We profiled pay TV provider DirecTV (DTV) earlier last week (click here), branding it as a Valuentum stock, and the firm’s first-quarter performance, released today, helped to support our view on shares. The company surpassed 38 million total subscribers in the quarter (including Sky Mexico, which is accounted for using the equity method), while adjusted operating profit before depreciation and amortization (OPBDA) advanced 7% on an adjusted basis. The firm’s free cash growth was excellent during the period, jumping 25%, to $886 million. Though traditional free cash flow (cash from operations less capital expenditures) is different than enterprise free cash flow (free cash flow to the firm), they are highly correlated. The strong cash flow performance in the quarter offers substantial support to our estimated fair value of $99 per share at the time of this writing. The company registers a near-pristine 9 rating on the Valuentum Buying Index (the equivalent of a “we’d consider buying” rating).
The commentary in the press release was quite reassuring. Though most management teams are always optimistic (and this should be expected whenever you’re reading through management commentary), we were still pleased to hear from the executive suite that OPBDA margins in the US continue to expand in the face of strong competition (and higher programming expenses) and that the company continues to profitably grow its share of the pay TV market in Latin America, the economic backdrop of which remains challenging. On an adjusted consolidated basis, OPBDA margin leapt 80 basis points, while its adjusted operating profit margin increased by 60 basis points. The margin improvement was driven by lower upgrade and retention costs coupled with reduced general and administrative expenses. Adjusted diluted earnings per share closed the quarter at $1.63, up from $1.43 in the prior-year period.
DirecTV continues to raise prices (mix) in the US (where more than half of its cumulative subscribers reside), as it holds the line on the pace of customer churn in the country. For example, during the first quarter, average monthly revenue per subscriber (ARPU) in the US leapt to $100.16 from $96.05 in the prior-year period, as it recorded 12,000 net subscriber additions and an average monthly subscriber churn of 1.45%, the latter mark unchanged from the previous year. Higher advanced receiver service fees, price increases on programming packages, and higher fees for a new enhanced warranty program contributed to the advance in ARPU. Though DirecTV continues to price aggressively for expansion in Latin America, we are huge fans of business models of firms with pricing power, and we believe DirecTV has it in the US.
We’re reiterating our view that DirecTV’s shares remain underpriced, and we view the merger talks across the industry as merely icing on the cake. We like the company more for its free cash flow generation and its pricing power than we do the likelihood of its assets being scooped up by Dish Network (DISH) or AT&T (T), both deals having been speculated upon in recent months. We would view any consolidation in the best interest of investors, though we would hold reservations if DirecTV’s assets are purchased for anything less that our estimate of their intrinsic value, or $99 per share. DirecTV remains a holding in the Best Ideas portfolio in light of strong first-quarter performance.