DISH (part 2) (full report with many tables/graphs available on email request)
Price Target Raised to $150
We have raised our price target to $150 from $100 based on three factors:
· Increased subscriber projections.
· Fewer than originally anticipated shares should be issued to News Corp. and
MCI WorldCom.
· Expansion of the EchoStar competitive advantage period that would be trig-gered
be legislation that allows satellite TV companies to transmit local TV
channels into local markets, which appears likely to become law, soon.
Increased 1999 and 2001 Projections for Net Subscriber Adds
Typically, DBS subscriber growth experiences seasonal weakness during the first
half of a year, which is subsequently offset by a seasonally strong December
quarter. With monthly net subscriber additions averaging in excess of 100,000,
the downturn did not materialize in 1999. To reflect this reality, our subscriber
growth expectations have moved higher.
Specifically, we have increased our 1999 and 2001 projections for EchoStar's net
subscriber additions to 1.35 million and 1.2 million. Our previous estimates were
1.2 million and 1.0 million, respectively. For 2000, our forecast remains un-changed
at 1.1 million as we believe the process of repositioning the installed
base of antennas will have adversely affect net subscriber growth during this pe-riod.
Table 10 details our longer-term forecast.
With projections for other key operating variables largely unchanged, the upward
revisions in our 1999 and 2001 subscriber growth forecasts translate into greater-than-
expected cash flows during the DCF forecast period (i.e., CAP), as the esti-mated
size of the paying customer base will be at a larger level for a longer pe-riod.
The higher cash flows necessarily imply a higher firm value.
Local into Local Positively Impacts Competitive Advantage Period
We have increasing conviction that legislation that would allow satellite TV com-panies
to transmit local channels into local markets will become law during the
summer of 1999. The inability to deliver local programming appears to be the
critical factor preventing a more significant DBS penetration of the cable indus-try's
stranglehold on the home TV subscription market.
Consequently, we view the removal of this barrier as a landscape-changing event
that would extend our estimate of EchoStar's CAP from 10 years to at least 12
years, lengthening the cash flow stream used to determine EchoStar's fair value.
The combination of more cash flow (higher subscriber count) for a longer period
of time (i.e., longer CAP) pushed our estimate of EchoStar's equity value to $9.3
billion. A later section of this report, “Value-Based Discounted Cash Flow Analy-sis,”
provides a more expanded discussion of the assumptions underlying our
estimate of EchoStar's CAP.
We believe our estimate of EchoStar's competitive advantage period, and conse-quently
valuation, is conservative. Conceptually, the cash flow dynamics of the
DBS model should ensure that the duration of incremental shareholder value
creation relates directly to EchoStar's ability to grow. At the moment, the growth
window remains enormous as DBS serves only roughly 10% of the potential mar-ket
(in terms of households) while the actual service is still in the embryonic
stages of development.
Stock Price Increase Reduces Expected Rise in Shares Outstanding
On November 30, 1998, EchoStar announced an agreement to acquire the satel-lite
assets of News Corp. and MCI WorldCom in exchange for common stock val-ued
at roughly $1.17 billion. The number of shares issued to News Corp. and MCI
WorldCom will be a function of the average price of EchoStar's stock during the
20-day period immediately preceding the closing date of the transaction. When
we raised our price target to $100 on April 5, 1999, we conservatively assumed
the relevant stock price would be $80, implying EchoStar's share count would
increase by approximately 14.6 million upon the close of the deal.
Subsequently, strong subscriber growth and increasing recognition of the value
likely to be derived from a longer-term evolution of the DBS service have pushed
the stock price sharply higher. As a result, the number of EchoStar shares issued
to News Corp. and MCI WorldCom should be lower than we anticipated. We now
assume the applicable average of EchoStar's stock price will be $110, implying a
share count expansion of 10.6 million, roughly 4 million lower than our previous
estimate.
The lower share count compounds our revised assessment of EchoStar's fair
equity value to producing a fairly significant rise in our 12-month target price.
Specifically, we now calculate the target price by employing 60.4 million shares in
the denominator as opposed to 64.4 million. Based on an estimated equity value
of $9.3 billion and the adjusted share count, we arrive at the $150 target price.
Potential for DISH $200 in 2000
EchoStar faces two meaningful operational challenges over the next 12 months.
First, EchoStar V and EchoStar VI must be placed into service without a hitch. The
satellites are scheduled to be launched in August and December, respectively.
Second, the EchoStar business plan will require the company to repoint its in-stalled
base of antennas during 1999. Upon completion of the transaction with
News Corp. and MCI, EchoStar will own 29 DBS channels at 110 WL versus 21
at 119 WL. Given the greater capacity at the former orbital position, EchoStar will
use the slot to transmit the core video programming, requiring the installed base
of antennas to be repositioned toward 110 WL. The satellites at 119 WL will be
used to deliver local channel programming and the advanced services that should
emerge over time.
Repositioning more than 2.5-2.7 million antennas represents an incredibly chal-lenging
task that could have a negative impact on churn and net subscriber
growth during this period. However, close to half of the antennas that should be in
the field by the end of 1999 are likely to have been installed by customers, sug-gesting
an equal amount could assume responsibility for repointing the dish.
This “project” could be avoided by entering into a transponder-sharing agreement
with DirecTV, a deal that would benefit both entities.
Reflecting the reality of these challenges, we are conservative in our operating
and cash flow projections for 2000 and 2001. Our estimates would increase to
levels that justify a $200 stock price in 2000 if:
· EchoStar V and EchoStar VI both are successfully launched and become
fully operational without any in-orbit difficulties.
· EchoStar survives the process of repositioning more than 3 million antennas
better than we anticipate or forges a transponder-sharing agreement with
DirecTV, either at 110 WL or 119 WL, that removes this burden.
Any weakness in the stock price from current levels caused by these transitory
issues creates an excellent buying opportunity.
Subscriber and Share Count Changes Affect EBITDA and EPS
Modifications to the subscriber forecast directly affect estimated revenues and
promotional subsidy expenses (i.e., subscriber acquisition costs) and have a sec-ondary
effect on EBITDA and net income. It is important to note that EchoStar
immediately expenses 100% of subscriber acquisition costs even though the cur-rent
churn rate implies an average subscriber life of six to seven years.
Since our subscriber projections have moved upward, the promotional subsidy
expenses flowing through our estimated 1999 income statement consequently
increased to $533 million from $478 million. Similarly, our top-line projections for
1999 and 2000 have expanded to $1.47 billion and $2.32 billion from $1.42 billion
and $2.26 billion.
Given the respective changes in projected revenue and promotional subsidy ex-penses,
the corresponding effect on EBITDA and net income will be more signifi-cant
in 1999 than 2000. The losses EchoStar incurs at the EBITDA and net
income lines during 1999 will likely total $138 million and $465 million, respec-tively,
which are greater than our previous estimates of $104 million and $418
million. For 2000, we expect EchoStar to report $71 million in EBITDA and a net
loss of $314 million, essentially unchanged from our prior outlook.
On a per share basis, our 1999 and 2000 EBITDA and earnings estimates will
change more dramatically since the revised figures are divided by a reduced de-nominator.
Specifically, we have lowered our 1999 EBITDA per share and EPS
projections to $(2.74) and $(9.24) from $(1.99) and $(8.00), respectively. For
2000, we have raised our EBITDA per share estimate to $1.27 from $1.07 while
we lowered our EPS estimate to $(5.64) from $(5.17).
Value-Based Discounted Cash Flow Analysis
To determine the intrinsic worth of a company, we employ a value-based dis-counted
cash flow analysis in combination with a mix of more traditional valuation
metrics. The centerpiece of this approach is a concept referred to as CAP (com-petitive
advantage period), which we define as the length of time in which a com-pany
can generate returns on incremental investments that exceed its weighted
average cost of capital (WACC).
During the CAP, a company will create shareholder value by growing its busi-ness,
since the capital invested provides positive economic returns (ROIC >
WACC). Based on the relationship between the current stock valuation and our
projections for revenue growth, net operating profits after tax (NOPAT), and
capital expenditures, we derive the market-implied CAP, or the consensus view of
a company's competitive advantage period. When a disconnect exists between
the market-implied CAP and a company's true competitive advantage period, the
stock is either over- or undervalued.
Alternatively, the market-implied CAP can be viewed as the number of years in
which a company would have to invest in positive net present value (NPV) proj-ects
to generate the cash flow implied by the current valuation. Therefore, CAP
also equates to the length of the forecast period in our discounted cash flow
analysis. At the end of the forecast period, we assume the rate of return earned
on new capital investments falls to the cost of capital, and consequently does not
contribute to present value. Thus, we measure the intrinsic worth of a company
as the present value of FCF generated during the forecast period plus the
NOPAT achieved in the first year beyond the CAP, capitalized as a perpetuity
and discounted to present value.
Valuation—VBA
The leverage EchoStar derives from its capital structure should enable the entity
to produce significant economic returns as the business expands. In our view, the
duration for which this can continue (i.e., EchoStar's CAP) will primarily be a
function of management execution and strategy as the inherent capital efficiency
of the DBS model should almost ensure value-creating growth (i.e., ROIC >
WACC). We would expect the evolution of the cable service to affect only the
magnitude of future economic profit.
Despite the potential for highly advanced Internet and data offerings to accom-pany
EchoStar's video product, we believe any DBS service would be challenged
to penetrate a customer base receiving an integrated voice, video, and data
service from cable. In such regions, we would expect DBS operators to leverage
their inherent capital-efficiency advantage and employ aggressive pricing
schemes to attract new subscribers. Initially, economic value created by “price-driven
growth” would be lower than traditional levels. This could be offset, how-ever,
by reducing churn and/or increasing the revenues stemming from these
subscribers over time, strategies EchoStar management has indicated are al-ready
under development.
Consequently, we believe a successful implementation of the cable strategy
would create a market environment that limits EchoStar's economic profit poten-tial
but does not eliminate its ability to continue expanding the operations through
NPV-positive incremental investments. Further, the cable vision faces meaningful
execution hurdles and will likely address only 30-50% of the potential market.
As we have indicated, the primary cash flow generating assets of a DBS business
are the high-powered satellites that comprise the backbone of the communica-tions
network. Accordingly, EchoStar's CAP should be evaluated in relation to the potential for future satellite investments to yield positive economic returns. Echo-Star's
most recent satellite expenditure consists of the $450 million allocated to
the two birds (EchoStar V and VI) acquired in the deal with MCI and News Corp.,
which should provide the company with sufficient capacity to deliver the ex-panded
services that we anticipate will propel revenue per subscriber higher.
Accordingly, the next batch of relevant capital outlays should be the investments
required for EchoStar I and II replacement satellites. Assuming EchoStar I and II
remain operational throughout their estimated useful life, the company will have
to inject incremental capital into the communications network in roughly nine
years (i.e., in March 2008). On the same basis, expenditures to replace EchoStar
V and VI would be necessary in approximately 15 years.
If our outlook for EchoStar and the competitive environment proves accurate, the
investments in EchoStar VR and VIR should yield positive economic returns, im-plying
a minimum 15-year CAP. If we are underestimating the longer-term chal-lenges,
there is risk EchoStar would be unable to create shareholder value
through satellite-related investments in 2008, which would effectively shorten the
entity's CAP to a nine-year period. Given our expectation for recent capital infu-sions
to drive ROIC toward 35%, we believe nine years represent the low end of
the potential EchoStar CAP.
Based on our cash flow projections (NOPAT - invested capital change) and an
approximate 12% cost of capital, a 15-year CAP implies an intrinsic equity value
of roughly $9.9 billion, or $165 per EchoStar share. The company's outstanding
stock would be worth approximately $8.8 billion, or $146 per common share, if
the entity cannot extend its CAP beyond 9 years. To reflect the broad period in which we have bracketed EchoStar's potential competitive advantage period, we
assumed a 12-year CAP in our valuation model and arrived at an estimated in-trinsic
equity value of roughly $9.3 billion, or $150 per share.
Consequently, the fundamental reason for our Buy rating is that the current mar-ket
valuation underestimates EchoStar's long-term cash flow generating potential.
Stated differently, the EchoStar business, as it currently exists, should produce
cash flows during the next 12 years that justify a market value higher than current
levels.
As a point of reference, we employ a 15-year CAP in our valuation of Loral and
PanAmSat. Further, WACC prevailing in the cable industry is roughly 8-9%. If we
employ a 9% WACC in our analysis of EchoStar, our estimate of the equity value
of the business would increase 30% to $12 billion, assuming a 12-year CAP.
Valuation—Per Subscriber
EchoStar's valuation frequently has been studied on a per subscriber basis. With
outstanding debt of roughly $2.0 billion, an estimated $9.4 billion intrinsic equity
value implies an enterprise value of $11.4 billion, which equates to $3,459,
$2,590, and $2,032 per 1999, 2000, and 2001 projected year-end subscribers.
These subscriber values compare favorably with those prevailing in the cable
sector, which we believe suggests further upside to our valuation of EchoStar.
Cable bulls would disagree and argue that the implied value assigned to an ex-isting
cable subscriber should exceed that for DBS, an assertion based on the
potential for cable to generate a considerably greater revenue stream from each
household it serves. While we concede the latter point as an obvious reality, the
associated logic fails to account for two factors:
· Subscriber growth.
· Capital requirements.
Subscriber growth: With future subscriber growth likely to be nominal in the cable
sector, dividing the existing number of customers into the estimated (or actual) value assigned to the cable assets does provide a reasonable benchmark for the
implied value of a single cable subscriber. Comparatively, DBS subscriber growth
should be brisk, with valuations consequently relating to a much larger customer
base than the one anticipated at the end of 1999.
Given this factor, we believe it is difficult to benchmark DBS value through a per
subscriber analysis that is based on a static subscriber count. Moreover, an ar-gument
could be made that the implied value of an existing DBS subscriber
should be higher than that for cable to reflect the potential for both a rapidly ex-panding
customer base and the emergence of incremental revenue streams,
without a corresponding rise in capital expenditures.
Capital requirements: In our view, the valuation of a service business (e.g., DBS)
must incorporate the capital investments required to enable the services that
should extract cash flow from each home. Quite simply, a company that invests
$1 to generate $5 in cash from a household necessarily has a more valuable
subscriber, and consequently, business, than one that invests $10 and gets $12
in return (assuming the average life of the respective customer is roughly the
same).
Relative to DBS, cable companies employ a substantially larger amount of capital
to service its customer base. Among the top three public cable companies, in-vested
capital per home passed averages $1,929 (see Table 17), a figure that will
likely expand over the next several years. For EchoStar, invested capital per
home passed averages $25. Given the disparity in the capital investments, the
potential for higher cable revenue stream will not necessarily equate to higher
subscriber value. On this basis, we believe that a DBS subscriber could ultimately
prove to be more valuable than a cable subscriber. |
