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Walt Disney’s (NYSE:DIS) purchase of ABC in the 1990’s rocked the media markets. The legendary content provider and distributor announced it was making a huge move into television. The move has paid off in spades for Disney, and now two gigantic companies are proposing an equally groundbreaking merger.
Telecom companies have long been rumored to be interested in acquiring satellite TV operators. These deals make sense, as both are transmitters of massive amounts of data from source to consumer.
To me, it was only a matter of time. But when would such a deal make the most sense and who would be involved?
I always suspected DirecTV (Nasdaq: DTV) would be the most likely buyout candidate. But it would only sell out once its growth had topped out.
The ideal acquirer could be any big telecom. None were growing their businesses, so an acquisition could help them grow their business in a big way. AT&T (NYSE: T) was the most likely acquirer, because it has the best balance sheet. Sure enough, this is the deal being discussed and I believe it will go through.
DirecTV has exploded over the past several years, from a modest domestic satellite provider to a global conglomerate. It now has 37 million subscribers, of which about 60% are domestic. The rest are in Mexico, Brazil, and other Latin American countries.
It has almost as many subscribers as all competitors combined. It also has 6 million ROOT Sports Network subs, and a 42% ownership in a game show network. The company had FY13 revenues of over $31 billion, EPS of $5.15 per share, FCF of $2.1 billion.
It is a recognizable brand with great content, exceptional marketing, and the company is always innovating. It aims for $8 per share in EPS by 2016, along with $8 per share in FCF. It has $4 billion in cash offset by $18 billion in debt, with an average cost of about 4.5%.
So the balance sheet is just fine. It’s not as stellar as it once was (there was more cash and more FCF), but it is in fine shape.
DirecTV stock was a growth story, but the easy growth phase is over. Analysts still project 12% annualized long term EPS growth. However, currency headwinds and competition are starting to gnaw at the company.
The time for a buyout is now, after the stock has enjoyed a great run but when further upside will get challenging.
AT&T is a different story. It isn’t a growth play, and it really isn’t even a Peter Lynch stalwart. EPS growth is pegged at 6%, but organic growth is less when one backs out stock repurchases.
Thus, AT&T is moribund with respect to growth, but sits on a massive free cash flow machine. It generates $14 billion annually and consistently. It is loaded with $70 billion in debt but at a 5.5% average interest rate.
The deal, then, is really a growth engine for AT&T. The combined entity will have plenty of cash flow, and room to grow. However, there was also a lot of debt that is nevertheless easily serviced, and should still throw off the nice dividend AT&T investors are used to.
I don’t like this deal, though. While I think the long-term vision for DirecTV is lacking, there is still growth to be squeezed and upside for shareholders. Merging with AT&T dilutes that growth engine.
That’s why the buyout price is only $92 or a 9% premium to the current share price.
Lawrence Meyers has sold naked puts against DirecTV stock.
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