Latin America Is DirecTV’s Dark Horse And Chips In 25% Of Its Value

We estimate that about 25% of DirecTV‘s (NASDAQ:DTV) value can be attributed to its operations in Latin America, making its implied worth of $8.5 billion based on our estimates.

The company has been able to grow its subscriber base in Latin America by offering higher quality video that gives it a competitive edge. Also the success of its middle-market focused programming packages and the growing popularity of prepaid products is helping it win market share. The company has done well in terms of understanding the needs of the market, which are different the U.S. pay-TV market in many ways.

We believe that these factors will continue to drive its growth in the near term. Long term growth will be broadly driven by the fact that pay-TV penetration is still low in Latin America, and therefore, there is significant potential to expand.

We forecast that DirecTV’s subscribers in Latin America will increase to 20+ million in long term (five+ years’ time frame). Here are some of the factors that will help it get there.

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Growing Pay-TV Market Will Help

The fast paced growth in the number of subscribers is largely driving this value. From around 3.3 million in 2007, DirecTV’s Latin American subscriber base grew to 10.3 million in 2012. This does not include Sky Mexico as its operating results are not consolidated by DirecTV due to its minority stake.

Currently, the pay-TV penetration is low in Latin America. DirecTV operates in Brazil, Mexico and Pan-Americana region which consists of Argentina, Chile, Colombia, Equador, Puerto Rico and Venezuela. We’ll leave out Mexico from this discussion as the company does not consolidate its results. DirecTV has little over 5 million subscribers in Brazil alone, with the remaining 5 million subscribers coming from Pan-Americana region. ^[1] In other words, half of the subscriber are from Brazil and the other half from the remaining countries. We’ll use this figure for estimating growth in its subscriber base.

Currently, there are close to 16.5 million pay-TV subscribers in Brazil, implying pay-TV penetration of close to 27%. This gives us a total of 60 million households. Assuming that the pay-TV penetration in the country grows to 60% within the next five to seven years, there could be close to 36 million pay-TV households.

If DirecTV can remain competitive and garner a market share of close to 25%, which is a little higher than its share in the U.S., it will have close to 9 million subscribers in Brazil alone. Further using the previously established fact that half of DirecTV’s subscribers are from Brazil and half from Pan-Americana, we estimate that another 9 million can come from the Pan-Americana region over the course of next few years. This leads to a total of 18 million subscribers. Another 2-3 million can come from potential expansion into other smaller markets in Latin America. Overall, we are confident that DirecTV’s subscriber base will grow past 20 million by the end of our forecast period.

What Does The Past Growth Suggest?

During the past six years, DirecTV has managed to grow its subscriber base in Latin America (excluding Sky Mexico) from 2.7 million to 10.3 million, implying an average annual gain of close to 1.25 million subscribers. The average annual growth rate stood at around 25%. If we look at the last two years, the growth seems to have accelerated. In 2011 and 2012, DirecTV gained a total of 4.5 million subscribers, with annual growth rate ranging between 31-36%.

Does that mean that the high growth will continue?

We don’t believe so as we forecast an average annual growth of close to 10% for the next five to seven years for DirecTV’s Latin American subscriber base. This will imply an average annual subscriber gain of close to 1.5 million, which seems reasonable and not too high. While the growth may have accelerated recently, it might not be sustainable as DirecTV’s penetration increases and competition from local players intensifies.

Increasing Competition & Low Subscriber Loyalty Might Moderate The Growth

So far DirecTV has enjoyed significant competitive advantage over its competitors. Prepaid products, middle market focused programming packages, the availability of HD & DVR services, all are contributing to the growth. However, lately, there have been some developments that indicate that the competition in the region will increase. Governments are also encouraging greater competition through certain regulatory measures.

One such example is Brazil. In September 2011, the country’s government passed a law that will help expand pay-TV services. According to the new law, local telephone companies and foreign players will be able to offer pay TV services along with mobile, fixed line and broadband. Before this, the phone companies had to bundle their service with existing pay-TV providers. What this essentially means is that the new law will spur the growth of pay-TV competition in Brazil, a significant market in Latin America for DirecTV.

In addition to this, Latin American customers are value focused. This fact is in tandem with the presence of prepaid programming packages that do not require any long term contracts, essentially implies that the subscriber loyalty will be relatively low as compared to that in the U.S. The churn could be higher and as competition increases, DirecTV will need to work much harder to gain subscribers.

The Valuation Impact

We estimate that Latin American business constitutes about 25% to DirecTV’s value. If the company can maintain the increased momentum it has seen in the past couple of years, its subscriber base can reach as high as 25 million by the end of our forecast period. This implies that DirecTV maintains its market share as well as expands into new markets. Such a scenario would imply an upside of about 10% to our price estimate.

On the other hand if the company’s expansion slows down, and its subscriber base reaches just 16 million over the course of next several years, there could be 10% downside based on our estimates. Of these scenarios we believe that DirecTV is more likely to beat our estimates than fall fall short.

Our price estimate for DirecTV stands at $58, implying a premium of more than 5% to the market price.

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1. Brazilian Pay-TV records 27.6% penetration rate, nextvlatam.com, March 5 2013 [↩]