Magic Formula Stock Review: DISH Network (DISH)
DISH Network (DISH) is the #2 household satellite television provider in the United States with nearly 14 million subscribers, trailing only DirecTV (DTV) who services over 17 million customers. Satellite television services are now virtually the only business that DISH engages in. The firm spun off it's set-top box business, as well as some satellite assets, into EchoStar (SATS) at the beginning of last year.
DISH Network's strategy is to be the low-cost leader in satellite television service. The company accomplishes this by focusing on costs and the identification and acquisition of subscribers who will both stick with the company's services and not utilize customer service assets at the drop of a hat. While this has caused DISH to lag behind DirecTV in subscriber growth, the firm has delivered solid returns on capital averaging 41% (on an Magic Formula, no intangible asset basis) and 18% (traditional ROIC) over the past 5 years. Management's focus on generating cash flow has also been successful, as DISH has run a solid 11.3% free cash flow margin since 2004, despite the very capital intensive nature of the business. Since the divestiture of EchoStar, return on capital has improved markedly.
At MagicDiligence, we look at potential investments from 3 directions, with an eye towards business risk as well, to identify Top Buy picks on the Magic Formula screen. Unfortunately for DISH Network, the company does not score very high in 2 of the 3 points of growth, financial health, and competitive position. Add in some questionable moves by management and there are plenty of reasons why DISH looks like a second-rate MFI stock.
Growth is going to be difficult going forward. While the past few years have delivered good revenue growth (about 10% per year), subscriber growth has slipped into negative territory and churn (people dropping the service) has increased. The competition for pay TV is heating up. In addition to direct rival DirecTV, DISH competes against the big cable companies like Comcast (CMCSA) and Cablevision (CVC) for subscribers. Satellite is at a natural disadvantage against cable. For one, cable can more easily provide local channels, a big deal to many people. Also, the cable companies can add on additional services, such as broadband Internet and digital telephone, that satellite providers cannot. Recently, the telecom giants AT&T (T) and Verizon (VZ) have entered the ring, offering video services over their networks. This threat has already manifested itself in AT&T dropping DISH as it's satellite reseller in favor of DirecTV. These are a lot of forces conspiring against DISH growing their subscriber base, and the outlook is not very good here.
Financial health is not exactly a strong point either, although DISH is in no immediate danger of insolvency. The company carries a staggering $5 billion dollars of debt on the balance sheet, against just about $560 million in cash. Interest coverage ratio, at about 6.5, is much tighter than I like to see in a company with major headwinds. Who knows if by the 2014-2016 period DISH is still viable enough to repay the nearly $4 billion in debt coming due? Any signs of trouble here will tank the stock price.
As for competitive advantage, I would argue that DISH can boast of at least some economic moat. TV services are fairly sticky, with less than 2% of subscribers leaving in any given year. Also, the barriers to entry are extremely high. Raising enough capital to lease or launch satellites is a daunting task, as is acquiring the necessary FCC permits. It's pretty unlikely any new satellite TV operators will be springing up anytime soon.
The final issue with DISH are some of management's decisions over the past few years. DISH is fully controlled by founder Charlie Ergen, who has over 90% voting control and a puppet board of directors. This allows him to do pretty much whatever he wants. The EchoStar spin-off was clearly done to highlight the value in DISH's satellite business, but this expensive undertaking does not really provide shareholders with any value unless it leads to a sale of the company at a premium. Ergen also dropped a chunk of change pursuing Sirius (SIRI), to no avail. What value that money munching entity would have brought to DISH and it's shareholders is a question that thankfully does not need to be answered now.
In conclusion, DISH Network is just not an MFI stock that MagicDiligence recommends picking up. While the company is clearly cheap against earnings and cash flow, the durability of those earnings is very much in question at this point in time.