by Marc Crossman and Anh Steininger

The year 2000 will be the breakout year for DirecTV. As of presstime, the President is expected to sign into law a bill that will allow the DBS operators to retransmit local signals into local markets. The successful rollout of local programming into local markets starting in December 1999, coupled with the introduction of new products and services such as AOL TV and AOL Plus via DirecPC, together with continued strong market demand, will help push DirecTV’s net subscriber growth above Wall Street expectations in 2000 and make DirecTV a winner. As a result, DirecTV will add over 1.8 million net subscribers in 2000, a 15 percent increase over 1999 net adds. If DirecTV is successful in achieving this estimate in 2000, DirecTV’s valuation will experience an additional multiple expansion. As a result, Hughes will be worth at least $110 per share at the end of 2000.

Our sum-of-the-parts valuation is as follows: $83 per share for DirecTV, $13 per share for Panamsat, and $14 for everything else, which includes manufacturing of satellites and related ground equipment, investments in other businesses, and net debt. This valuation for Hughes implies a $3,300 per subscriber valuation for DirecTV based on our 2001 subscriber estimate. By comparison, Echostar currently trades at $4,100 per subscriber on a forward four quarters basis, and DirecTV is currently trading at approximately $2,300 per subscriber on a forward four quarters basis. The valuation for Hughes in 2000 assumes a multiple expansion for DirecTV from $2,300 per subscriber to $3,300 per subscriber. At this target valuation, DirecTV would still be trading at a 20 percent discount to Echostar’s current forward four quarters subscriber multiple. DirecTV will realize further multiple expansion in 2000 as the company posts higher net subscriber additions than the current consensus.

In 2000, our estimates reflect churn of 1.5 percent and a 15 percent growth in net subscriber additions compared to 36 percent in 1999, 15 percent in 1998, and -6 percent in 1997. Currently, consensus is looking for net subscriber additions in 2000 to be relatively flat with 1999. However, consensus is still catching up to the performance of 1999 and has yet to give full credit to the potential in 2000. As DirecTV continues to experience strong momentum for its core service, successfully rolls out local programming to six major markets by the end of December and another 14+ major markets in the first couple of months of the new year, and deploys AOL TV late in the second quarter, DirecTV’s subscriber net additions will outpace consensus.

The estimate of DirecTV’s net adds of 1.8 million will be driven by 3.3 million gross adds, an increase of 27 percent. This compares with gross subscriber increases of 52 percent in 1999 and of 24 percent in 1998. The table above illustrates what will be the three sources of subscriber growth. Start with 1999 as the base for gross subscriber additions in 2000. DirecTV’s core gross subscriber acquisitions will grow 15 percent in 2000.

Core subscriber growth will be the result of three factors. First, continued market awareness (DirecTV is in one of every 12 television households in the United States). Second, an increase in the affordability of the product through lower manufacturing costs (the cost of a second receiver continues to fall). Third, increased distribution through the acquisition of Primestar. Introducing local programming into local markets will add 15 percent incremental demand above current levels in the markets in which it is offered.

Since DirecTV will offer local programming to approximately half of U.S. television households, providing local programming will add approximately 200,000 incremental subscribers in 2000 before churn (2.6 million base x 50 percent of U.S. TV households = 1.3 million addressable new gross subscribers x 15 percent incremental demand = 200,000 incremental new gross subscribers). Finally, the new AOL TV box will add another 100,000 new gross subscribers that in the absence of AOL TV would not have purchased DirecTV (this is achievable given DirecTV will spend $700 to acquire an AOL TV subscriber compared to the $500-$550 it currently spends to acquire a subscriber).

Overall subscriber growth of 30 percent will occur in 2000, excluding acquisitions. This 30 percent growth of DirecTV’s core subscriber base estimate is predicated on a 27 percent increase in gross adds and a 1.5 percent monthly churn rate, yielding net sub add growth of 15 percent. Including acquisitions, subscriber growth will still top 20 percent. Including the effects of the Primestar merger lowers the growth rate for two reasons. First, the acquisition of Primestar has created a larger base from which to grow and second, the assumption is that over 500,000 subscribers will churn off of Primestar (the acquired platform) during the process of converting over to DirecTV.

Marc Crossman and Anh Steininger are satellite analysts at J.P. Morgan in New York City. These views are those of the authors and do not necessarily reflect the views of the Via Satellite editors or J.P. Morgan.