The Lalapalooza Effect of DTV
Board: Berkshire Hathaway
Latin America growth story...
The company continues to increase average revenue per user and add subscribers. Two divisions, DirecTV US and DirecTV Latin America, both adding net subscribers year over year. Admittedly a mature market in the US, Latin America revenue growth has driven the growth over recent years. Forty-two percent increase in revenue for that segment as of December 2011, year over year. Very low pay TV penetration in Latin America suggests this trend can continue. Estimates are that there will be 3x as many pay TV subscribers in 10 years in Brazil alone. DTV owns the crown asset there. For more information, view the comprehensive investor day presentation from March and conference call transcript from May.
Outstanding shares have been reduced by 45% since the beginning of 2008, including about 23% over the last two years. In less than 4.5 years, the company has repurchased almost half the outstanding stock. Repurchases been funded by both operations and debt issuance. Debt has increased materially over this time. The CEO has stated that he will continue to go to the bank to borrow at 2% after tax to buy back shares so long as the Street gives the company such a low EBITDA multiple.
The power of buybacks - done at the right prices - is absolutely astounding. All else equal (underlying earnings power, valuation multiple), repurchasing 50% of your shares increases the earnings per share by 2x. Moreover, if you can repurchase 50% of your shares and also grow underlying earnings power, your value per share increases by more than 2x.
There's a third factor, creating a "lalapalooza effect." If you can repurchase half your shares, grow underlying earnings power, here due to net subscriber additions and average revenue per user, and also enjoy a higher valuation multiple, it's an incredibly powerful force.
DTV's GAAP earnings are materially less than its truly discretionary cash flow. The company charges subscriber acquisition costs against earnings (a large component of this is the set top boxes they buy and then depreciate over 3-4 years). Mason Hawkins put it this way in his 2009 letter:
"Management of DTV added subscribers, increased ARPU (average revenue per subscriber), and bought in undervalued shares throughout the year. Although we trimmed some shares as price rose, DTV remains the Fund’s largest position and still sells at a steep discount to our appraised value. Truly discretionary free cash flow far exceeds reported
earnings because the cost to gain net new subscribers, an optional investment with a high long-term return, is deducted from current profits."
The company recently announced a $6 billion buyback program. If the stock price doesn't move, the company will likely repurchase 20% of the shares over the next 12 months. This would increase earnings power by 25% per share, just from "financially engineering", not from any underlying operational improvement.
I'm not surprised the Street hasn't noticed. When PM announced a 3-year , $18 billion buyback last week, the stock jumped. It's amusing that this isn't priced in. What has PM done since its 2008 spinoff? What did its predecessor do for countless years? Consistently buy back shares. What has management said they will do? Return capital to shareholders.
This dynamic alludes to what Bill Ackman recently wrote in his quarterly letter regarding "time arbitrage". There's a lot of money to be made by those with a longer-term vision than the next hour of trading. One of the biggest areas in which I have seen this is the pricing of long-term call options on high-quality, predictable businesses.
I can see what Weschler and Combs like in DTV. I hope they are right - and that they are still accumulating. It doesn't take much to see how this stock could eventually be worth 4x its current price.