Despite losing 147,000 customers across its U.S. and Latin America operations, DirecTV (NYSE:DTV.DL) reported strong earnings results for its third quarter. The company beat the consensus analyst estimates on both the top and bottom lines, posting revenue of $8.4 billion and earnings per share of $1.33.
Operating profit continues to grow despite pressure from content companies increasing costs of programming. Operating profits grew 4.8% overall last quarter. Meanwhile, the company's Latin America segment is on track to become cash flow-positive this year, being allowed to operate independently of DirecTV U.S.
After the earnings release, DirecTV's management team spoke with analysts to provide more context on the results and an update on the progress of the merger deal with AT&T (NYSE:T). Here are five things from the conference call that DirecTV's management wants investors to know.
Progress with the AT&T merger
During the quarter, we completed two important milestones that we needed to, to close the merger. The first was our successful shareholder vote, in which over 99% of our shareholders cast votes in favor of the transaction. And the second was ... the signing of our long-term agreement with the National Football League to continue our 20-year partnership.
-- Mike White, CEO
The only things still needed for the merger to go through are approval from regulators in both the U.S. and Mexico. In the U.S., the FCC halted the 180-day review clock at day 76 because of concerns from content providers. The concerns also caused the FCC to halt the review of Comcast's proposed merger with Time Warner Cable, so it's not an issue relating to DirecTV or AT&T specifically.
Nonetheless, both AT&T and DirecTV remain confident that the merger will be approved sometime in the second quarter of next year. The overwhelming approval of shareholders and the renewed Sunday Ticket deal were the only two hurdles within DirecTV's control. The rest is up to the FCC, the Department of Justice, and the regulatory board in Mexico. The merger was already approved in Brazil.
Why fewer people signed up this quarter
Gross additions declined 8% on a year-over-year basis, mainly due to stricter credit policies implemented during the quarter. These stricter credit policies were applied as a result of improvements in our lifetime value, or LTV, model.
-- Patrick Doyle, CFO
Earlier this year, DirecTV found a problem with its lifetime value model that found that certain subscribers, particularly low-income renters, had a negative value when it factored in acquisition costs and their higher churn rate. As such, the company started implementing an upfront fee for those customers, which generally causes those customers to look elsewhere.
As a result of going after higher-income customers, DirecTV's average revenue per user increased 4.8% year over year. That allowed DirecTV to increase its U.S. revenue 5.4% year over year, despite only a 0.2% increase in subscribers.
Why more people disconnected
During the quarter, we saw discounting, and in particular, cash-back offers and bounties that, in some cases, were both significantly higher than a year ago, but also extended that heavily discounted fixed price for two full years. This, along with consumers who are increasingly under stress from the ongoing weak economy, resulted in more customers than ever shopping for better deals, which caused our monthly churn rate to climb higher than, frankly, we wanted.
DirecTV lost 1.73% of its customers on average each month last quarter, which is 12 basis points higher than the same period a year ago.
While many might be quick to point to cord-cutting as the issue, the bigger issue is balancing price increases with a competitive market full of promotional offers. If you look at the industry as a whole, net additions and disconnects are about even, with the phone companies increasing subscriber count as cable and satellite providers lose subscribers.
Management believes adding more high-quality subscribers (ones more interested in quality service than value) through its more stringent credit checks will help improve churn going forward. Additionally, the company has taken steps to improve its call centers, and it says its churn rate in October returned to 2013 levels.
Latin America is suffering a hangover
The completion of the FIFA World Cup drove lower reconnect rates from prepaid subscribers, resulting in a modest loss of subscribers in the quarter.
-- Bruce Churchill, CEO of DirecTV Latin America
Last quarter, DirecTV Latin America suffered its first quarterly net subscriber loss. Management saw this coming, however, and there's one driving factor: the World Cup. Last quarter, DirecTV saw a huge boost in subscribers from the World Cup, increasing net subscribers in Latin America by 543,000.
Unsurprisingly, prepaid subscriber churn was much higher in the third quarter this year compared with last year, as 2.99% of prepaid subscribers left the service each month on average, compared with 2.23% in the same period last year.
The real problem with DirecTV's Latin America segment is that the dollar remains strong, pushing down revenue growth. In local currency, revenue increased 28%. In U.S. dollars, Latin America revenue increased just 9.5% and average revenue per user declined 1% despite a 15% increase in local currency.
Keeping content costs in check
Based on our year-to-date performance in the category, we now expect [average programming costs per user] growth to be a bit below our 7% to 9% growth rate target for the full year.
Part of the reason DirecTV has increased its average price per user is that the content companies are pushing their programming costs higher. The renewal of the NFL Sunday Ticket package for 50% more than DirecTV previously paid is a perfect example.
Still, DirecTV hasn't been afraid to drop certain channels if it doesn't think it's getting a fair deal. As a result, average programming costs increased just 5.3% last quarter in the U.S., nearly in line with the 4.8% increase in revenue per user.
Management says price increases from content companies are unsustainable. As DirecTV's costs increase, so do its prices, which gets more customers to look at alternatives. The driving factor that will put a cap on inflation, White notes, is the amount of churn DirecTV experiences. Too much churn, and it doesn't become worthwhile for content companies to raise rates.
Doing one better than cable
Overall, there weren't many surprises in DirecTV's earnings results. The churn rate was higher in both the U.S. and Latin America, but for two different reasons. There isn't much DirecTV could have done to improve that churn rate, as it's shedding lower-value customers in the U.S. and is suffering a hangover from the rush of World Cup sign-ups in the second quarter.
Going forward, DirecTV looks to have strong operations, and everything is in place for its merger with AT&T to go through. Until then, the stock price ought to remain tied closely with AT&T's.