Many U.S. consumers are choosing direct-to-consumer (DTC) streaming video services, while opting out of pay-TV video bundles--also known as cord-cutting. Although these trends have eased slightly in recent quarters, S&P Global Ratings believes the slowdown could be temporary and primarily COVID-related. Not only were many consumers stuck indoors over the past year watching more TV, but government stimulus helped customers pay bills. We expect cord-cutting to return to pre-COVID levels as restrictions ease and stimulus ends. Furthermore, the industry faces a significant long-term threat from potentially massive government funding for the buildout of broadband in rural markets where satellite TV is prominent.

However, the two U.S. satellite TV providers--DISH DBS Corp. and DIRECTV Entertainment Holdings LLC (which consists of DIRECTV, AT&T TV, and U-Verse TV)--have different customer bases, subscriber trends, strategies, and credit profiles. In this report, we closely examine shifting industry dynamics, how each company is positioned within the industry, and our view on the creditworthiness of these two operators.

Video Cord-Cutting Could Accelerate As COVID-Related Restrictions Ease

Escalating television programming costs have led to rising consumer prices for quite a while.   The higher programming costs, primarily from networks that carry sports, have been fueling the consumer-defection trends we've witnessed in recent years. These networks, such as ESPN, typically carry minimum penetration guarantees in contracts that limit distributors' abilities to create customized video packages for consumers. As a result, some nonsports fans have concluded that the traditional TV bundle is too expensive and left the ecosystem. In response, media companies have raised prices further to make up for lost affiliate revenue, which inevitably must be passed on to consumers, leading more nonsports fans to exit the bundle. Due to this cycle, we expect programming costs to keep rising, particularly for sports rights, leaving die-hard sports fans and higher-income consumers increasingly as the primary viewers of traditional linear TV. We believe consumer price sensitivity could increase as competing forms of entertainment re-emerge.

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Sports Rights Are Becoming Available On Streaming Platforms

We view sports as a crucial element holding together the pay-TV bundle and the availability of key sports programming on both linear TV and streaming platforms could accelerate cord-cutting as consumers have more options to watch live sports.   Key sports programming, such as the National Football League (NFL), Major League Baseball (MLB) and National Basketball Assn. (NBA) playoffs, hasn't historically been available on streaming platforms (CBS All Access has been the exception). This will change shortly because all four NFL broadcast TV partners gained streaming rights under their new contracts. We believe NBC, CBS, and ESPN are likely to immediately utilize these rights to strengthen their respective streaming platforms (i.e., Peacock, Paramount+, and ESPN+). The National Hockey League (NHL) and MLB have recently followed suit and we expect the NBA will allow streaming when its contract renewal cycle begins in 2025. Furthermore, regional sports networks--which tend to have loyal local followings--are entering the streaming arena, as Sinclair Broadcast Group Inc. (which has exclusive rights for 43 teams across MLB, NBA, and NHL) recently announced plans for a streaming service.

Quality General Entertainment Content Is Shifting Toward DTC Apps

We believe the traditional live TV bundle will keep unraveling as media companies focus on improving streaming platforms.   As the number of cord-cutters grows, programmers are being forced to compete for these customers. In order to do so, they are increasingly moving some of their best content to their direct-to-consumer (DTC) platforms. This redirection of content away from the traditional bundle not only improves the quality of the DTC substitutes, it simultaneously deprives the traditional ecosystem of fresh content, making the traditional ecosystem less appealing.

Therefore, we believe the combination of rising prices, widening availability of sports on streaming platforms, and lower-quality general entertainment content will likely result in even more cord-cutting for the next several years.

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The Satellite Segment Is Most Exposed To Cord-Cutting

We believe satellite providers are more vulnerable to cord-cutting because they lack a high-margin broadband product across their footprints to help absorb video costs.   Comcast Corp. and Charter Communications Inc. have similar, or greater, video scale compared with DISH and DirecTV so we believe satellite providers lack a significant programming cost advantage against these two providers (that together cover about 80% of the U.S). Typically, these cable companies will offer a bundled price discount if consumers opt to subscribe to both internet and video services. Assuming similar video costs per subscriber, this makes it difficult for satellite TV providers to compete on price for video consumers that desire high-speed internet as well. Therefore, we believe satellite will continue to lose market share in scaled cable markets.

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In fact, as the internet becomes more essential for Americans, cable providers continue to take share from slower digital subscriber line (DSL) internet providers. We believe this trend doesn't bode well for satellite TV providers because there are two primary reasons to switch to cable internet from DSL:

• Faster internet to stream applications (apps) that substitute for satellite TV.
• Faster internet for video conferencing, remote learning, online gaming, and smartphone apps, for example. This transaction point could prompt satellite TV customers who previously had DSL to re-evaluate their traditional video provider. In most cases, there are significant savings by switching to cable TV. We've seen evidence of this recently, as Charter increased its TV subscriber base slightly in 2020, attributing some of it to market share gains from satellite.

The Shrinking Addressable Market For Satellite TV

We believe satellite providers can compete most effectively in markets that don't have a cable provider offering high-speed internet (representing approximately 15 million homes today).   However, there's bipartisan government support to bridge the digital divide and increase the availability and affordability of high-speed internet. We believe that as the government continues to subsidize high-speed internet buildouts, consumers in unserved markets will increasingly have more video options from online alternatives not currently available.

President Biden has communicated a goal of achieving 100% broadband coverage in the U.S. through a massive infrastructure bill. He recently indicated that a bipartisan group of senators has reached a deal that would allocate $65 billion to broadband infrastructure over the next 8 years. While many details of what it contains remain unclear and Congress still needs to vote on the proposal, if Congress were to pass a law that allocated incremental money toward broadband buildouts, this could significantly hurt satellite TV providers--with potentially greater impact on Dish because we believe it skews more rural. Currently, the Rural Digital Opportunity Fund (RDOF) will direct up to $20 billion over 10 years to telecom providers to finance up to gigabit-speed internet in unserved rural areas and any infrastructure spending would be on top of RDOF.

DISH Is Moderately Better Positioned Competitively Than DirecTV

We think the Dish customer base could be stickier than DirecTV.  Dish is further along in its customer pruning initiatives because it spent much of 2017-2019 ending nonprofitable promotions with a focus on ensuring that new customers were of higher credit quality. As a result, it experienced elevated subscriber losses in previous years that have decelerated in recent quarters. We believe this could be a sign that Dish's remaining customers skew more rural, with fewer video alternatives. Furthermore, Dish has been creative, in our view, in its retention of profitable subscribers that may be prone to churn by creating skinny bundles dubbed the "Flex Pack" that allow for a somewhat customizable, cheaper bundle of channels.

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DirecTV is in the midst of a similar strategy of being more selective about its customer base and promotional activity, which resulted in significantly higher churn than peers over the past 18 months as promotions end. While the pace of subscriber declines has been slowing, the level of churn could remain elevated given that we believe DirecTV has a higher portion of customers in suburban markets with more video alternatives.

Sports Strategies Differ, With DISH Showing Signs Of Success

Dish has been willing to drop costly regional sports networks to keep programming costs per subscriber down.   Given that one of the primary reasons to have traditional linear TV is to watch live sports, one would expect to see a pickup in customer churn as the selection of sports options diminishes. However, when Dish dropped Sinclair regional sports networks in 2019, churn didn't accelerate (1.78% in 2018 vs. 1.62% in 2019) which in our opinion could mean that Dish subscribers may not value sports as much as the average household.

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DirecTV is the No. 1 provider of linear sports content, with a focus on providing premium content, which may help with customer retention. However, we believe that as sports costs continue to rise, more consumers may re-evaluate the value proposition of having access to a wide variety of sports content. Furthermore, DirecTV may be more exposed to churn from sports enthusiasts if sports increasingly become available from a variety of streaming alternatives over time or if the company opts to drop costly sports programming. In our opinion, some NFL Sunday Ticket subscribers are vulnerable to churn if the contract isn't renewed. While the exclusive contract is unprofitable, its absence will leave DirecTV with less content with which to differentiate itself. This could result in heightened churn among some of its longer-tenured most profitable subscribers, in our view.

DISH's Profits Have Grown Significantly, But We Do Not Believe Trend Is Sustainable

Dish has shown promising signs of improving its profit margins in the face of intense secular pressure on profitability from rising programming costs.   DISH's EBITDA has risen more than 30% for the last twelve months ended March 31, 2021, with most cable and satellite peers experiencing declines in video profitability over the same time period. However, we believe many factors that have led to recently strong earnings may be temporary and video profitability could decline for DISH over the next few years similar to peers:

• DISH raised prices significantly, with average revenue per user, or ARPU, rising 5.5% in the first quarter of 2021 compared with a year earlier. We believe the company may struggle to raise prices without causing elevated churn, particularly when government stimulus for consumers ends.
• DISH has been able to reduce subscriber acquisition costs, as gross customer additions were down 30% in the first quarter of this year compared with a year earlier, but this benefit comes at the expense of long-term growth prospects.
• In our view, DISH has been driving tough negotiations with programmers and has been more willing to drop networks than other pay-TV distributors. This resulted in a significant drop in programming costs in 2019-2020, providing a boost to EBITDA. While this allows the company to appeal to its more value-conscious subscriber base, there are fewer opportunities to do so without risking elevated churn.

Streaming Strategies Diverge, Though Both Face Significant Hurdles

Each company has live streaming alternatives to traditional TV that may appeal to consumers outside of the core satellite TV market, targeting primarily a younger demographic with access to high-speed internet.   However, we believe both services will struggle to offset declines in the traditional business:

• Dish offers SlingTV, which is a narrow bundle of live channels at a low price point to about 2.3 million subscribers. We believe this service will struggle to expand in a crowded field of virtual multichannel video programming distributors (MVPD), as demonstrated by its sluggish growth rate of 2.7% in this year's first quarter compared with the same period last year. While it differentiates itself by being the lowest-price live offering that includes some news and sports, profit margins are slim. We estimate ARPU minus content costs to be in the $5 area per subscriber for SLingTV compared with about $35-$40 for a satellite TV subscriber. The biggest potential opportunity, in our view, lies with targeted advertising but even under robust growth assumptions, the mix shift toward streaming will be unfavorable for Dish DBS. For reference, FuboTV (a sports-focused virtual MVPD) currently generates about $8 per subscriber in monthly advertising revenue so all-in streaming profitability is unlikely to approach satellite TV levels.
• DirecTV plans to pivot toward AT&T TV, a streaming service with price points and channel lineups similar to traditional cable. Therefore, we do not envision an incentive for consumers to switch from a scaled cable operator offering a bundled broadband discount. The big difference with AT&T TV compared with traditional TV is that there's no satellite or set top box to purchase. Like Sling, there is no truck roll for this self-install service so the overall cost structure is much lower. However, we believe it will be difficult to attract new customers to this service because it will be competitive primarily in niche markets where small operators are the incumbent cable provider (about 10% of the U.S. population). We believe that DirecTV could partner with these smaller cable operators that are disadvantaged in the video marketplace due to lack of scale. As AT&T builds out fiber to 30 million homes (about 25% of the U.S) by 2025 from about 15 million today, bundling AT&T TV with AT&T fiber could also occur. However, we believe these opportunities are insufficient to offset declines in satellite TV subscribers.

DirecTV Has A Moderately Stronger Financial Profile Than Dish DBS

DirecTV carriers lower financial leverage than Dish DBS, providing more cushion for operational disruptions.   Both companies generate solid free operating cash flow (FOCF) but each faces significant uncertainty around the pace of EBITDA declines. While Dish has built cushion into its rating on the heels of recent strong financial performance, it opted to refinance $1.5 billion of its $2 billion maturities in 2021, rather than pay down debt. Therefore, if EBITDA declines by 10%-15% per year as we project, it's unlikely the company can fully refinance upcoming maturities without increasing risk regarding the long-term sustainability of the capital structure. This is because if leverage were to approach 4.5x due to declining EBITDA, Dish DBS's ability to reduce leverage in 2023 and beyond would be difficult. We currently project that FOCF will gradually approach $500 million by 2025 (from about $1.5 billion in 2020), which may be insufficient to keep pace with accelerating EBITDA declines in the future if the company doesn't reduce its debt burden soon while cash generation is healthy. Similarly, for DirectTV we project FOCF (after dividends for tax payments) could approach $1 billion by 2025 from about $1.5-$1.8 billion in 2022 (boosted by AT&T's reimbursement for NFL Sunday Ticket losses).

However, we recognize a high degree of uncertainty around our base-case operating assumptions for both companies. If Dish maintains solid operational performance such that EBITDA remains flat over the next two years, it would have greater capacity to distribute cash to its parent and access the unsecured credit markets to fully refinance upcoming maturities. For DirecTV, our base-case EBITDA declines are about 10% per year in 2022 and 2023, with EBITDA being supported by cost savings and NFL Sunday Ticket loss reimbursements from AT&T (about $1.2 billion per year). Under these assumptions, leverage remains relatively flat at around 2.5x-3x.

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Financial Policy Weighs More Negatively On Our Dish DBS Rating Than On DirecTV

Dish DBS is owned by controlling shareholder Charlie Ergen and is the primary cash-generating subsidiary of Dish Network, which is in the early stages of becoming a nationwide wireless player. We believe Ergen will operate Dish DBS at the maximum leverage that markets are willing to tolerate, without jeopardizing the sustainability of the Dish DBS' capital structure. This is because we believe Ergen views the company on a consolidated basis, with the pay-TV business serving as a funding vehicle to invest in the long-term wireless business. This view is supported by the recent refinancing, which helps preserve cash flows at Dish DBS to be distributed to the parent. The wireless network buildout will cost at least an additional $10 billion (plus potential spectrum purchases and near-term startup losses). Given build-out requirements associated with this massive capital requirement, this is a key credit overhang for Dish DBS, which doesn't operate with a clear leverage target.

In comparison, we believe DirecTV's financial policy will be more stable over the next two to three years. DirecTV has a stated leverage target of up to 1.5x debt to EBITDA (excluding preferred stock that we treat as debt) and AT&T has joint control of the board so capital allocation decisions, such as voluntary shareholder returns, must be agreed upon by both AT&T (70% ownership) and private-equity firm TPG (30%). We believe this places more guardrails around aggressive financial policy decisions compared with Dish. Still, we recognize the potential for a re-leveraging event in the future, particularly if AT&T divests further and operating trends stabilize.

RELATED RESEARCH

• DirecTV Entertainment Holdings LLC Rated 'BB-' On Spin-Off From AT&T; Outlook Stable; Debt Rated 'BB', July 7, 2021
• Dish DBS Corp.’s Proposed $1.25 Billion Senior Unsecured Notes Rated ‘B-’ (Recovery Rating: ‘3’), May 10, 2021
• How the Decline In The U.S. Television Ecosystem Could Squeeze Credit Ratings, April 22, 2021
• Dish DBS Outlook Revised To Stable From Negative On Strong Pay-TV Results; ‘B-’ Rating Affirmed On Cash Upstream Risk, Dec. 7, 2020