DirecTV Could Unlock Further Stock Upside from Latin America

DirecTV (NASDAQ:DTV) competes with satellite pay-TV providers like Dish Network (NASDAQ:DISH), cable companies like Comcast (NASDAQ:CMCSA) and Time Warner Cable (NYSE:TWC), and telecom operators like AT&T (NYSE:T) and Verizon (NYSE:VZ). The company recently released its Q4 2010 earnings and we have updated our price estimate to $48.63 as a result of continued subscriber gains and ARPU growth both in the U.S. and Latin American businesses. Our price estimate stands at a roughly 5% premium to market price.

However, we may still be conservative in our price estimate given the traction that DirecTV is getting in the Latin American region. Below we discuss some highlights of growth for DirecTV’s Latin American operations and examine the potential upside to our base forecasts.

DirecTV’s Growth in Latin America

DirecTV’s Latin American subscriber base has been growing at a pace of more or less 20% per year for the last few years. It has increased from about 1.6 million in 2005 to 5.8 million in 2010. The company expects to continue this rapid growth in the foreseeable future. Given that the Latin American region has a higher population than the U.S., DirecTV still has lots of room to grow. This potential should be bolstered by economic growth in Latin America that will boost the purchasing power of Latin American consumers. ^[1]

See our full analysis and $48.63 price estimate for DirecTV

One of the key aspects of DirecTV’s expansion in Latin America during the recent quarter was its success in offering products that were targeted to middle-market segments, especially in Brazil. So the company is not just going after the high-quality subscriber base like it has done in the U.S., it is also targeting the middle levels with lighter packages. This seems to be the right strategy for this region. More interestingly, the company has been able to do all this while keeping its gross margins and SG&A expenses in check and more or less close to the levels seen in the U.S.

So Why Does DirecTV’s Latin American Business Only Represent 14.5% of its Stock Value?

The somewhat low valuation contribution from DirecTV’s Latin American business can be partially attributed to high levels of capital expenditures (relative to gross profits). DirecTV is still spending very high in terms of capital investments, which weighs on its cash profits. Although margins may look fine on the surface, cash profits are still very low. In fact, they’re actually negative. This will improve going forward, however, as capital intensity comes down and revenue growth accelerates.

Additionally, our valuation remains highly sensitive to terminal growth rates. We currently forecast above average capital expenditures through our forecast period, meaning that our subsequent terminal growth expectations could still prove conservative (although we do anticipate this to be higher than for other markets).

Nevertheless, our interactive model allows you to modify terminal growth rate expectations for DirecTV’s Latin American operations to see the affect of various scenarios on the company’s stock value.

1. Economies in Latin America Race Ahead, The New York Times, June 30 2010 [↩]