DISH Survives The Zombie Outbreak -- Here's Why I'm Short Anyway

Shares of DISH Network (Nasdaq: DISH  ) are up more than 2% this morning on news that the satellite supplier is airing episodes of The Walking Dead once more, ending a four-month dispute with AMC Networks (Nasdaq: AMCX  ) just in time for Halloween.

For DISH customers, the settlement is no doubt good news. For me, if the results of the tussle reveal anything, it's that DISH and its peers are doomed. And I'm not just saying that to be snarky: I'm backing up my take with a five-year underperform CAPScall. Here's why.

The high cost of disappointed subscribers
DISH depends on two things:

  1. A pleasing menu of content
  2. Lots of subscribers willfully paying a profit to access said content

Great content isn't cheap. DISH is paying $700 million cash to settle with AMC and former parent Cablevision (NYSE: CVC  ) . Technically, the arrangement resolves a lawsuit over DISH's early termination of Voom, a channel joint venture among the three companies. And yet record-busting ratings for AMC's Breaking Bad and The Walking Dead, achieved without DISH's help, probably also played a role.

Meanwhile, Amazon.com's (Nasdaq: AMZN  ) Instant Video and Apple's (Nasdaq: AAPL  ) iTunes have emerged as acceptable substitutes for distributing new episodes. Netflix (Nasdaq: NFLX  ) , too, remains popular for catch-up programming.

Less clear is whether these same alternatives have made it harder to win viewers, but the process is costing more than it used to:

Company

Q2 2012

Q2 2011

Q1 2012

Q1 2011

Gross new subscribers

665,000

572,000 

673,000

681,000 

Total subscriber acquisition costs

$404,499,000

342,801,000 

$398,037,000

$354,889,000

Cost per gross new subscriber

$608.27 

$599.30 

$591.44 

$521.13 

Net new subscribers

(10,000)

(135,000) 

104,000

58,000 

Total Customers

14,061,000 

14,056,000 

14,071,000 

14,190,000 

Source: DISH Network SEC filings.

What an awful pattern. Subscriber costs go up, content costs rise, and the subscriber base declines. Isn't this the very definition of what a death spiral looks like?

Let's go to the tape
Perhaps that's unfair. After all, the Voom settlement grants DISH some 500 MHz of multichannel video and data distribution data service spectrum for serving upward of 150 million customers in 45 direct markets. The list includes premium cities such as New York, Los Angeles, Chicago, San Francisco, and Philadelphia.

Plus, what other choice did DISH have? The company is a distributor, and as such depends on acquiring broadcast rights it can resell to subscribers at a profit. AMC is a network that depends on a combination of "retransmission fees" from the likes of DISH and advertising revenue. What's good for one isn't necessarily good for the other.

So like a star football player hoping for a better contract, DISH held out on reupping AMC in hopes that a blackout would crush viewership and force a deal. The boycott began on July 1, and for a time, it worked precisely as expected.

In late August, The Wall Street Journal cited Nielsen data that showed AMC's average prime-time viewership declining by 7% to 9% each week during the last three weeks of July, compared to the year-ago period.

Around the same time, during AMC's second-quarter earnings call with analysts, CEO Josh Sapan said that losing DISH would reduce its total subscriber base by about 13%. Hits to adjusted operating cash flow and operating income, however, were expected to be "materially higher than that," Sapan said. The stock fell 11% in the two weeks following the announcement.

What's next?
AMC's stock has since recovered on hopes that a combination of high ratings and increasing contributions from alternative distributors will create a tailwind that guts DISH and its peers like a zombie on a feeding frenzy. Sapan touched on this dynamic in comments made at B of A Merrill Lynch's Media, Communications, and Entertainment Conference last month:

So [customers] really are sort of a bit emancipated by the fact that when something happens, you go online and you get it. And if you operate a [distribution network], you have a page that has everybody's comments for everybody to see. So if they don't like you, everybody's reading it. So instead of it being a sort of behind the curtain commercial dialogue between [two] companies in which consumers don't participate, the consumers are participating.

He's only partially correct. Customers aren't just expressing their frustrations, they're also voting with their feet. New spectrum gained in the Voom settlement may alter the equation for DISH over the short-term, but the structural faults in its business remain. The zombies are on the loose again, Fool. It's only a matter of time before they devour traditional TV distribution.

Who'll survive the ongoing outbreak? How about Netflix? True, the company is leaving new shows to larger peers, but when compared to its most direct competition (i.e., Hulu) the streaming sensation is blessed with a much bigger library of catch-up content, including prior seasons of The Walking Dead.

We'll know more about how this advantage manifests into subscriber growth when Netflix reports third-quarter earnings tomorrow after the bell. Over the long term, my colleague Jim Mueller says sustainable international growth is one of three key areas to watch. What are the other two? Click here to get your copy of a special report that reveals his latest thinking, as well as his opinion on whether the stock is a buy or a sell.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team and the Motley Fool Supernova Odyssey I mission. He owned shares of Apple and Netflix at the time of publication. He also had a long-term call options position in Netflix. Check out Tim's Web home, portfolio holdings, and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Netflix, Amazon.com, and Apple. Motley Fool newsletter services have recommended buying shares of Netflix, Apple, and Amazon.com. Motley Fool newsletter services have recommended creating a bear put ladder position in Netflix. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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