Subscribers Flock To Dish, Stock Still Has Very Little Upside

Picking up subscribers

DirecTV recently reported its Q3 earnings. Based on continued subscriber gains and cost improvements in its Latin American business, we have increased our price estimate for DirecTV’s stock to $42.51 which is very close to its current market price.

DirecTV competes with satellite pay-TV providers like Dish Network, cable companies like Comcast and Time Warner Cable, and telecom operators like AT&T and Verizon in the pay-TV business.

One of the key aspects of the earnings were strong net subscriber gains in the U.S. given the amount of competition in the industry. DirecTV added about 174,000 ^[] subscribers in Q3 2010, which is about 28% higher than for same period in 2009.

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We now expect the company to have close to 19.1 million subscribers by end of 2010 which amounts to a pay-TV market share of 18%. Although we forecast stabilization in market share, if DirecTV adds another 2 percentage points of market share over the course of our forecast period, this increases our price estimate by almost 7%.

Interestingly, while DirecTV gained a significant number of pay-TV subscribers in its recent quarter, its competitor Dish Network lost about 29,000 subscribers ^[]. Dish Network seems to be struggling while DirecTV is flourishing. What is the company doing right?

1) Market Push Paying Off

The company spent about $420 million in marketing in 2009, ^[] which was about $110 ^[] million more than Dish Network’s marketing spend. Moreover, DirecTV reportedly spent a significant amount on new advertisement for NFL Sunday Ticket.

2) Avoiding Pricing Disputes

Dish Network got caught up in carriage fee disputes with content owners like Disney and Fox, which led to programming interruptions. We think blackouts hurt the brand value as a result. DirecTV has been successful in avoiding such disputes and inconvenience for its subscribers.

3) High Quality Subscriber Base

As DirecTV is seen as a premium brand, it attracts a higher quality subscriber base with customers more likely to have higher incomes and lower churn rates. Dish dolled out compliments to this effect in its recent earnings call ^[].

We believe DirecTV’s audience is more likely to take up promotional offers like free HD since a higher proportion might have high-definition TVs or be willing to commit to longer contracts. This leads to lower churn, higher net subscriber additions and market share gains.

You can see the complete $42.51 Trefis price estimate for DirecTV’s stock here.

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Cost Cutting Could Unlock Upside At Motorola

Motorola’s research and development (R&D) expense to gross profit ratio is now coming down quickly thanks to aggressive cost cutting measures and improving sales. Motorola primarily competes with Research in Motion, Apple, Nokia and Google in the mobile phone market which have all taken market share from Motorola in recent years.

Motorola’s R&D expenses increased from around 30% of gross profits in 2006 to around 45% by end 2009, ^[] as its margins shrank faster than the actual R&D spending. For 2010, this figure could actually come down to around 35% by our estimates.

If the R&D expense ratio drops in coming years as sales pick up, we could see an increase in our price estimate. We currently have a Trefis price estimate of $8.30 for Motorola’s stock, which is close to the current market price.

Aggressive Cost Cutting

Motorola revenues and market share declined in recent years forcing the company to undertake several cost cutting measures. In addition to laying off around 8,000 employees in 2008-09, Motorola cut salaries of top management and froze pension plans. ^[][] While this helped bring expenses under control, the company likely missed out on revenues as new products, like smartphones, reinvigorated growth.

Improving Sales Reduce Cost Burden

In Q3 2010, Motorola recorded its first quarter of growth in almost four years led by the success of its Android based smartphones, Droid and Cliq. Motorola stated that its total cash increased to $9 billion. The revenues from its mobile phone division grew 20% compared to same period last year. ^[] This is good news for Motorola’s whose margins have been dormant from quite some time.

If Motorola is able to continue its success with Droid, its leading smartphone product, and margins inch up, the company could well keep its costs in check.

The average forecast of Trefis members for R&D as % of gross profit indicate a decrease from 35% in 2010 to 26% by the end of the Trefis forecast period, which is similar to the baseline Trefis estimates.

Our complete analysis for Motorola’s stock is here.

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Dish Stock Still Has Big Upside But Not As Much If Promotional Pricing Persists

Watch those prices

Dish Network’s average subscription price for its high-definition TV service has declined in recent years from our estimate of $20 a month in 2006 to about $10 in 2009 amid increasing competition from DirecTV, AT&T and Verizon, which also offer HDTV services.

Dish Network, DirectTV and Verizon are extending promotional plans in the hopes of attracting new customers while Time Warner Cable does not charge extra for HD channels. This combined with ongoing disputes with content owners that provide HD programming are creating a challenging pricing environment.

We expect average subscription prices to stay around current levels in the near term; however, if promotional activities continue longer than expected or new content agreements adversely impact Dish, this could lower our price estimate of $25.84, which is currently 30% higher than the current market price.

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Promotional Extension Hurts Pricing

Dish Network’s recent marketing campaign offers to waive the $10 per month add-on fee for HD programming if customers commit to a two-year contract. Initially this offer was intended to last until the end of September 2010; however, the company recently extended this offer until January 2011.

We interpret this as a sign of poor pricing power as Dish is willing to sacrifice HD revenues in an effort to attract new customers. While we do not know how successful this strategy might be, the willingness to offer free programming hurts pricing for HD services overall. If Dish extends promotions even further, this will lead us to lower our estimates for average HD pricing.

Dispute with Content Owners

Dish has been in disputes with content owners like Disney and Fox over increases in HD programming costs and recently faced a complete blackout from Fox due to an impasse. The company argues that if it agrees to higher content prices, it would need to pass these costs on to its customers hurting its business and image as a low cost service provider.

While an agreement was finally reached with Fox, service interruptions frustrate customers and hurt brand value pointing to further pricing issues for the company. In these circumstances, Dish becomes more reliant on offering promotions to attract new customers or retain current ones, further eroding the perceived pricing premium associated with HD services.

Since competitors like DirecTV also offer free HD programming for new customers and Time Warner Cable is not charging for HD channels, Dish is forced to compete on price, which makes it more likely that further price cuts will come.

Lower Pricing on the Horizon

We currently forecast that average HD subscription prices will decline slightly and stabilize around $9.50. However as issues mount for HD providers, we believe that pricing might decline further. If average prices gradually reach $5.00 by the end of our forecast period, this subtracts 4% from our price estimate.

You can modify our forecast above to see how Dish Network’s price estimate is impacted by change in average HD subscription fee.

You can see the complete $25.84 Trefis price estimate for Dish Network’s stock here.

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