After a potential acquisition target of DIRECTV (NASDAQ:DTV) was taken off the market, chatter of a DirecTV-DISH Network Corp. (NASDAQ:DISH) merger has escalated. The big obstacle would be anti-trust hurdles, and given recent trends in US anti-trust regulation, that could be difficult to defeat. However, let’s take a look at what could happen if regulators allow it.
Increased Leverage Over Content Creators
One of the consistent themes we at Valuentum have been hitting on over the past year in the media space has been the rising cost of content. Netflix, Coinstar, Amazon, Hulu, cable, and satellite are all fighting for eyeballs, so the competition for content, particularly exclusive content, has heated up. Things have gotten so fierce that both Amazon and Microsoft are creating their own content to distribute via Prime and Xbox Live, respectively.
A merger between DISH Network Corp. (NASDAQ:DISH) and DIRECTV (NASDAQ:DTV) reduces the amount of players bidding for content, and it also would create a combined entity with 34 million TV subscribers in the US. With such a large subscriber base, satellite could better compete with the likes of Comcast and Time Warner Cable. We aren’t sure if it would materially lower overall content costs, but it helps to have another bidder out of the auction. Dish Chairman Charlie Ergen recently said that he thinks sports programming costs are quickly hitting the law of diminishing returns, so a merger between the two would give the company more leverage over Disney’s ESPN—one of TV’s costliest stations. We are confident ESPN’s advertisers would not want to potentially lose 30 million eyeballs.
Operating Leverage
In addition to leverage over content creators, we think a merger between the two satellite TV companies offers obvious cost savings. Both firms have a similar business model, and we think hundreds of millions of dollars in cost savings could materialize, generating robust free cash flow. DISH Network Corp. (NASDAQ:DISH) is known as the “meanest company in America,” known for its fantastic, if not overbearing, cost controls. Ergen, the man culpable for this attitude, remains the majority shareholder of Dish and would likely demand a meaningful position in a merged company.
DISH Network Corp. (NASDAQ:DISH) and DIRECTV (NASDAQ:DTV) already have low churn, and a merger between the two could also help the company raise prices. The satellite TV business is no longer a growth industry, and if anything, it could be heading for a secular decline. The days of over-aggressive price cutting to gain market share could be behind us. Therefore, we believe a combined company could achieve both higher ARPU and stronger operating margins as price increases and fixed costs decline.
Financial Flexibility
When it comes to financial flexibility, size does matter. While Apple may not have any desire to utilize its cash hoard, we have reason to believe a combined Dish/DIRECTV (NASDAQ:DTV) would put its substantial free cash flow to work. Dish has aggressively purchased spectrum over the past few years in order to create a streaming service, or maybe even a cellphone provider. The company has been linked to several smaller mobile providers like MetroPCS and even made a bid for Clearwire. With SoftBank acquiring 70% of Sprint, we think that company is off the table, but could Dish/DirecTV acquire T-Mobile, the US’ fourth largest cell phone carrier? We believe so.
Ergen clearly believes the industry is moving away from pay-TV all or nothing programming bundle, and he has expressed admiration with what Netflix has done with House of Cards. Even if the two companies do not merge, we would not be surprised to see DISH Network Corp. (NASDAQ:DISH) enter the content space, but deeper pockets could give a combined company an even greater chance at success, as well as a greater audience (approximately 34 million householders) to charm. Even if the industry remains in flux, Ergen’s adaptability and increased financial flexibility, could allow a new company to thrive.
Feasibility
There’s little doubt, in the view of our team at Valuentum, that Ergen wants to merge his company with DirecTV. He tried over 10 years ago, but the FCC and regulators rejected the deal on the premise of monopoly creation. We think the environment is completely different now due to the rise of chord cutting, but it’s hard to ignore the regulatory hurdles that have stifled mergers in the past few years.
DIRECTV (NASDAQ:DTV) CEO Mike White indicated that a merger would be “pro-consumer” due to the rising costs of content. In our view, DirecTV also sees the logic and appeal of a deal, and we are pretty optimistic that both sides would want to get a deal done. Both firms look fairly valued at this time, but we think a deal between the two would create a much more attractive combined entity. We’ll keep a close eye on the situation.
The article A Dish/DirecTV Merger Would Be Golden originally appeared on Fool.com and is written by RJ Towner.
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