European and U.S. DTH Markets Analyzed (Part I)

Over the last few weeks, all the major satellite pay-TV operators in Europe and U.S. have announced their results. Here, in a special two-part article, we look at how well satellite pay-TV operators are performing against cable and telco alternatives. With telcos aggressively targeting the television market, and able to offer television services as part of an overall bundle, we assess the recent performance of the major satellite pay-TV operators both sides of the pond, as competition intensifies.

DirecTV and EchoStar Close to 30 Milion

DirecTV and EchoStar now have virtually 30 million subscribers between them in the United States. Both operators released their latest numbers in the last week. EchoStar ended June with 13.58 million subscribers and DirecTV ended June with 16.32 million subscribers in the United States. However, while both operators continue to grow their subscriber bases impressively, intense competition in the U.S. pay-TV market means both operators face a number of challenges going forward. Throughout the last year, both operators have added an impressive two million customers between them, with EchoStar gaining the lionshare of new subscribers with more than 1.2 million.

Ben Swinburne, a satellite equity analyst at Morgan Stanley said in a research note, “DirecTV and EchoStar added net 300,000 customers in 2Q07, versus a net loss of 190,000 for the cable operators under coverage. While RBOC (Regional Bell Operating Company) on-net video subscribers increased, on a year-on-year basis the RBOCs continue to increase their contribution to Direct Broadcast Satellite (DBS) additions through co-marketing agreements.”

* U.S. Figures only
Source: Satellite News, Company reports

DirecTV

DirecTV has had a strong year adding around 800,000 subscribers in the last year. Its numbers were better than analyst expectations, although the churn figure was a concern. Spencer Wang, a satellite equity analyst at Bear Stearns wrote in a research note, “DirecTV U.S. added 128,000 net subscribers (vs. our 106,000 forecast and consensus expectations of 136,000), and virtually flat with 2Q 06 (125,000), to end the quarter with a total of 16.316 million subscribers. DirecTV’s gross additions of 900,000 were strong (4.3 percent growth vs. 2Q 06), and was above our estimate of 854,000 and consensus of 881,000 gross adds. Gross adds have been quite strong year to date, despite expectations for slight declines. However, higher than expected gross adds were offset by higher than expected churn. Monthly churn declined by 1 basis point year over year to 1.58 percent, but was above our 1.54 percent estimate, and consensus expectations for churn of 1.53 percent.” Todd Mitchell, a satellite equity analyst at Kaufman Brothers said in a research note, “DirecTV (U.S) added 128,000 new subs in 2Q06, in line with consensus, but a little below our expectations. Gross adds of 900,000 were up four percent from 863,000 a year ago, but net adds were held back by higher-than-expected churn at 1.60 percent. On a positive note, DirecTV’s distribution channel is performing much better than this time last year. Direct sales generated about 40 percent of gross adds in the quarter, a 30 percent increase year over year.”

EchoStar

EchoStar’s results were not greeted as positively by analysts. According to Bryan Kraft, a satellite equity analyst at Credit Suisse, “Gross and net subscribers fell short of our expectations. EchoStar had 850,000 gross subscribers and 170,000 net subscribers, while we expected 892,000 gross subscribers and 201,000 net subscribers. Average Revenue Per User (ARPU) rose less than we thought it would to $66.06 (5.4 percent growth) vs. our estimate of $66.66 (6.3 percent growth). Churn beat our estimate slightly at 1.68 percent vs. our estimate of 1.70 percent. Subscriber Acquisition Costs (SAC) also beat our expectations by coming in at $645 vs. our estimate of $653.” Wang believes lower than expected subscriber numbers were due to higher than expected churn figures. He said, “Despite almost meeting the consensus gross adds estimate, churn of 1.68 percent kept net adds below Street expectations. We had expected churn of 1.61 percent and the Street was expecting 1.62 percent. Note that like EchoStar, DirecTV posted higher than expected churn in 2Q as well.”
 

Satellite vs. IPTV vs. Cable

While both operators maintain a strong position in the U.S. pay-TV market, it is clear this market is now multi-faceted with the threat not just coming from cable, but cash-rich telcos such as Verizon and AT&T. While both DirecTV and EchoStar have entered into partnerships with telcos, ultimately it is likely that the telcos will become more of a competitive threat over time. However, while this threat is growing, there are areas where the operators should be able to maintain a competitive advantage. In the area of HD, Swinburne believes that both EchoStar and DirecTV are well-positioned. He said, “Our analysis of DirecTV’s and EchoStar’s current and forecast satellite fleet capacity suggests that they will have the capacity to offer a materially higher number of national HD channels than cable for the next three to five years. For cable operators to match the HD channel capacity we forecast for DirecTV and EchoStar during this period would require a network upgrade from 750-800 MHz to 1GHz or to all-digital, both expensive and time-consuming processes. We estimate DirecTV will have capacity for up to 160 national HD channels and 189 local HD markets (covering about 99 percent of total TV households) by year-end 2007 (estimate). We forecast this to remain constant through year-end 2010 (estimate). By comparison, we estimate that EchoStar will end full-year 2007 (estimate) with the capacity to offer up to 72 national HD channels along with local HD programming in up to 97 markets with an average of eight local HD channels per market (covering about 85 percent of total TV households).”

Steve Mather, a satellite equity analyst at SMH Capital believes DirecTV will lead the way in terms of HD in the United States. He said in a research note, “HD is on tap to finally hit America by storm, and DirecTV will be the leader in the number of channels on a nationwide basis, per our checks. DirecTV will launch 70 channels of HD at the end of Q3. This ramps to 100 HD channels by year’s end and to 150 HD channels at the end of Q1 2008.” Chase Carey, DirecTV’s CEO believes HDTV will be a vital element of the company’s armoury. He said on the results conference call last week, “There is an incredibly growing, significant portion of this marketplace that is putting that (HDTV) at the top of the list of what they value in a television experience.”

As well as gaining what it hopes is a competitive edge in HD, the operator also has high hopes in the on-demand space, another imminent major strategic push. Carey said, “The other major content event during the second half will be the launch of our initial video-on-demand (VoD) offer in the fall. This VoD offer, which will use both the hard drive and broadband connection, and will be we think really will be a truly distinctive and exciting new feature. We believe customers will find its easy-to-use characteristics, which is something we focused a lot on, and attractively packaged offering will really be uniquely attractive and differentiated from others out there.”

Competitive Landscape

Charlie Ergen, EchoStar’s chairman and CEO, addressed the competitive landscape issue in EchoStar’s conference call last week. He said, “I think, the competitive landscape is probably more competitive than it has been. […] Obviously, you have got cable, which continues to have a good offering with the triple play bundle, and you have got really new entrants in both Verizon and AT&T with their own video offerings. He adds, “There is a move towards more advanced services like HD and DVRs (digital video recorder), where I think satellite has an advantage in terms of those product offerings, both in terms of quality and product hardware. It going to be an interesting dynamic to see how this all shakes out.”

Concern

When analyzing DirecTV results’, Wang admitted he was “concerned by DirecTV’s dependence on the RBOCs as a significant source of net adds.” He added, “Between 20 percent to 25 percent of DirecTV’s quarterly net additions have been coming from the company’s partnerships with the RBOCs. We view this key source of net additions as under threat, however. There is a strong possibility that BellSouth will eliminate its current deal with DirecTV and move its deal over to EchoStar, allowing BellSouth to align itself with its new parent, AT&T. If this were to happen, we would expect to see this as a 2008 event. Additionally, as Verizon rolls out FiOS, the RBOC will likely put its own video product first in markets where its proprietary product is available, reducing DirecTV subscriber growth.

He continued, “We believe that the rollout of RBOC video is worse for DBS operators than it is for cable operators as the RBOCs will be offering a bundled service offering that will be harder for DBS to defend against than it will be for cable operators to defend against. Increased competition will likely put pressure on subscriber growth, upgrade and retention costs, ARPU growth, subscriber acquisition costs and churn.”