TiVo: Potential Impact of DirecTV Acquisition by News Corporation
05:47pm EDT 10-Apr-03 Blair, William & Co. (David Farina) TIVO TIVO.O
William Blair & Company, L.L.C. David Farina (312) 364-8918
DTF@wmblair.com
TiVo Inc. (TIVO)
Comp.
Price 4/10 Earnings Per Share P/E Ratio Div. Yield LTGR Rating Prof.
$4.60 1/03A 1/04E 1/05E 1/04E 1/05E $0.00 0.0% 70% O A
($2-$8) -$1.08 -$0.75 -$0.21 NM NM
*** William Blair & Company, L.L.C. has received compensation for investmentbanking services within the past 12 months, or expects to receive or intends to seek compensation for investment banking services in the next 3 months from the company.***
Highlights
* Yesterday, General Motors' (GM $34.50) Hughes Electronics (GMH $10.36) subsidiary, operator of DIRECTV, agreed to be acquired by News Corporation (NWS $25.45) for $6.6 billion. We believe TiVo will continue to service DIRECTV customers going forward.
* Cable operators' mass deployment of digital video recorders (DVRs) is still a few years away despite the recent noise about their entrance into the DVR space, in our view.
* We continue to like the risk/reward trade-off of TiVo shares, particularly at current levels.
* We reiterate our Outperform rating and Aggressive Growth company profile.
Background
TiVo stock has come under pressure over the last few days. We believe the $6.6 billion bid by Rupert Murdoch's News Corp. to acquire a 35% and controlling stake of Hughes' DIRECTV may be weighing on the stock. Moreover, softer same-store sales numbers from national consumer electronics retailers and a wave of recent articles on the cable industry's entering the DVR space also could be pressuring the stock. In this note we provide some additional commentary on the DIRECTV deal and the recent noise about the cable industry's rollout of DVRs.
DIRECTV Acquisition Overview
DIRECTV's agreement to be acquired is not an unforeseen or new event. However, the fact that it may fall under Mr. Murdoch perhaps concerns current TiVo shareholders. The deal still must pass customary regulatory hurdles, but critics believe it is expected to pass antitrust regulators.
Our Thoughts on the Deal
We estimate that approximately 220,000 of TiVo's 625,000 subscribers are DIRECTV customers. In the U.K. markets, News Corp. offers a similar TiVo-like DVR through its SKY-branded service. Although not nearly as robust of a product, it serves the basic needs of a DVR customer. We believe that TiVo investors are concerned that News Corp. possibly could roll out its SKY DVR product to its DIRECTV/TiVo customer base. Although a reasonable assumption, we believe there is a low probability of this event's occurring.
Why? First, this deal will take at least a year to get through all the necessary regulatory and operational hurdles. At that point, we estimate there will be about 600,000 or so DIRECTV customers who subscribe to the TiVo service. Moreover, we believe it would be at least two years before News Corp. would consider an operational detail that only affects 5% of its customer base. At that point, we estimate there would be nearly a million DIRECTV/TiVo customers, or about 10% of its customer base. Second, TiVo is the best brand name in the DVR market and is a value-added service offering that competes with EchoStar's DISH Network (DISH $28.27) and digital customers. Hence, why would Mr. Murdoch's team want to do away with such a powerful brand and marketing engine? Third, we estimate DIRECTV makes about $2.50 a month per TiVo subscriber, which is a very high-margin vertical service for the company. All the heavy lifting in terms of contract negotiation has been completed, allowing DIRECTV to continue collecting highly profitable revenue.
Opportunities for DIRECTV and TiVo
We believe the recent deal could offer additional opportunities for DIRECTV and News Corp. Namely, since TiVo has such tremendous brand recognition and loyalty within its customer base, perhaps Mr. Murdoch would consider rolling TiVo out to his other companies. Although a very speculative event, the opportunity does exist for TiVo.
Cable Companies
Cable companies' decision to enter the DVR space also is not a new event. We discuss this factor in great detail in our TiVo Basic Report of March 17. However, it seems that the test trials of cable-DVR markets are proving successful for the cable operators. Although great for the industry, it still is a tough proposition for the cable operators to roll out DVRs on a large scale. We continue to believe cable operators could be a viable long-term competitor to TiVo, but cable's DVR push most likely will be very measured in the near term.
Why? Simply put, the set-top boxes still are too expensive. Scientific-Atlanta (SFA $14.37) currently is selling its Explorer 8000-series DVR box for $500 to operators. The cable operator currently garners about $10 per month on the box rental and between $5 and $10 a month on the DVR service. Taking the service revenue's midpoint, this translates into $15 per month in incremental average revenue per user for a DVR customer. An undiscounted payback period of revenue stream results in nearly three years for a cable operator to just break even on its initial $500 purchase. Given the weak balance sheets in the cable industry, coupled with its propensity to push its video-on-demand service offering to justify its $60 billion network buildout, we believe cable operators will continue to roll out DVRs very judiciously.
Stock Thoughts
TiVo is a great, revolutionary product, in our view. The company continues to defy the skeptics with its disruptive technology, which has broadcasters' and advertisers' rethinking their business models. The growth potential for this company is enormous, in our view. We continue to be attracted to its market-leading position, recurring-revenue model, and opportunities for growth. However, TiVo is a young company with limited capital resources that has to be cognizant of the media and consumer electronic giants. Despite its speculative nature, we believe there has never been a better time to acquire the shares. Its customer base is growing, the company should earn positive EBITDA this year, and the balance sheet continues to improve. Moreover, we believe investors should buy the stock on dips and before the fall shopping season begins. We continue to like the risk/reward profile of the shares.
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