Description

MDU Communications (“MDTV”) has a business model which represents a compelling and unique investment opportunity due to (i) its large target market, (ii) barriers to entry, (iii) guaranteed and fully-funding economics, and (iv) recurring revenue nature. It should easily be able to achieve $0.30 in run-rate fully-taxed EPS later this year and to grow quickly to $1 per share in several years, and is worth $10 per share on an NPV basis. Currently, my fund has a long position in this security.

MDU Communications delivers digital satellite television, as well as high-speed internet access, to the U.S. multi-dwelling unit (“MDU”) market. The MDU market includes over 26 million residences and the company is DIRECTV’s primary representative in this market. After running a successful family cable business, the company’s CEO established MDTV in Canada to address that country’s MDU market as a representative of StarChoice, one of two Canadian satellite TV providers. With the passage of the Satellite Home Viewer Act of 2000, US satellite TV providers were allowed to provide local television to subscribers and MDTV sold its Canadian operations to focus its capital and efforts on the more lucrative US MDU market, particularly in the Northeast. After nearly a decade of offering satellite services, DIRECTV and its competitor, Echostar, have struggled in penetrating the MDU market. As a point of comparison, the individual residence market contains 80 million homes. The satellite companies have secured 21 million subscribers in this market but only 200,000 in the MDU market. Proportional coverage would be nearly 7 million subscribers. DIRECTV’s historical efforts to penetrate the MDU market have included (i) developing a proprietary MDU-specific technology, (ii) coordinating a marketing effort to MDU’s with equipment suppliers and local retailers, and (iii) signing countless independent, and largely inexperienced, installation and service providers to contracts with tight margins and low upfront fees. Satellite’s low MDU penetration attests to the ineffectiveness of this approach.

In late 2003, MDTV had only 13,000 subscribers due to a lack of required capital. However, the company was one of the few surviving MDU service providers and the only one with anything approaching critical mass. DIRECTV had been referring potential MDU customers exclusively to MDTV and the company had a backlog of 18,000 subscribers and an installed presence in dwellings whose owners had buildings with an additional 150,000 potential subscribers. Most importantly, MDTV had entered into a new, seven-year System Operator Agreement (“SO Agreement”) with DIRECTV in September. The SO Agreement provides MDTV with lucrative margins and upfront payments and is designed so that MDTV can provide DIRECTV with needed growth as the independent residence market begins to stagnate.
The SO Agreement provides the company with nearly $300 for each new subscriber provided to DIRECTV. This fee will typically cover the installation costs for a given MDU as the service is rolled out throughout the residence and effectively removes MDTV’s capital constraints. In the recurring cases in which the new subscriber is simply a new tenant in a previously installed apartment, the fee will essentially be pure profit. Other revenue components include an increased share of the monthly DIRECTV bill and monthly access fees from the subscriber. All in, DIRECTV’s agreement with the company provides it with lower subscriber acquisition costs than in the single-home market and subscribers generally find DIRECTV to be less expensive than competing cable servers. Even after the SO Agreement expires, its terms require DIRECTV to continue to pay the company for any remaining customers. In addition, MDTV retains its long-term video access agreements with the MDUs themselves which prohibit access to any other satellite providers (and in some cases any video providers). The SO Agreement clearly represents substantial value for MDTV and a significant investment in the company by DIRECTV. In a step which is likely related, a former member of DIRECTV’s senior management recently joined MDTV’s board. MDTV’s CEO is very well regarded in the industry and has relationships throughout the REIT industry, which owns and makes decisions for a substantial portion of the MDU market.
In projecting MDTV’s results based on the SO Agreement, I believe that the company will start adding MDU customers rapidly and reach a run rate of at least 5,000 new subscribers per month sometime this year and at an increasing rate thereafter. This initial run-rate assumes they penetrate buildings a little better than twice as quickly as they did within six months of first launching this business in Canada with a shoestring budget and no upfront payments coming from StarChoice. Given the nature of the industry, the company’s revenues are largely recurring and future growth should continue at a steady pace. DIRECTV’s goal is to grow its customer base by one million subscribers per year.

Catalyst

Announcements of quarterly results and backlog driven by the new SO Agreement.