DirecTV (DTV.DL) has plans to sell itself to AT&T (T 0.87%), but it's still repurchasing shares before the deal closes. However, many observers believe that regulators will block the merger, making it important for DirecTV to continue business as usual. As deliberations continue, investors should consider whether DirecTV's share repurchases are the best way to return capital to shareholders.
The AT&T deal could be nixed
In February, DirecTV unveiled a new $3.5 billion share repurchase authorization -- all of which it expects to use in 2014. At the time, Chief Financial Officer Patrick Doyle said the company's stock price "remains significantly undervalued" at $75 per share. The stock rocketed 17% to as high at $88 in May after the company announced plans to be acquired by AT&T in a cash-and-stock transaction valued at $95 per share.
The deal would be a boon for DirecTV investors. Shareholders would receive about two-thirds of the deal value in the form of AT&T stock, and the combined company would be a diversified communications company with a leading market position.
However, the deal may be a little too good for regulators' satisfaction. Last month, Public Knowledge and the Institute for Local Self-Reliance formally petitioned the Federal Communications Commission, arguing that consumers would be harmed by a "highly concentrated, centralized marketplace, with fewer choices, homogeneous offerings, and increased likelihood of coordinated effects."
In addition, the pending merger between Comcast (CMCSA 0.41%) and Time Warner Cable (NYSE: TWC) may heighten the FCC's concerns that the communications industry risks becoming too consolidated. If the FCC were to block the AT&T-DirecTV merger, Reuters reports, DirecTV would receive no compensation from AT&T. Its share price, however, would probably fall -- which could make share repurchases at today's price look foolish.
Are share repurchases the best use of cash?
DirecTV has two main options for spending its cash flow: It can either reinvest cash for growth or return cash to shareholders. It has opportunities to do both while awaiting the FCC's decision on the AT&T merger.
Latin America is the most promising growth outlet for the company. DirecTV was the first North American pay-TV provider to make a major push in the Latin American market and has captured a leading share. The company's various Latin American subsidiaries had 17.6 million subscribers at the end of 2013, compared with 20.3 million U.S. subscribers.
Latin America is quickly scaling up to the size of DirecTV's U.S. business, but so are the capital expenditures. In 2013, DirecTV spent $1.7 billion to build and maintain its Latin American operations and $2 billion for its U.S. operations. DirecTV had about $2.6 billion in free cash flow left over after those capital expenditures -- leaving it with plenty of cash to repurchase shares.
Even though DirecTV has cash left over after making necessary investments, giving it all back to shareholders in the form of share repurchases may not be the most efficient way of returning it. Its stock price has soared over the past two years and will probably decline significantly if the AT&T deal falls through. Meanwhile, the company has billions in free cash flow that it can't reinvest in its business, yet it pays no dividend.
Instead of repurchasing $3 billion-plus worth of stock at elevated prices, shareholders may be better served if DirecTV institutes a dividend. Paying a $3 billion annual dividend would allow it to pay $5.97 per share -- a 7% yield. Even distributing half of that amount would give DirecTV an enviable dividend that could keep its share price elevated even if the deal gets nixed.
Even so, share repurchases at 15 times earnings are not value-destructive. AT&T's offer suggests that DirecTV's shares could be worth $95, so repurchasing shares in the mid-$80s may be a good use of cash if the deal proceeds. Shareholders shouldn't fret that management continues to repurchase stock after the run-up -- but a move to institute a dividend would be reason to cheer as well.
