DISH Network Corp. (DISH): Attractive As Long-Term Satellite, Wireless and Mobile Play with Stable, Predictable Revenue; Shares Could Weaken Near Term

DISH Network Corporation (DISH) is a Fortune 200 company that brings high-definition satellite television to over 14 million paying subscribers in the U.S., with over 200 national HD channels, the best menu of international channels and cutting-edge digital video recording (DVR) technology. In addition, DISH has 436,000 broadband subscribers.

DISH shares closed at $63.85 on April 3, 2014 – very close to their all-time high of $64.52 – giving the company a market capitalization of $29.3 billion and a price-to-earnings ratio of 36x which is above DISH’s long-term average P/E of 23.5x. However, shares trade at a more reasonable 12.7x cash flow. Shares are up a solid 74% over the past twelve months and recently got a boost on reports that DISH’s CEO had approached DirecTV over a possible merger (so something could be brewing on that front, or not…only time will tell).

DISH Compares Well Against Peers

As the table below shows, DISH has delivered the highest 1-year return relative to its peers, and has delivered close to double the returns of primary competitor DirecTV (DTV) which is significantly larger than DISH. And on net margin, DISH (at 9.2%) is in the same ball park as operators DirecTV and Time Warner Cable (TWC) but well above other operators such as Charter Communications (CHTR). [DISH distributes content so it cannot be directly compared on margin to content producers.]

The company does not pay dividends.

Aggressive Corporate Strategy Could Payoff

Over the past few years, DISH has made a number of smart moves in high-growth areas such as the acquisition of spectrum assets (to potentially provide mobile and wireless offerings that serve new and existing subscribers). In July 2013, DISH bought the assets of Light-squared for $2.2 billion; Light-squared focuses on providing 4G LTE services through satellite; however, that transaction is on-the-rocks with significant litigation with Light-squared’s major equity owner, Philip Falcone.

DISH also made an unsolicited $25.5 billion bid to acquire Sprint Corp. but the deal fell through when Sprint agreed to get acquired by SoftBank of Japan. Clearly, management is aggressively focused on expansion initiatives and is willing to pay top-dollar for the right deal. This could cut both ways for shareholders, with a smart deal adding value over time but a bad deal hurting shareholders over the long run. But the shares’ 74% gain over the past year signals Wall Street’s enthusiasm for DISH’s aggressive deal making posture.

Continues to Expand Content and Viewership Options

DISH continues to expand its appeal with new contracts that expand content offerings and offer more high-definition programming such as recent deals with ESPN (ahead of college sports season), Disney (DIS) and ABC. DISH also continues to improve user experience, and announced a deal with Amazon’s (AMZN) Kindle Fire that allows users to download DISH Anywhere so they can watch live or recorded TV on-the-go. Dish also extended its partnership with Southwest Airlines (LUV) for free in-air access to 20 live TV channels and 75 on-demand shows on wi-fi enabled flights.

DISH’s award-winning Hopper whole-home high-definition digital video recorder (DVR) can record up to 2,000 hours of TV, two times more than any other DVR in the market, and watch shows on any device in the home.

DISH also recently introduced two portable, light-weight satellite antennas – the Pathway X1 and X2 – that deliver HD programming for outdoor activities such as camping, RVs or tailgating. The Pathway X1 is the smallest portable HD satellite antenna on the market.

So DISH continues to invest in partnerships, technology and innovation in response to changing technology and user habits, to offer its subscribers the best satellite TV and broadband experience. This approach should increase subscriptions and reduce churn over the long-run, while positioning DISH for revenue protection and future growth.

Strong Growth in Broadband

For the year ended December 31, 2013, DISH added 253,000 net new broadband subscribers, reflecting solid demand for its dishNET high-speed broadband service that was launched in late September 2012.

In 2013, DISH added 343,000 gross new subscribers and ended the year with 436,000 paying broadband subscribers.

Pay-TV Growth Slowing as Subscribers Move Online

In all of 2013, DISH activated about 2.666 million gross new Pay-TV subscribers, down 2.7% from 2.739 gross new Pay-TV subscribers in 2012 on general economic weakness and increased competitive pressure with aggressive marketing, discounted promotions and more aggressive customer retention efforts.

DISH also saw marginally higher churn as existing customers opted out of plans at a rate of 1.58% versus 1.57% in 2012 – primarily because of an increase in package price in Q1 2013 and secondarily due to industry factors such as aggressive competition, service interruptions driven by programming disputes, piracy and fraud. Churn rates are, however, down significantly from 1.63% in 2011.

As a result, in 2013, DISH had just 1,000 net new Pay-TV subscribers, down dramatically from 89,000 net new additions in 2012 as subscribers moved online for the convenience of on-demand programming which is often available at lower cost (with or without subscriptions).

Consequently, at year end, DISH had 14.057 million Pay-TV subscribers, up from 14.056 in 2012. Even so, 14 million subscribers is a significant number, well above the 2011 level of 13.97 million subscribers, and reflects stable annual subscription income, which is further supplemented by strong adoption of the company’s dishNET broadband offering.

… Yet Pay-TV Prices Are Up

Though Pay-TV growth is flattening, DISH hiked its average monthly revenue per subscriber (ARPU) by 4.4% to $80.37 for higher program package prices and higher hardware prices (as customers switch to digital video recorders and smart TVs). This increase in ARPU translated into higher revenues for 2013.

Subscriber Revenues Up 5.4% to $13.8 Billion

With increased broadband penetration and higher ARPU, DISH reported a 5.4% increase in 2013 revenues to $13.765 billion, up from $13.065 billion in 2012, of which $221 million came from broadband subscriptions. So broadband subscriptions are just a drop in the bucket but are growing at a strong rate and are definitely where the future is headed.

… But New Subscriber Acquisition Costs Are Rising

Due to increased competition, DISH had to increase advertising. In addition, DISH introduced a new set-top box (Hopper with Sling) and saw an increase in equipment costs because most new subscribers wanted the latest set-top receivers. Consequently, Pay-TV’s subscriber acquisition cost (Pay-TV SAC) increased 10.5% to $866.

As a result, subscriber-related expenses increased 7.8% to $7.818 billion (in FY 2013), up $564 million on costs related to higher fees for certain programs and an expanding broadband subscriber base. Increases in programming costs are tied to contractual rate increases in programming contracts with content providers.

Strengthened Broadband Positioning with EchoStar Deal

With broadband on the rise, DISH transferred five of its satellites and $11 million in cash to EchoStar Corp. (SATS), and received preferred tracking stock that gives DISH an 80% economic stake in Hughes Network Systems LLC. Hughes is EchoStar’s subsidiary that provides residential satellite broadband services. With this transaction, DISH will monetarily benefit from the growth in residential broadband.

Strong, Seasoned Management

DISH predecessor EchoStar Communications Corp. was founded by Charlie Ergen, Candy Ergen and Jim DeFranco, both of whom serve on the Board and are focused on strategic long-term business development, planning and acquisitions. Joseph Clayton, President and CEO, joined DISH in 2011 and is a veteran of the consumer electronics, satellite and telecommunications industries. Clayton also served as Chairman of the Consumer Electronics Association (CEA) and has deep industry contacts and knowledge, and understands retail consumer preferences very well.

Blockbuster Writeoff Impacted Profits in 2012 and 2013

In April 2011, DISH acquired video and gaming distributor Blockbuster and its 1,700 stores for $233 million and $87 million in liabilities. DISH subsequently went about closing branches and ultimately decided to close all stores and stop DVD-by-mail rentals also. As a result, DISH took significant write-offs in 2012 and 2013 that caused profits to dip relative to 2011.

Summary Financials

For FY 2013 (ended 12/31/2013), DISH reported subscriber-related revenue of $13.765 billion (up 5.4% from $13.065 billion in FY 2012), equipment sales of $94.9 million (down 3.7% from $98.5 million in FY 2012) and $45.2 million in revenue from EchoStar (up 152% from $17.9 million in FY 2012). Total revenue was $13.9 billion, up 5.5% from $13.2 billion in FY 2012.

DISH reported total costs and expenses of $12.557 billion, up 5.3% on higher subscriber-related expenses due to increased competition, higher G&A expenses and technology-related costs. For the year, DISH reported net income of $807.5 million, up 27% from $636.7 million in 2012, and earnings per diluted share of $1.76 based on 459.166 million shares outstanding.

Net income was, however, down significantly from $1.5 billion in 2011 due to write-offs related to discontinued operations (Blockbuster), a $438 million second quarter impairment charge on two satellites (D1 and T2), a $730 million litigation settlement in 2012 (with Voom) and investments made in 2012 and 2013 to grow the company’s broadband offering.

After accounting for interest expense, taxes, depreciation and discontinued operations, DISH reported adjusted EBITDA of $2.8 billion, up 16% from $2.4 billion in FY 2012, and adjusted free cash flow of $1.056 billion, down marginally from $1.058 billion in FY 2012. Operating activities delivered $2.31 billion in cash of which the company spent $1.25 billion on the purchase of property and equipment.

DISH ended the year with $4.7 billion in cash, $5.04 billion in marketable securities, property worth $4.1 billion (net of depreciation), $3.3 billion in FCC authorizations and $20.4 billion in total assets. Long-term debt totaled $12.62 billion (excluding current portion) and stockholders’ equity was about $1 billion.

Summary

DISH shares have done extremely well over the past year and now trade at a P/E of 36x which is well above the company’s historical average. The company’s market capitalization is also well ahead of stockholders’ equity, and net debt (after cash and marketable securities) exceeds total equity. Shares appear rich on valuation (at $63.85 as of April 3, 2014). However, DISH is doing an excellent job of positioning itself for future customer needs with strong growth in broadband subscribers, while also holding fort well on Pay-TV with the choicest menu of programming and content backed by excellent smart technology. Therefore, DISH shares are an attractive long-term holding. The company is smaller than a lot of its peers/competitors and could also be an acquisition target at a more reasonable valuation. DISH has also broached merger discussions with DirecTV and that could deliver significant additional value to shareholders. This is but one media name that I am watching on a daily basis.

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