I couldn't take it any longer. I just could not watch NFL football in lousy standard definition anymore. I upgraded from DirecTV's (NYSE:DTV) plain ol' NFL Sunday Ticket to the SuperFan package, giving me all the games in HD.
Then I realized I'd fallen right into DirecTV's hands. I'd been upsold, like so many other DirecTV customers -- one reason why the company's financial results are always solid. Not only does it have an outstanding core product that delivers quality at a reasonable price, but it also has so many options, all with perfectly chosen price points, that few subscribers have only the basic service. The company's average revenue per unit is some 20% above its basic package.
Not that we should be surprised. Subscribers have been growing at a steady clip for years. In the past six months, in the midst of a terrible recession, the company added 684,000 net new subscribers, 60% more new subscribers than were added last year! And DirecTV keeps those subscribers. Churn is a tiny 1.42%. And before you think a rising tide lifts all boats, competitor DISH Network (NASDAQ:DISH) lost subscribers in the first half of 2009, although it reversed that course by adding 150,000 new subscribers this past quarter.
Sure, it costs money to acquire subscribers, and DirecTV has spared no expense there or on technological enhancements. But despite a 10.5% increase in these expenses, it still pumped out $643 million of free cash flow in the quarter, and more than $1 billion for the first half of the year. The company lives and breathes sweet, sweet cash flow. Those piles of greenbacks have allowed management to buy back $9 billion worth of stock -- that's billion with a "b" -- in the past three years. The company has also used cash to replace $900 million of 8.375% senior notes with $2 billion in 4.875% senior notes, enhancing its liquidity at little additional cost. And it's currently sitting on $3.3 billion in cash.
What's my point?
DirecTV is just one of those businesses where net income -- which was down 3.5% year-over-year -- doesn't matter nearly as much as free cash flow.
Why not? DirecTV's expenses are not uniform across quarters. They will fluctuate madly, depending on a variety of factors. For example, the company rolled out a complete system upgrade to accommodate HD, first on its satellite ops, then on its subscriber boxes, which lasted several quarters. Those costs were reflected in the expense column, but some also got amortized. Then those costs went down, yet the amortization was still there. And then DirecTV began marketing the big new HD upgrades to customers, giving it huge upgrade and retention costs during their big promotions.
Since the company doesn't break these out from "regular" expenses, one really cannot make year-over-year or quarter-over-quarter comparisons on net income.
What's important, therefore, is DirecTV's cash flow. It is more indicative of the company's health, because it shows if all these varied expenses can be paid for, along with debt service, and the stability of subscriber revenue.
On a PEG ratio basis, which I often use as a guide to determine relative value, DirecTV trades at 0.49, compared to 2.43 for Dish, 1.63 for Comcast (NASDAQ:CMCSA), and 0.75 for Time-Warner Cable (NYSE:TWC).
In short, the company is tearing up the market, and it's in unbelievably sound financial shape. It does not rest on its laurels, constantly adding to its services, maintaining a watchful eye on subscriber and retention costs, and plotting how to keep competition, such as Verizon's (NYSE:VZ) FiOS, from overtaking it.
Now, if you'll excuse me, I want to go soak in some more of that luscious HD programming.
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