You gotta spend money to make money.
DirecTV (NYSE: DTV ) is in the "spending money" phase right now. It isn't the usual fat expenses for launching new satellites. Instead, it's cash investment in growing and upgrading the company's customer base that pulls down the net income line. And you can expect the investment to continue for a very long time.
Explaining the depreciation machinery
In the spring of 2006, DirecTV started a lease program for its digital set-top receivers and started accounting for set-top box installations as a capital expense. Before that date, this required equipment counted as a subscriber acquisition cost, reducing operating and net income, but leaving the balance sheet unaffected.
Now, the company pumps about $400 million a quarter into its property and equipment balance, bypassing the income statement entirely, except for an ever-increasing depreciation charge on the thusly growing asset base.
All of this should be purely theoretical -- an accounting strategy that moves things back and forth between income statements and balance sheets over time, resulting in wider earnings today tapering out into smaller earnings later on.
There are long-term tax benefits to this strategy, but it messes around with standard metrics like earnings per share. For example, DirecTV saw about $880 million higher taxable income over the past year than it would have without the equipment leases; the direct cost savings and increased depreciation will even out in about five quarters' time, and after that, earnings will suffer and taxes will be lower. A price-to-free cash flow valuation can compare results from last summer to those of 2010 on a fruit-to-fruit basis, while a P/E comparison would weigh apples against pork chops. It's an old, asset-light operation versus an asset-heavy future one.
But wait, there's more!
This is standard operating procedure in the TV business these days. Satellite rival EchoStar (Nasdaq: DISH ) is doing the same thing; Comcast (Nasdaq: CMCSA ) tacks on another $0.5 billion a quarter to its assets, in part through a similar program; and Verizon's (NYSE: VZ ) triple-play fiber rollout and equipment leases grow that balance by about $2 billion per quarter, offset by $3.6 billion in depreciation.
The company gained 401,000 net new subscribers across North and Latin America, half of which signed up for "advanced services" like HD programming or a DVR box. The opportunity to convert more customers to high-margin extras like that is still large, since only about 40% of the customers have it today.
Recession, schmecession -- people will always pay for entertainment. Cable and satellite TV ain't done growing on us yet, to say nothing of fiber rollouts and online programming.