Dr. Dishhead: What Does Malone Have Cooking for DirecTV?

Et tu, Dr. John? Despite John Malone’s deep roots in the cable industry, Fri’s long-expected announcement that his Liberty Media would take control of DirecTV means Malone will soon become one of cable’s biggest competitors. The definitive agreement (subject to shareholder and regulatory approval) basically swaps out Liberty’s 16.3% stake in News Corp for News’ 38.5% stake in DirecTV—along with the Fox Sports’ Rocky Mountain (Denver), Northwest (Seattle) and Pittsburgh RSNs, and $550 million in cash (3 board seats now held by News Corp are expected to switch to Liberty reps). It looks like DirecTV pres/CEO Chase Carey and his team will stay in place after the transaction closes next year, but the whole deal has everyone wondering: What does Malone have up his sleeve? DirecTV has struggled to compete with cable’s triple play because of technology limitations, and its nearly 20% annual churn rate isn’t exactly enticing. Many, therefore, expect Malone to focus on DirecTV’s HD offerings to retain and lure new subs. Phillip Swan at TVPredictions.com noted that DirecTV will launch 2 new satellites in ’07. "The new birds will give DirecTV the capacity for 150 national HDTV channels, which would give it a tremendous advantage over rival EchoStar and the cable TV operators." Of course, the HD play isn’t necessarily a slam dunk. "HD is a double-edged sword for DirecTV," said Sanford Bernstein’s Craig Moffett, noting that it could cost DirecTV around $2.5bln in retention marketing to upgrade its customers to HD and catch up with cable. "The problem isn’t the capacity in the sky," he said. "It’s the equipment on the ground." So might Malone just be in it for the quick buck? After all, estimates are that Liberty avoided some $2bln in capital gains taxes because of the deal’s structure (Merrill Lynch estimates News saved more than $1bln in taxes). Not only that, but Moffett noted that DirecTV’s underlevered status could allow Malone to issue a special DirecTV dividend at some point, perhaps using his own personal proceeds to buy back even more Liberty stock. "John Malone is first and foremost in the business of making money," he said. Another possibility is an eventual merger with EchoStar, although Washington policymakers have long indicated they would block such a deal on antitrust grounds. As for News Corp, the deal amounts to a $11bln share repurchase that could clear the way for more News share buybacks in the future. UBS’ Aryeh Bourkoff said in a research note that the deal helps News Corp "as it removes an overhang and should lead to further return of capital to shareholders" with any benefits to DirecTV not likely to materialize until the 2nd half of ’07 after the deal closes. Malone technically will get DirecTV at a discount: UBS estimates an implied DirecTV price of $21.53 per share, 13.8% below its Dec 21 closing price of $25. But Merrill Lynch’s Jessica Reif Cohen stated in a research note that "the deal terms are in line with average prices over the past six months, an important consideration given the recent significant price appreciation in [DirecTV] shares." DirecTV’s stock is up some 30% since mid-Sept when Liberty management acknowledged a deal could happen; it closed Tues at $24.59. Meanwhile, Fitch on Fri revised its rating outlook for DirecTV to "stable" from "positive," reflecting "the uncertain direction of [DirecTV’s] future financial policies… under the influence of Liberty." One thing’s for sure: Dr. John will likely keep us guessing on what that future entails.