Description

DISH equity - long

Summary

The stock is at $27.22 and $12.2bn market cap

Dish is the satellite pay TV company with about 14% pay TV market share.

Basically, the pitch for Dish is pretty straightforward: there's a lot of value in Dish's spectrum assets that they acquired from bankrupt companies (DBSD and Terrestar) that isn't baked into the stock’s price.

I’ll get to the punchline and upside first:

- With the stock at $27.22, you’re buying the core satellite pay TV business at

5x 2012 EBITDA (which will likely be one of the weaker years financial for DISH), and you get the spectrum assets that they've acquired for "free".  The spectrum is potentially worth around $7.6bn,  or about 62% of the current share price).

Of course there’s a wrinkle, there are a few hurdles to get through before this spectrum’s value will be fully realized, but I think the past of least resistance will end in Ergen’s realizing the value through a sale or partnership:

-         The FCC has to grant DISH the waiver to allow the spectrum to be used for terrestrial wireless services without a satellite requirement (which it was originally intended).  Timing perhaps Q4 2012

• This is likely as the FCC knows that the industry is starved of spectrum right now and its only getting worse.   Politicians are pushing for more spectrum to be freed up

-         The current administration ideally should impose few limitations on use, build-out requirements, saleability, etc.  

• Supposedly, the Spectrumco / Verizon acquisition of AWS spectrum is hung up more because of the joint marketing agreement, not the spectrum side
• Thus far in the rulemaking process, the build-out requirements are reasonable, and there has been no serious talk of sale limitations and profit taxes (if they want to get this into the hands of those who need, it makes sense that they shouldn’t stifle investment and transferability)

-         Ergen (the majority shareholder) has to decide to sell the spectrum or partner up with someone else

• It is of course unlikely that Ergen will decide to spend however much it would cost (~$10bn?) to buildout a wireless network to compete with the 6 other wireless providers given the competition in the market and the likely low returns on investment

-         The wireless industry has to be interested in this spectrum (either acquiring it or partnering)

• Everyone in the industry is interested in 2 things:
  • More spectrum (e.g. all the spectrum swaps, VZ/Spectrumco, AT&T/T-mobile, Sprint/Lighsquared, etc.). 
  • Merging and consolidating (e.g AT&T run at T-Mobile,  Sprint/MetroPCS tie-up, all the other rumors out there). Clearly, the administration is not very keen on it though.  Plenty of articles about potential tie-ups with DISH as well.   Also DTV and DISH always publicly say that a merger would make sense

Other valuation metrics

$1150 EV / sub

9.5% FCF/ yield.  But no dividend  (DISH generally invests more in the business, less capital return, unlike most cable & satellite companies that have a steady dividend yield and buyback – which is what the market likes at the moment)

11x P/E vs. comps around 11-15x P/E

So basicallyDISHtrades at a somewhat reasonable multiple - if not cheap (DirectTV - DTV trades at 5.5x EBITDA and the other cable companies trade at 6-7x EV/EBITDA),  but Dish warrants a lower multiple as it suffers from the Ergen discount as the Chairman Charlie Ergen is usually more mysterious in his capital allocation and strategic moves.  Also there's no dividend.    

2012 earnings will also be a bit weak asDISHhas decided not to raise prices in order to offset rising content costs.  Subscribers are growing as a result.  They’ll start to pass through price increases again and earnings should bounce back next year

Spectrum Valuation

Valuing spectrum is a bit of an art.  Obviously (like land), you can’t make more of it.  It’s a scarce resource that literally every wireless company is trying to acquire more of.  It’s a priority for everyone:  AT&T, Verizon (despite being spectrum rich already), Sprint (despite having CLWR), T-mobile, MetroPCS, and Leap.   And in the case of AT&T and MetroPCS, it is a very public #1 priority.  Overtime, Spectrum has only increased in value

For quick background, lower MHz spectrum generally provides better building penetration, higher distance and lower throughput.   Higher MHz spectrum provides less penetration, lower propagation, and higher throughput.  Clearly, VZ prefers the higher frequency AWS spectrum (more similar to Dish’s) and is less interested in 700 MHz. VZ’s purchase of the AWS spectrum is better suited for high speed 4G LTE services in dense areas than the 700 MHz spectrum that they’re selling.  Also, the 700 MHz spectrum that VZ is selling (ostensibly to appease the FCC’s concerns about spectrum concentration and hoarding – although VZ says that it the FCC did not ask them to do it) has some interference issues as well, which means that it may not solve anyone else’s problems immediately (AT&T owns the most similar block and would be the likely acquirer)

- Dish spectrum at cost:

The spectrum is worth $3.5bn, or $7.77 / share – or 28% upside.   

The MSS spectrum (aka AWS-4) was purchased at about 22 cents / mhz-pop

And the 700 MHz spectrm was purchased at about 48 cents / mhz-pop

- At recent transaction multiples of similar spectrum sales:

Using Verizon’s acquisition of the cable TV spectrumco assets at ~68 cent / mhz-pop to value the MSS spectrum (Spectrumco picked up 20 MHz licenses in the AWS B-block covering most of the populated areas of the continental US, plus an odd extra 10 MHz in Houston. They also went afterHawaii, although Verizon out-bid them for the B block, so they picked up the C and D blocks there instead.) 

And 90 cents for the 700mhz spectrum (which is where AT&T bought spectrum from Qualcomm, which is in the exact same band as the 700 MHz spectrum DISH has)

The spectrum is worth $9.8bn  or $22 / share  or 80% upside on the stock which is at $27.22. 

You could argue that Dish’s AWS spectrum could be worth more or less than what VZ paid recently.  It’s not immediately ready to plug and play (a negative of course since you have to build a new ecosystem around it), but you do have a full 20x20 mhz of nationwide, unencumbered spectrum that allows for faster speeds, higher bandwidth, higher efficiencies, etc., which will effectively solve a company’s spectrum issues for an extended period of time.   So it could be worth more as well.  It’s not everyday you get the chance to own on such a large swath of spectrum.   In the meantime, the rest of the unused spectrum that could eventually be used for wireless has to be weaned from other owners (government and private) in a process that will likely take 5+ years.   There hasn’t been any spectrum auctioned since Jan 2008 (in the meantime, data growth has grown exponentially) – and most agree that data growth will continue to grow at 75% a year. 

Every wireless carrier (except VZ) will run out of capacity by 2013 or 2014.  VZ before the Spectrumco acquisition would have been OK through 2015.  This is why everyone has already started putting on data caps and tiering prices.  Also, they can’t wait for it since it takes years for the new spectrum to be built out and utilized

Verizon’s recent acquisition of the AWS spectrum from spectrumco / cable companies highlights the value of AWS spectrum and Dish’s spectrum.  

- After taxing the gains by 35% if they sell it, it's still worth $7.6bn,  $17/share in upside, or 62%

FCC / Government

There are concerns that there may be a windfall profit tax charged by the government.  However, there has been no discussion out of the FCC in the recent notice of proposed rulemaking towards that outcome and it seems as if the government may not be punitive at all.   Lightsqured was granted a similar waiver and was not made to pay for it.  It’s also difficult to argue that Ergen was simply gifted anything.  He took the risk to purchase the spectrum from bankruptcy companies for billions in transparent auctions.  I think the other wireless companies didn’t bid because it’s had uncertainty and shareholders certainly would have revolted if, for example, AT&T spent billions on a risky (but high EV) instead of buying back stock and paying a fat dividend.  MetroPCS was in the hunt but they have a more limited balance sheet and certainly can’t bet the farm on something of this magnitude. 

Given the scarcity of spectrum in the wireless industry, that the government and the wireless industry both clearly want to fix, the FCC is highly incentivized to get this spectrum out there and it is one of this administration’s goals

Wireless Industry

Their 700 mhz spectrum that they have is very similar to spectrum that AT&T just purchased from Qualcomm for $1.9bn.  

Their 2ghz spectrum is similar to what carriers are using for their 4G services and expanding into.   So both are highly compatible and are attractive to all the carriers

 There has been a shortage of spectrum (no new spectrum auctioned since Jan 2008) and all the wireless providers are clamoring for more spectrum.   Pretty much every wireless company has been talking about the need for more spectrum and have all talked about potentially doing something withDISH.  Of course, wireless data usage continues to expand exponentially and the carriers are running out of capacity - and they'd prefer to get more spectrum rather than continue to increase the density of their networks (which is more costly).

VZ has been buying up spectrum (despite being the only spectrum rich company), part of the rationale of AT&T’s proposed merger with T-mobile was spectrum.  MetroPCS needs more spectrum;  Sprint said that they’re interested inDISHspectrum despite having CLWR.  AT&T is interested as well, but they’re waiting for the NPRM.  Leap and T mobile need spectrum too.   

Also, Dish’s spectrum is a full 40mhz of useable spectrum, which is much more valuable.  It allows for much higher bandwidth than those services running on 10 mhz of spectrum.  Spectrum is already scarce, so large chunks of contiguous spectrum are much more valuable.  Full LTE speeds requires at least 20 mhz of spectrum

For example,  Sony Ericsson had a prototype that was running on 60 mhz of spectrum that could do wireless speeds of 1 gb / second in controlled tests. 

Every wireless carrier is interested in this spectrum and needs it.  Though of course it's not a sure bet that it gets realized,  I believe it's highly likely that this spectrum falls into the hands of a wireless carrier who needs it (e.g. everyone except Verizon).  Every wireless carrier prefers to own the spectrum as well – since it gives them more control over the network and the buildout. 

With Lightsquared’s fiasco and this Spectrumco acquisition, there’s nothing left, except Clearwire – which has a ton of its own issues.  CLWR’s 2.5 GHz spectrum has poor building penetration and propagation characteristics.  All carriers don’t want to use it except for very specific circumstances (e.g. exterior wi-fi according to AT&T).  Even Sprint doesn’t even want to rely on it either, and Sprint basically owns CLWR.  But that’s another can of worms.

Ergen can get an amazing return on investment if he sells the spectrum (120% in the few  years that he’s owned it).   There's no guarantee of what may transpire,  but Ergen, the government, the FCC, and the wireless industry are all on the same page here:

- Ergen wants to make money

- the FCC wants to make this spectrum available (of course it's unsure how many restrictions they’ll impose or how they may spread the spectrum out amongst the carriers 

- the wireless industry wants and needs this spectrum for 4G LTE.  And they want to stop spending tons of capex and finding ways to increase their capacity otherwise

- consumers want more data and faster speeds

Regulatory

Right now, the FCC is going through the regulatory process to figure out how it will give Dish and Charlie Ergan the terrestrial waiver in order to use this spectrum for solely mobile terrestrial wireless (instead of satellite use as it was originally set for)

Thus far, the regulatory process has been pretty favorable forDISHand it seems that the FCC will grant dish the spectrum waiver with very reasonable build-out requirements, and few limitations in general (including few or no limitations on selling it).  Also many have feared a potential windfall profit tax, but thus far the rulemaking process hasn't mentioned much of that being contemplated. 

So all in all, the FCC basically outlined a very favorable stance towards giving Dish the most latitude towards realizing the value of the spectrum.  The comment submission period ended recently.

Timing is up in the air,  but this seems to be a late 2012, early 2013 timing of getting the waiver. 

Key points from the FCC outline so far

-         Less onerous buildout requirements (95mm POPs in 3 years,  220 POPs in 7 years)

• much less onerous than Lightsquared’s requirements.  More restrictive than Sprint

-         No major penalties or giveback discussed thus far

-         No wholesale restrictions

-         Should be able to sell their spectrum to someone – subject to FCC approval

• Whether the FCC allows VZ’s acquisition of SpectrumCo is another potential catalyst / risk

-         They’re calling the spectrum AWS-4 now – a nod towards how similar this spectrum is to other commonly used AWS

Risks

Process/ timing

Clearly, a few things involving the government and a maverick chairman have to go right,  but logic and normal judgment point towards a favorable outcome as outlined above.  

The NPRM will likely finish after elections since the administration wants to avoid making decisions.  But Ergen is hinting that this could get done in the summer (which seems unlikely)

After that, it remains to be seen what provisions and limitations will be imposed if any. 

Go it alone buildout

Of course, it would be quite bad if Dish actually tried to build out some wireless service on its own.  Ergen has said that they're more interested in partnering up with others (and perhaps selling the spectrum).   I think most the talk about potentially building it out is to appease the FCC and the government in order to get the waiver (e.g. asking Qualcomm to design some chips for them).

Building a network could easily cost some ridiculous amount (call it ~$10bn), and given the competitive market and long time frame, even Ergen shouldn’t be seriously considering it.  

Clearly, the easiest way to recognize the value of the spectrum is to sell it, but Ergen has been going around saying that he has a grand plan of offering video, internet, phone and everything else at home and mobile.  Again this is probably lip service to the FCC.   Partnering up with some could get him closer to this goal though and allow him to realize the spectrum value as well

Ad-hopper / TV Networks Spat

The most near term concerning issue is that recently Ergen has decided to take on the TV broadcasters with the introduction of a DVR that can automatically skip commercials (with plenty of provisions and limitations though).   He's historically always been combative and willing to push the envelope, but this seems a bit much in my opinion.  Even if he gets the ability to have this feature, it’s not a game changing feature.   Hence I'd lean towards waiting for this to settle down and see how this plays out.   Seems like somewhat of a slight lose / lose situation.  If he gets to provide this feature, it’s nothing earth shattering.  And either way, he pisses of the content guys.   But at the end of the day, it’s probably just another negotiation tactic to combat rising content costs (much like going dark, or threatening to drop content – e.g. this AMC Networks spat)

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Content

Everyone knows content costs are increasing.  But consumers have been simply eating the increases.  Content costs make up about 38% of revenues.  It’ll continue to go up, until the customers can’t take it anymore.  And then the cable networks will start dropping more content, at which point price increase will likely abate

Satellite TV business

I'm not a huge fan of the core satellite business for obvious reasons like increasing content costs, threats from the internet and competing distribution channels.

But I think you're creating the core company at a decent valuation, if not cheap at around 5x EBITDA that's already factoring in these secular pressures and decline.  In the meantime, Dish still generates plenty of FCF.  

2012 numbers will look a bit ugly as they've chosen to not increase prices this year to offset content cost increases (which are about 38% of revenues), which has helped improve churn.  Dish usually caters to the low end customer. 

Dish also acquired blockbuster (also in bankruptcy).  Blockbuster, on a standalone basis, generates negligible positive EBITDA, but they've started to bundle more of Blockbuster's total access product, which has likely helped churn somewhat (no specific numbers).  This service could provide some upside to financials

I think it was a smart acquisition that adds something different to their product lineup, gets them into the Over-the-Top arena, and gives them better relationships with the content guys.  It basically gave them a mini Redbox + NFLX on the cheap.  They’ve been shutting down stores rapidly – so that albatross should be gone soon.

Americans still watch about 4 hours of TV a day on average.  The death of cable/satellite has been greatly exaggerated.  Yes it’s not growing, but NFLX and Hulu are mostly complementary services.  If housing grows, could be an added boost

Financials

Capital structure

$5bn of cash

$9bn of debt

$12.25bn market cap  (27.25,  and 450mm shares)

EV $16.1bn

$14.4bn in revenue

$3.2bn of EBITDA in 2012  (should pick back up in 2013),

$2.4bn EBIT  (D&A about $850mm).  

38% gross profit margin

22% EBITDA margin

18% EBIT margin

Churn about 1.6% monthly churn

SAC $775

ARPU monthly $78

5x EBITDA

6.8x EV/EBIT

$2.5 in EPS in 2012,  10.75x EPS

14mm subscribers (increased through 2011,  but currently slowly falling off)

$3.25bn of EBITDA

~$800mm of capex  (generally lower capital intensity than cable, around 6% vs. cable in the low teens)

~$550mm interest

~$700mm taxes

Minimal working capital changes

= $1.25bn of FCF

Catalyst