The figures out at the end of last week for DirecTV show an astonishing growth in the pay TV subscriber levels for Latin America, with 415,000 net additions in a single quarter. This is four times what it achieved in the US. We might say that this is a result of the enlightened policies of DirecTV, but at Faultline we view it more in terms of the luck of finally being in the right place at the right time. Latin America is economically on fire and that has implications for everyone in this business.
Before thinking about the reasons for this, the results are what are most interesting. For years we have been obsessed with China and the rest of the BRIC countries, because they have driven service growth in many areas, broadband as well as Pay TV, and of course cellular. But perhaps now the entire region surrounding the B in BRIC, Brazil, will need to be accommodated.
And it has plenty of implications for the companies that have invested wisely and successfully there, for instance suppliers to DirecTV, but also other players.
In this recession, Latin America has not been too badly hit. In the past it was an area of political strife, interfered with overmuch by an oversensitive US foreign policy, and beset with debt defaults, currency devaluations and bailouts from richer partners. Recessions began early, ended late and struck deeply.
But as economies like China and India have grown, they have shown a greater and greater need for what Latin America does well, it has vast deposits of everything from copper to iron ore, tin and gold and these are in need in industrialized times.
Combine that with the fact that many of these countries, especially Brazil and Argentina, wishing to find their own, non-US dependent, identities and we have a well controlled, inflation free zone, which is shifting its export base to China and the Asia Pacific. The World Bank says the entire region’s economy will grow 4.5% in 2010. China is already the biggest economic partner for many of these countries, overtaking the US.
Brazil is leading the recovery and grew 9% in the first quarter and for the entire year it is expected to remain above 6.5%, though externally economists expect it to beat these figures. It could go as high as 7.3% says Brazil’s central bank and it didn’t even shrink during 2009. What if it does 9% for the full year? That would put it on a par with China. (Alright China has done that level of growth for years, but it’s a start). In such economies people get rich, that money spills out into other services and luxuries become more affordable ‘ spurring success in broadband, pay TV and cellular.
At the same time these countries are using their new found wealth to buy in industrialization. Brazil puts an 85% tax on imported consumer electronics. So Japanese, Chinese and European firms, as well as US companies, are all tempted to put factories for the region in Brazil and export from there. This week we have Siano and Conax opening offices there (see elsewhere in issue). In the long term this will have an impact on the standard of living of the middle classes and a knock on and continued effect in service purchasing.
There are 420 million people in just Brazil, Argentina, Mexico, Chile, Peru, Venezuela and Ecuador alone and 570 million people over the entire sub-continent. In economically strong times, and if those times are sustained, this is a bloc worthy of China and India.
Mexico is perhaps thought of in a different way. It is closer politically to the US, and technologically, and it went into a sharp contraction during 2009. But already Mexico is on the mend. Its economy grew 4.3% in the first quarter and may reach 5% this year in line with most of Latin America.
We should not then be too surprised at the DirecTV outcome and instead should look top predict other similar results. Although DirecTV may be less happy with its performance in the US in terms of customer acquisition.
But what is now interesting about this region is that it is less likely to go mimicking the politics of the countries that bring it wealth, and more likely to forge supply and economic alliances while maintaining the region’s own style of political control. So it can take China’s money, but it won’t become Maoist, a mistake that has left Latin America exceptionally volatile in the past.
The upshot of all this is that the US owned satellite Pay TV provider leveraged its Latin American strength and reported outstanding financials a few days before rival Dish confirmed investors expectation of the opposite – disappointment. DirecTV in the US grew its customer base just 100,000 in the quarter to 18.76 million while Dish Network subscribers went backwards by 19,000 subs and so stayed at 14.3 million. But while Dish has in the past helped overseas operations, any upside to the business will now live within its satellite service operator sister company Echostar, now an entirely separate financial entity. But that has experienced the same type of success as DirecTV, without it having quite the same effect on its results.
Dish Mexico (a jointly owned venture with MVS Corporation) ordered $48 million of set tops from EchoStar over and above the deal whereby the organization was set up with continued investments from both sides.
It’s a far cry from 415,000 new subscribers each paying an ARPU at DirecTV of around $57, because that’s an additional $284 million of service revenue being added each quarter. At this rate it’s an additional $1 billion a year and this is just among a single operator.
What we are seeing here is identical to the satellite TV operations in India which grew 10 million subscriptions across 6 separate DTH suppliers during 2009, a growth that is continuing into 2010. The only reason that this has not happened in China is because it does not have the same geographic problems ‘ both India and Latin America have to contend with massive mountain ranges, which favor satellite delivery ‘ and China is happily taking cable TV and IPTV through the phases ‘ before pushing its own slow growth terrestrial technology, which still has not fully matured.
Latin America has no choice ‘ IPTV and cable have been tried and in many cases found wanting. Oh they exist and in some cities, Mexico, Sao Paulo etc’ they flourish, but satellite reaches everywhere. And we think we see a clear reason for its sudden acceptance.
In the past pay TV in Latin America has been exceptionally volatile. In 2004/5 pay TV homes fell dramatically (almost halved) as the region’s economy fell off. In virtually every other region in the world pay TV survives virtually unscathed through a poor economy. But in this region much of the Pay TV has previously been purchased not by locals, who are well served by free to air broadcasts and locally created content, but by visitors to the region.
A few years ago (2008) when Faultline did a project on Bazilian TV, it was obvious from the content that is carried on those Pay TV services that this was happening. Some of the stronger channels were in French, German, Japanese and of course English ‘ not Portuguese and Spanish. And pricing for the most basic pay TV service was $68 a month. This was huge as a percentage of domestic salaries at the time and now as local salaries have risen and prices have come down, it is perhaps more reasonable.
For instance now DirecTV LA has an ARPU of $57, which is below the basic TV service price of a few years ago.
What is happening is that suddenly the indigenous workforce is the target for Pay TV, not mostly ex-Pats from marauding overseas based export businesses.
This is a significant and sustainable change for perhaps the first time, and will have a continued effect on DirecTV, all local cellular operations, which we think we already knew through the reporting of the big players in the region ‘ America Movil, Telefonia, Telecom Italia and Telemar (Oi) ‘ who grow and grow.
Broadband of course is just as much in demand, but its growth is often constrained by geology in some parts of the continent. But uni-directional broadcast satellite TV reaches everywhere.
In the end this benefits both DirecTV and EchoStar, it has led to investments by Telefonica, in a technology that it has usually shunned in its native Europe, and set top suppliers like Technicolor look set to make hay off the back of not just this quarter, but the quarters to come. Like India, more and more local operations will look to work with satellite owners to launch more DTH in the region and we can expect every set top maker to open offices for the region, probably in Brazil.
If you add to this the fact that the entire region has agreed ‘en masse’ to adopt ISDB-T as its terrestrial broadcasting technology, it has in one fell swoop given itself a route into digital TV, but also into both HD and mobile TV ‘ because ISDB-T has segments targeted at each.
Brazil is already a long way down this adoption curve, perhaps 3 years into it, and significant volumes of ISDB-T TV sets are shipping, mostly from factories built with Japanese money on the market’s doorstep. ISDB-T one seg is developing in Brazil, and shortly will begin to be trialed and developed across the region. Siano, the mobile TV chip leader, says that already 1 million handsets have shipped in Brazil with 1 seg on them. What Japan shows us is that people gain a larger appetite for pay TV when they have better free to air TV ‘ and of course ISDB-T could be upgraded with a DRM to offer pay TV also.
So expect this trend to continue, and for the next few quarters to start to show in the figures of companies like Technicolor which is a lead DirecTV supplier in the US (and we presume in Latin America). Other set top manufacturers with DirecTV contracts announced in the past include Pace and LG, and of course many of the US DVRs use TiVo software and service, and this will almost certainly be worth shifting to the Latin American region now that ARPUs are up in this region. All of these will benefit from HD TV sets becoming more commonplace across the region, as ISDB-T offers HD viewing, and this will increase their average selling prices over time. Of course NDS provides all conditional access these days to DirecTV, so it too will see a corresponding upswing in its numbers, but then again, it always does.
Elsewhere in the numbers of these two giant US DTH firms we can see that Dish has hugely disappointed, but it’s not straightforward. Last quarter it added 237,000 net new subscribers, which it warned was because of signing people up for longer terms a while ago, and there being very few due for renewal in the first quarter. This latest quarter where Dish lost 19,000, this factor was out of the equation, but across the two quarters that still means that Dish has grown by 218,000 subscribers in the US. DirecTV as just had two quarters in a row at around 100,000, so for the year so far, it is actually lagging Dish in the US in customer acquisitions.
This is a bit hard to fathom until you dig a little deeper into its numbers.
Looking at gross additions, we see that Dish has two consecutive quarters of 833,000 and 747,000 customers new to Dish. So there is definitely a cooling off in customer acquisition, but this is mostly seasonal, because it’s in line with previous years.
The churn on the quarter has risen from 1.4% in the first quarter to almost 1.8% in the second This means that while 592,000 decided not to renew in the first quarter, as many as 766,000 customers cancelled in the second quarter. If we assume that less of them had an opportunity to cancel in the first, the later figure of 1.8% churn is more likely what you can expect going forwards.
At DirecTV gross additions in the second quarter were 946,000 and last quarter 925,00 ‘ a much more granular and controlled variation, and churn saw off 846,000 and 825,000 with churn rates of 1.5% for both quarters give or take a handful.
What this leaves is an impression that DirecTV is controlling its growth. The heavy and rising cost of $768 for each new customer acquired at DirecTV and $786 at Dish, eats into profits. We think that DirecTV in the US will continue to slow subscriber additions, and drive up ARPU among its existing customers, far more like the US cable companies who don’t seem to care if they grow their customer base at all, but prefer to drive revenue and margin growth. This is enabled partially by having AT&T behind DirecTV which makes acquiring customers more predictable.
However AT&T as an influence may have gone away somewhat because it only seems to market DirecTV services where its U-Verse IPTV network cannot reach, and that’s fewer and fewer places in the US. AT&T actually lost 74,000 satellite TV customers during the quarter and more like 157,000 over the past year. These can be either DirecTV or Dish, since it used to sell both, even though new customers are only going to DirecTV.
ARPU for DirecTV in the US rose $4.74 over the year to each $87.90, while Dish has risen 2.68 to $73.05. That has meant that DirecTV could produce an operating income of $899 million in the US for the quarter while Dish managed $526 million, on respective revenues of $4.9 billion and $3.2 billion. These don’t seem so far apart, but when you add the Latin American figures for DirecTV which almost double its operating profit to $1,409 million you are left with a net income for DirecTV of $543 million and free cash flow of 383 million, and for Dish a $257 million net income and free cash flow of just $173 million for the quarter.