 34 percent stake, the company has beefed up its customer base, sold off assets and built a cash balance approaching $3 billion. However, costs are soaring. Last week, Mitch Stern, Murdoch’s hand-picked chief executive of DirecTV’s largest unit, resigned after just a year on the job. The stock is sliding; after reaching as high as $18.81 last May, it’s now hovering in the $15 range.
“Acquiring new subscribers is really important, and judging on that performance, the company gets an A,” said Jimmy Schaeffler, a senior analyst with the Carmel Group. “But the share price is at about a C right now.”
DirecTV said it has no plans to replace Stern, whose reasons for leaving, according to news reports, range from the bicoastal commute (he lived in New York though DirecTV’s headquarters are in El Segundo) to the company’s desire to eliminate layers of management. There also has been speculation that the ultimate goal was to consolidate power in the hands of DirecTV Group Chief Executive, Chase Carey. But the reason could be much simpler.
“Wall Street does not like the stock price, and there’s been a lot of pressure building up within the company,” Schaeffler said. “It was apparent they were looking for someone to be responsible.”
Subscriber costs
At the end of 2004, DirecTV had 13.9 million subscribers, up almost 2 million since News Corp.’s arrival. But they didn’t come cheap.
It spent $669 to acquire each new customer in the fourth quarter, compared with $640 a year ago, and projected subscriber growth slowed to between 1.25 million and 1.5 million this year. (By comparison, EchoStar Communications Corp.’s Dish Network spent just $588.)
Satellite and cable companies are competing fiercely. With cable or satellite television already in 94 million households, Jupiter Research analyst Todd Chanko said there is a limit to the expansion.
“The only opportunity for satellite is to try and nibble away at the margins of cable, and in order to do that, you’ve got to dislodge a customer that already has some kind of relationship with a provider,” Chanko said.
The only way to dislodge a customer is with costly marketing.
The monthly service costs are roughly comparable, averaging $48 a month for satellite and $49 for cable, according to a J.D. Power and Associates 2003 survey. DirecTV offers plans ranging from $39.99 per month to $300-plus.
To bring in new customers, DirecTV has been subsidizing up to five set-top boxes for each household, throwing in a TiVo Inc. digital recording device at a reduced rate even high-definition services.
But churn is a problem. While DirecTV’s average turnover rate is 1.5 percent per month, the figure for customers with TiVo is only 0.5 percent. “It makes sense for us to get a DVR receiver into as many homes as possible,” said Bob Marsocci, DirecTV’s vice president of communications. The company has been upgrading customers to keep them on board.
News Corp. owns a company that has developed its own DVR device, London-based NDS Corp., and the company announced plans to roll out the box later this year. While causing relations with TiVo to cool, it potentially offers another revenue stream if it can get customers to pay for it.
In all, DirecTV has doubled its spending on customer retention. The company says those costs are temporary, but not everyone sees it that way.
“They’re deluding themselves if they think they’re not going to have to continue to invest in this,” said Victor Hawley, principle of Reed Conner & Birdwell LLC, an L.A.-based management firm that owns 3.8 million shares. “They’ve trained their customers to expect it, and it’s got to be factored into the costs of doing business.”
Others say that it’s part of Murdoch’s strategy. DirecTV wants to differentiate its programming through special offers and features, such as its exclusive NFL Sunday Ticket package, at $249 last year, which included every NFL regular-season game. Packages and prices for 2005 have yet to be released.
It also offers an exclusive Mega March Madness package that includes every game for the first three rounds of the NCAA college basketball tournament for $59.
“If DirecTV is able to deliver in dropping the churn, you’re willing to pay more for those subscribers,” said Connor Browne, associate portfolio manager at Thornburg Investment Management, which owns 6.5 million shares.
While the share price may suffer until costs stabilize, Hawley said he believes the strategy will ultimately pay off. “Anyone who has paid attention to News Corp and what’s happened at BSkyB knows how they do things: They spend a lot of money, they conquer the world, then they make a lot of money when they reap the benefits,” Hawley said.
Cash hoard
One question for DirecTV is what plans it might have for its $2.8 billion in cash.
News Corp. took charge in December 2003, paying $6.6 billion after Hughes’ parent, General Motors Corp., initially tried to sell the unit to Echostar.
A $600 million termination payment from Echostar bolstered DirecTV’s coffers from the start, then new management started pruning. It sold its 80 percent stake in satellite operator PanAmSat for $3.5 billion in April and dumped the manufacturing operation of Hughes Network Systems for more than $250 million in May. It sold half in the remaining Hughes Network Systems for $360 million to Apollo Management’s SkyTerra Communications in December. It unloaded a 9 million-share stake in XM Satellite Radio for about $230 million and a 10 percent stake in TiVo (3.5 million shares) for about $24 million.
In its leaner form, DirecTV Group is made up of DirecTV U.S., DirecTV Latin America (1.65 million subscribers,) and a 50 percent stake of Hughes Network Systems.
Historically, the company has reported significant losses, but much of that is made up from non-cash depreciation of its expensive satellite equipment. The satellite television operations typically generate enough cash flow to more or less offset capital expenditures.
In February, Chief Financial Officer Bruce Churchill said the company would either buy back shares or pay a dividend to shareholders with its extra cash.
“I’d like to see them buy back as much stock as they can this year, and see more buybacks next year,” Hawley said. But DirecTV is restricted by terms of the News Corp. transaction and can only repurchase a limited amount of shares through December.
That leaves plenty of speculation about what company officials will do with the remaining billions. Marsocci declined to elaborate on DirecTV’s plans.
“They’re probably going to be patient,” said Browne. “For short-term shareholders it’s probably frustrating, but for those who take a longer term perspective, whether they begin to buy back stock now or in December won’t make much of a difference.”
