We reiterate our long-term Neutral recommendation on DIRECTV Inc. as we believe the stock is currently fairly valued. The company posted strong financial results for the fourth quarter of 2012, easily beating the Zacks Consensus Estimates.
Why at Neutral?
DIRECTV continues to enjoy huge net subscriber addition in both the U.S. and Latin America, growing average revenue per user in the U.S. and higher operating margin and operating profit before depreciation and amortization. The company is trying to establish itself as a premier pay-TV operator targeting high-quality subscribers. Management is confident that it will be able to achieve its financial goals for 2013 easily.
However, macroeconomic fluctuations, huge programming costs and growing competitive threats may restrict the company’s upside potential. Already, the rate of subscriber addition in the U.S. has moderated due to a stricter credit standard and reduced promotional discounts. DIRECTV currently has a Zacks Rank #3 (Hold).
Risk/Reward Virtually Balanced
DIRECTV has improved its subscriber quality – shrinking the proportion of subscribers with low credit ratings - by restructuring dealer incentives (changed the commission and penalty structure), cutting the proportion of third-party dealer sales, and implementing a credit card policy for new subscribers.
Both DIRECTV and its closest rival DISH Network Corp. (DISH - Analyst Report) are gradually transforming their respective business models from being a low-priced operator to a premium service provider.
Meanwhile, DIRECTV is trying hard to acquire Vivendi SA’s subsidiary unit Global Village Telecom (GVT) – a Brazilian telecom carrier. GVT offers voice, broadband and pay-TV services in Brazil. At present, DIRECTV is Brazil's No. 2 pay-TV service provider.
If successful, the company will generate substantial synergies from the acquisition by offering bundled voice, broadband, and high quality pay-TV services in Brazil. Apart from DIRECTV, other major bidders for GVT are America Movil SAB (AMX - Analyst Report), Liberty Global Inc. (LBTYA - Analyst Report) and a private equity group.
Nevertheless, a major near-term headwind for DIRECTV is the recent currency devaluation in Venezuela. The government of Venezuela has devalued its currency Bolivar by 32%. This was Bolivar’s fifth devaluation in a decade. Venezuela contributes approximately 3.5% of the total revenue of DIRECTV.
The company has already declared that it will incur a one-time pre-tax charge of $160 million in 2013 related to the devaluation of Bolivar. This will negatively impact DIRECTV’s Latin American revenue, net earnings and cash flow growth.