Warmer Days Ahead for Satellite Industry
By Thomas W. Watts
The global satellite industry has entered a new Ice Age. Revenues are stagnant, strategic activity has ground to a halt, and capital is scarce.
The last time the future looked so bleak was in the late 1980s. Fibre optic cable was stealing away telephone traffic – the main source of revenues for the satellite industry. Consolidation was winnowing down the number of players. In the United States, the number of fixed satellite service (FSS) players dropped from nine to three in less than a decade.
The good news? The slump of the 1980s ended. Ultimately, it led to a period of profound growth and transformation for the satellite industry. We believe the industry will see another burst of growth after the current slump is over.
How We Got Here
The causes of the current slump are well known. The satellite industry expanded capacity to meet the exploding demand from Internet traffic and the increasing demand for television and telecom services from emerging markets. The collapse happened in several stages. First, the Asian economic crisis put the brakes on satellite projects designed to serve that region. Second, the numerous satellite Internet projects around the world closed their doors and cancelled their orders for satellite capacity. Third, economic weakness spread to the media industry and led to contraction in the TV industry, which had become critical to the satellite industry.
On top of this, the proposed merger of EchoStar Communications and Hughes Electronics put these two large satellite TV players in limbo. As an adjunct to the merger, the associated sale of Hughes’ stake in PanAmSat to EchoStar created uncertainty over the future of the FSS sector. Moreover, the two companies’ satellite Internet plans were iced, which had a further chilling effect on the satellite Internet market.
How We Get Out
The causes outlined above create a simple formula for industry revival: 1) resolution of the EchoStar-Hughes saga; 2) rebirth of satellite Internet demand; 3) economic rebound to boost media spending. We believe all three of these elements are at hand.
After The Merger
Now that the Federal Communications Commission and Department of Justice have decided to block the EchoStar-Hughes merger, everyone is speculating about whether EchoStar will try to get out of purchasing PanAmSat and paying Hughes the $600 million break-up fee. I certainly do not have any proprietary knowledge on the topic; however, my reading of the merger agreement gives EchoStar very little wiggle room. Moreover, if I were General Motors, the majority owner of Hughes, I would do everything possible to ensure EchoStar pays. Prudent investors have to assume EchoStar ends up paying. This would reverse the current situation in the U.S. direct broadcast satellite (DBS) market. Hughes would end up debt free after the payment. EchoStar’s debt would climb from $1.4 billion to $6.1 billion. We believe this difference in leverage could position Hughes to compete much more aggressively. In addition, General Motors plans to put Hughes back on the auction block. The next owner of Hughes may manage it more aggressively.
So, what of PanAmSat? If EchoStar buys PanAmSat, we expect EchoStar to become a forceful industry consolidator. We expect Intelsat and PanAmSat to compete to acquire European satellite operator Eutelsat. PanAmSat may also look at a smaller player like New Skies, which could be bought for less than asset value. If nothing else, freeing up PanAmSat to play in the market should help break the logjam that has developed in FSS.
We expect a strong revival of satellite Internet demand in the next few years. While the EchoStar-Hughes merger put satellite Internet plans on hold, we expect them to start up again shortly. Hughes’ SpaceWay broadband satellite system is scheduled to be operational in 2004. WildBlue and Astrolink are likely to be revived. Telesat Canada is proceeding with its plans to offer satellite Internet service. In Asia, IPStar is pushing ahead with its plans. In Europe, SES Global is on track with its Satlynx venture and Eutelsat is establishing a platform for independent broadband service providers. By 2005, we expect more than 20 direct-to-user satellite Internet systems to be operational.
While satellite will capture only a small share of overall Internet connectivity, we believe it will play a critical role in reaching remote and rural users. This should lead to a rebound in demand for FSS operators, broadband service providers, satellite equipment suppliers and even satellite makers. Look for the boom to begin generating material revenue in 2007 and 2008.
Predicting when the global economic upturn will come may prove harder than forecasting specific satellite industry events. Macroeconomic data shows few positive signs. Many economies need substantial restructuring. Overextended media companies need to pare costs and revamp operations.
There are early signs of a media-spending rebound. By 2004, revenues for media companies should fund new television projects, boosting satellite demand. These projects include specialised programming, high-definition TV, pay-for-view and innovative new program offerings.
The thaw has not begun yet. The first signs of a warming trend should occur early next year. Once the EchoStar-Hughes merger mess is sorted out, that should set in motion events that will lead to a satellite industry rebound. Add some macroeconomic growth to the weather forecast, and we could see much warmer days for the satellite industry in 2004.
Thomas W. Watts is managing director at SG Cowen Securities Corp. He can be contacted at e-mail: Thomas.firstname.lastname@example.org