The Buyout by AT&T Could Provide an Opportunity to Sell DirecTV at the Top

After a couple of years of strong gains by DirecTV, a premium buyout by AT&T will provide an opportunity to sell at the top of the market.

May 20, 2014 at 12:05PM

After holding a stock for a few years, no better exit opportunity exists than unloading the stock on a buyout with a nice premium. In the case of DirectTV Group (NASDAQ:DTV), the company's stock has nearly doubled in the last couple of years and the gains are attracting competition. The purchase price of $95 by AT&T (NYSE:T) would provide an ideal exit point from an investment in the leading satellite television provider.

Exiting a position is always tricky, especially for one that has worked extremely well. The stock of DirectTV Group traded below $45 as recently as the middle of 2012. With the company's stock now worth nearly $42.5 billion with it trading around $85, it might have peaked... especially with competition heating up from AT&T(NYSE:T) and the recently proposed Comcast (NASDAQ:CMCSA)  and Time Warner Cable (NYSE:TWC) merger.

AT&T wants video subscribers
AT&T is willing to pay upwards of $50 billion to buy DirecTV in order to acquire video subscribers. The communications provider continues to push its internal landline-based U-verse service, though it has only grabbed 5.7 million subscribers so far. The DirecTV domestic customer base of around 20.3 million would place the combined company on equal footing with the new Comcast. In addition, the satellite service provider has 18 million subscribers in Latin America.

The growth rates of video subscribers for the companies involved in these potential mergers places the advantage to the satellite and landline-based services that have been eating into the cable operators businesses. In the latest quarter, Comcast saw video customers increase by only 24,000, which is minimal compared to the customer base of over 20 million.

The merger between Comcast and Time Warner Cable hopes to boost the size of the cable company to improve scale and operating efficiencies of up to $1.5 billion annually. With Comcast having 21.7 million video subscribers and Time Warner Cable offering 11.4 million video subscribers, the combined entity will lead the industry. After a divestiture agreement with Charter Communications, the new entity plans to have just less than 30 million video subscribers.

Slowing domestic growth
DirecTV continues to see moderate growth, especially in the United States. The company only saw revenue grow 5% in the latest quarter while earnings surged due to a massive stock repurchase plan that is dramatically reducing the company's stock float. Long term, though, the company faces increasing pressure from a mature industry where customer attrition could become similar to AT&T's landline phone business. In addition, the inability to offer Internet services comparable to the legacy cable and phone companies places the satellite giant at a long-term disadvantage of bundling services.

Regardless, analysts continue to forecast strong earnings growth at DirecTV. This has partially contributed to the rumors that AT&T wants the satellite provider. For 2015, analysts forecast DirecTV earning around $6.76 per share or around 14 times the offer price of $95. In addition, the company generated first-quarter free cash flow (FCF) of $886 million.

The strong FCF from DirecTV can be funneled to pay the large dividend at the giant phone provider. The value isn't overly expensive for the earnings growth rate of the satellite provider, but a lot of questions abound on whether the company can continue that growth rate.

Investor takeaway
DirecTV isn't trading near the offer price due to fears regarding regulatory approval that isn't likely an issue. In addition, the deal is conditioned upon DirecTV renewing the Sunday Ticket at similar terms to current discussions. Every market is the U.S. currently has numerous layers of competition from the two major satellite providers and the legacy cable provider, including the stronger combination of Comcast and TWC. The legacy phone company is an emerging competitor along with various forms of Internet services, but it doesn't appear that this deal would limit any material level of competition.

For DirecTV investors, the offer price provides an opportune time to exit a position at the top after a couple of years of strong gains. Now its only a matter of being patient until the market rewards investors with that price.

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Mark Holder and Stone Fox Capital clients own shares of AT&T and DirecTV. The Motley Fool recommends DirecTV. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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