Description

I find the DTV deal spread of 9% attractive, especially for non-taxable accounts.  The spread is wide due to the carnage in the risk arb world and complications that might arise out of the TWC/CMCSK deal and Title II broadband regulation.  Both of these issues are unrelated to the fundamentals of a DTV/T deal.

#1) DTV is an attractive business to own long term at current prices.  

#2) The arb spread of 9.2% is attractive on an unleveraged basis compared to other opportunities in the markets.

#3) Deal completion is reasonably likely within 6-8 months; IRR on spread therefore quite good

DTV is a good business with great management.  DTV is the #1 satellite video service in the US and Latin America.  DTV’s has a very strong competitive advantage in delivering linear video at both the lowest cost and highest quality in a uniform way nationwide.  It only costs a couple hundred million dollars for a modern satellite, but tens of billions (maybe hundreds) for full fiber deployment to achieve nationwide coverage. The weakness is obvious, a lack of 2 way communication for internet and random access TV viewing.  I don't want to downplay this issue, but I would note that EBITDA has tripled in less than 10 years and continues to grow.  This weakness has always been present.  Growth is driven by superior service, high quality product, and exclusive content like the NFL Sunday Ticket all for a reasonable price.  Ultra high definition is on the horizon and I expect this will once again highlight the weakness of the domestic cable competitors, which are mostly unequipped to handle its much higher bandwidth requirements (this is underplayed by the market but a big problem coming for cable).  DTV’s Latin America business is better than the domestic business due to an advantaged competitive position, relatively low pay-TV penetration and an emerging middle class, though it's been a bit rocky over the near-term and I’d expect that to continue.  I value the downside here at $81.50 or 10X FY16 FCF ($68) + unconsolidated assets (Sky Mexico, GSN; $4.50) + FCF generated in the interim ($9) using 507M shares.  This is another way of saying you are paying 10.8x FY16 FCF today.

The AT&T deal provides DTV $28.50 in cash and $66.50 in stock and includes a collar on T’s stock price of $34.90-38.58.  This is up 9.2% unleveraged in 6-8 months, which looks pretty good relative to low interest rates and high equity valuations.  If you hedge T you will need to make ~2 dividend payments.

In terms of deal completion, the remaining hurdles are primarily FCC and DOJ with DTV having recently resigned the NFL Sunday Ticket.  T recently got burned with T-Mobile, so I'd assume the merger team did more work and received more winks and nods than typically.  On the other side, DTV’s CEO is a details oriented guy and would not do a deal he didn't think would get done.  Various hearings and comments have been largely supportive of a deal.  Politicians will appreciate the rural broadband aspects and, not so subtly, T has pointed out that they are unionized and DTV is not, gathering support for the deal from more traditional adversaries.  The FCC stopped the 180 day clock recently, but that's largely related to contracts media companies are jockeying to block access to rather than the merits of the deal.  Recent results from DISH and DTV revealing sub losses and the onslaught of new OTT initiatives make traditional TV concentration arguments obsolete.  

Risks:

Risk arb is generally more risk than arb; I happen to know and like the assets even if a deal fails.  If you don't, stay away.

FCC/DOJ rejection + increased traction among OTT offerings in FY15

T stock price goes below collar requiring dynamic hedge, reducing return by dividend payments

Deal closes but delayed, reducing IRR

Mark 2 market - Since re-signing the NFL the spread was as high as $10 in October vs. current $8 and low of $7

HHI technicalities - a lot depends on how the FCC defines the market overall and how they view the market geographically (data viewed on a state or DMA basis vs. nationally vs. actual physical overlap?).  In certain markets the combined T/DTV will have a lot of market share.  Could create noise but should be workable with partial divestitures, etc.  

This write up is obviously incomplete so you should do your own homework and not rely on my numbers. 

Background:

*DTV’s projected FCF in here (my numbers are a bit more conservative): 

http://www.sec.gov/Archives/edgar/data/1465112/000119312514315989/d775092ddefm14a.htm

*Sky Mex results here (http://i2.esmas.com/documents/2014/10/23/3361/third-quarter-2014-results.pdf). 

*GSN valuation from the 10K/Q based on recent sales prices and the remaining stake. 

http://www.fcc.gov/transaction/att-directv

Q3 DTV call:

With regards to the AT&T transaction, 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, as I'm sure you've all read, the signing of our long-term agreement with
the National Football League to continue our 20-year partnership offering our hallmark NFL SUNDAY TICKET
package. In addition to that the Brazilian telecom authority, Anatel, also approved the transaction during the quarter.
Now this leaves us with the regulatory review process here in the U.S. and in Mexico. We're making progress in
Mexico.
As it relates to the U.S., as I'm sure you're aware, the FCC had halted its 180-day review clock of our transaction at day
76, as they worked through a number of issues with the content providers regarding a review of their confidential
contracts and related materials. Based on the FCC's orders entered earlier this week, we now expect the clock will start
again some time mid next week.
That said I would remind you it's not unusual for the FCC to halt the clock in large deals like ours, and it's certainly
possible that they will stop the clock again at some point in the future.
But in the meantime we continue to work diligently with both the Department of Justice and the Federal
Communications Commission to fulfill all of their information and data requests, answer their questions so that we can
help them make an informed decision on the merits of this transaction and based on the facts that we're submitting. In
summary I believe the process is going well. And I remain confident that we'll close the transaction some time probably
in the second quarter of next year.

Catalyst

deal approval (h1 15)

deal closing (q2 15)