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DirecTV's Long-Term Picture Blurs

With competition growing and John Malone about to take over, the company's future is unclear.
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With

DirecTV

(DTV)

signaling a quick payoff for shareholders, the satellite TV giant's long-term picture remains grainy.

Shares of DirecTV have been stagnant all year since Rupert Murdoch's

News Corp.

(NWS) - Get Report

announced in December that it will sell its 38.5% stake in the company to John Malone's

Liberty Media

(LCAPA)

. At $24.38, the stock is down about 2.2% for the year after logging a 77% gain in 2006.

The deal has been held up by regulators, but DirecTV CEO Chase Carey said at a recent media conference in New York City that he expects the transaction to be cleared in a month's time.

The agreement raises the prospect that Malone will either buy all of DirecTV once he takes control, or add a load of debt to its pristine balance sheet and pay a dividend. Both scenarios would be good for shareholders.

At least some of that value, however, probably figures into the company's stock price already. Moreover, DirecTV's growth is waning.

"DirecTV continues to add customers, though growth has slowed sharply as the market has matured, competition has increased, and the firm has tightened credit policies," says Morningstar analyst Michael Hodel. "We think growth will continue to slow in the coming years."

The nation's two largest cable companies,

Comcast

(CMCSA) - Get Report

and

Time Warner Cable

(TWC)

, have added to their massive scale by recently carving up

Adelphia

and rolling out telecom systems so they can offer a package of TV, Internet and phone service together.

Meanwhile, phone companies like

Verizon

TheStreet Recommends

(VZ) - Get Report

and

AT&T

(T) - Get Report

are introducing television service.

DirecTV and its satellite rival,

EchoStar

(DISH) - Get Report

, both have deals to provide satellite TV service to AT&T, but the nation's largest telephone carrier has plans to drop one of them by the end of the year. Wedbush Morgan Securities analyst William Kidd says it will probably be DirecTV to get the boot.

"AT&T is a material distributor for both companies, and that will be a major catalyst for the stock price in the near term," says Kidd.

In the long run, satellite TV players could suffer as technologies enabling consumers to watch video over the Internet improve. DirecTV has partnered with

Clearwire

(CLWR)

to offer wireless Internet along with its TV service, but the company's still a one-trick pony.

EchoStar has been a spoiler for DirecTV in the News Corp.-Liberty deal. The company has petitioned the Federal Communications Commission to define rules in order to keep Liberty from favoring DirecTV over EchoStar at its other media assets. That controversy has delayed the transaction from its planned close in June.

With the deal looming, Carey has said shares of DirecTV are undervalued. As a result, the company has been using its cash flow to repurchase stock, including the repurchase of 26 million shares in the second quarter. It also has announced a new authorization for another $1 billion buyback.

"We recognize this buyback does not answer the larger issues around our balance sheet and growing cash flow, but as we said before, we believe it is important to make those decisions with our long-term shareholders in place," said Carey on a recent conference call with analysts. "However, as we wait on the ... Liberty transaction approval, we do want to make sure we take advantage of our undervalued stock."

Oppenheimer & Co. analyst Thomas Eagan says recent conditions in the credit market could put a damper on whatever plans Malone may have for DirecTV's balance sheet, since he would have to get financing from gun-shy bankers for any of the moves that Wall Street is anticipating.

"I wouldn't be surprised if there's a cash dividend, but I don't expect Liberty to buy the whole company," says Eagan. "The stock is trading as if there's going to be some kind of takeout, and that seems unlikely, especially since the credit market has dried up."

Whatever happens, most observers say that DirecTV's fundamentals and its cash flows still look healthy, despite the multitude of competitive threats facing it. While it's getting more difficult to win new customers, the company has been successful at squeezing more money out of existing subscribers by offering add-ons like a digital video recorder and high-definition TV.

In the second quarter, DirecTV increased its subscriber base to 16.3 million, up from 15.5 million at the same time last year. Its monthly churn rate -- the percentage of customers that left in the quarter -- fell to 1.58% from 1.59%, but that level remains a concern for investors as the company has taken steps to tighten its credit policies.

"You'll see improvements in churn in the second half of the year," said Carey at the media conference.

He also said, "In all honesty, I would not say the housing issues have impacted our business," referring to the national housing slump that threatens to weigh on consumer spending. Carey said consumers view their TV bill as a necessity, not a discretionary purchase that could be sacrificed in bad economic conditions.

Eagan says that may be true, but he also thinks slower home sales will hurt DirecTV's performance, along with all of its competitors.

"Less new TV households means less growth for DirecTV," Eagan says.

For his part, Carey plans to stay onboard at DirecTV, and he thinks Malone will be a better owner than Murdoch.

"News Corp. had a lot of businesses that related to DirecTV and therefore had a view with how our relationships fit with theirs," Carey said on the company's most recent earnings call. "I think with Liberty, you got a partner that does not have the same degree of sister businesses and therefore probably provides us a greater degree of flexibility to simply determine to pursue things that really are looked at from a DirecTV perspective as opposed to part of a larger whole."