Increased Customer Acquisition Costs Could Pressure Dish Network Stock

Dish Network (NASDAQ:DISH) competes with satellite pay-TV service provider DirecTV (NASDAQ:DTV), cable companies like Comcast (NASDAQ:CMCSA) and Time Warner Cable (NYSE:TWC) and telecom operators like AT&T (NYSE:T) and Verizon (NYSE:VZ).

In a previous article, we discussed the mounting profit margin pressure that caused us to lower our price estimate for Dish Network. (See Dish Network’s Margin Under Pressure from Competition). In this analysis, we examined the dual threat of alternative platform adoption and competitor pricing pressure, and also mentioned the potential for increased marketing spending. Here we dive deeper into the outlook for marketing spend and its impact on SG&A costs and Dish Network’s stock value.

Dish has resorted to promotional incentives and increased advertising to drive subscriber gains in the recent past and as a result its Selling General & Administrative (SG&A) expenses have witnessed growth over the past year. SG&A expenses (as % of gross profits) increased from 47% in 2008 to almost 51% in 2009.

It is interesting to note that despite several promotional initiatives, overall subscriber subsidies due to promotions have been declining. However we believe that this may not continue in the future given the company’s position amidst intensifying competition. If promotional incentives increase and SG&A (as % of gross profits) rises more than our base forecasts, there could  be a potential downside of 15% to our price estimate for Dish Network’s stock.

Drag the trend-line in the chart below to see the impact of various SG&A trends on Dish Network’s stock value.

Subsidies From Promotional Initiatives Have Decreased

Dish Network’s promotional measures included offering programming discounts to customers who committed to a 2-year contract (promoted in 2009), reduced installation costs and the latest Free HD for Life offer for new customers. Such incentives put pressure on SG&A costs through the corresponding increase in subscriber acquisition costs.

Interestingly for Dish Network, subsidies related to promotional initiatives have declined. While revenues grew by nearly 1% and subscribers grew by 3% during 2009, promotional subsidies declined by almost 5% ^[1]. This improvement can be attributed to Dish Network’s shift in focus from subscriber acquisition to improving financial metrics.

Equipment Related Subsidies are Rising

Dish Network, like its other competitors, has been promoting advanced services including HD and DVR to trigger ARPU growth. In order to do so, the company is subsidizing the cost for receiver systems it sells to its customers, prompting a rise in equipment-related subsidies. While revenues grew by roughly 7% and 1% in 2008 and 2009 respectively, equipment related subsidies grew by 35% and 13%.

However as promotional subsidies far outweigh equipment-related subsidies, Dish Network’s overall subsidies have declined.

Increased SG&A Could Pressure Stock Value

With equipment-related subsidies expected to rise, the decreasing trend in promotional subsidies might also turn around and follow suit. The pay-TV market has become increasingly competitive and it is becoming more difficult to add new subscribers. We currently expect SG&A (as % of gross profits) to hover around 52% going forward. However there could be a downside to our price estimate for Dish Network’s stock value if promotional subsidies gradually increase towards historic levels seen in 2006.

To demonstrate the stock sensitivity of this effect, there could see almost 15% downside to our price estimate if SG&A (as a % of gross profits) rises to 55% by the end of our forecast period, vs. our base case projection of stability 52%.

You can see the complete $24.87 Trefis price estimate for Dish Network’s stock here.

1. Calculated from figures given in Dish Network’s SEC Filings [↩]