Cablevision Commits $864M To DBS

Cablevision Systems [NYSE: CVC] last week nearly doubled its financial commitment to its high risk Rainbow DBS satellite TV venture. The Bethpage, N.Y.-based cable operator that serves 3 million subscribers in metropolitan New York also took steps to separate the fledgling satellite TV business from the company’s core business.

Rainbow DBS, scheduled to launch its first satellite July 17 to the 61.5 degrees West Longitude (W.L.) orbital slot, intends to provide up to 100 channels of digital television via satellite to the U.S. mainland, except for parts of the West Coast where the spacecraft’s look angle makes service unfeasible.

Cablevision’s board of directors voted to spin-off the development-stage satellite TV platform and the Clearview Cinemas theatre chain as a tax-free distribution to existing Cablevision shareholders. The spin-off plan, to be completed by year-end, includes a commitment by Cablevision to invest up to $450 million in the new entity if and when the separation occurs.

Cablevision’s increased financial stake in the project did not stop there. The company’s board last week approved an additional $114 million investment in Rainbow DBS for the balance of 2003. Cablevision expects to generate positive cash flow from the spinoff in 2004, its officials said.

The $564 million infusion this year is on top of the $300 million that Cablevision already has committed for the construction, insurance and launch of the satellite, according to Karim Zia, a satellite and cable analyst with Deutsche Bank.

The challenge now is whether Rainbow DBS can become a viable U.S. satellite TV operator in the face of two entrenched rivals, Hughes Electronics’ [NYSE: GMH] DirecTV and EchoStar Communications [Nasdaq: DISH]. Cablevision has offered scant information about its strategy for Rainbow DBS; company officials provided little new information last week beyond the news of the increased investment in the venture.

The spin-off will close a “black hole” for Cablevision by setting a dollar limit on the company’s commitment to the satellite TV endeavor and by removing an “overhang” on its stock price, according to a research note by Deutsche Bank’s Zia.

Case Study

Loral Space & Communications [NYSE: LOR] is a case study in the dangers of a company supporting a high-risk satellite venture. Its massive financial support for Globalstar consumed the parent company’s precious financial resources and left Loral with high debt and an anemic stock price that it is trying to push above $1 a share with a planned 10-to-1 reverse stock split. Without boosting the stock price above $1 a share, Loral is in danger of losing its listing on the New York Stock Exchange.

Rainbow DBS expects to launch its satellite from Cape Canaveral on a Lockheed Martin [NYSE: LMT] Atlas rocket July 17 and plans to begin commercial service later this year. The Rainbow DBS service will cover between 80 percent and 90 percent of the country. It will be able to deliver a combination of more than 100 high-definition (HDTV) and standard-definition (SD) channels, company officials said. Subscribers will be able to use an 18-inch rooftop dish to receive the signal.

Cablevision is expected to retain the rights to offer DBS service in the New York area, with Rainbow DBS offering satellite TV service in other parts of the country, company officials said.

Derek Baine, senior vice president and senior analyst at Kagan World Media, thinks the spin-off is a good move and shows Cablevision is committed to giving Rainbow DBS a chance to develop a business.

“Many were skeptical they would launch this service,” Baine said. “This not only shows they are serious, it could attract more attention from EchoStar — a logical buyer for the assets. If EchoStar doesn’t buy, it’s probable they will partner with someone like the NRTC [National Rural Telecommunication Cooperative]. Pairing it with Clearview Cinemas will give them some cash for working capital for the business after the theaters are sold.”

Steve Blum, a satellite broadcasting consultant who heads Tellus Venture Associates, described the spin-off of Rainbow DBS as a positive move for the venture.

“As an independent entity, it can compete against cable interests, and do deals with programming interests, in ways that it couldn’t as part of a cable and programming conglomerate,” Blum said. “It also gives it more financial flexibility down the road, including increasing its options in terms of mergers and acquisitions.”

EchoStar currently has licenses for 11 frequencies at 61.5 degrees W.L. and has access to six additional frequencies through a leasing arrangement with Dominion, a provider of religious programming that uses the two remaining frequencies it controls at that orbital slot. EchoStar officials have not expressed interest in working with Cablevision in a joint venture and declined further comment.

Bob Marsocci, a spokesman for DirecTV, said his company currently has no plans to partner with Cablevision. In addition, any service that either EchoStar or DirecTV would offer from 61.5 degrees W.L. would require consumers to use a second satellite dish.

Jimmy Schaeffler, a media consultant who heads The Carmel Group, said he is supportive of the Rainbow DBS initiative. Schaeffler said he recognizes that Cablevision has put much study into the service and hired one of the satellite TV industry’s top experts, Mickey Alpert, who has assembled a team to develop the service.

“Don’t forget, people laughed at DBS when it [first] began challenging cable, at MCI when it bucked AT&T [NYSE: T], and at Wendy’s [NYSE: WEN] when it countered McDonald’s [NYSE: MCD] and Burger King,” Schaeffler said. “It’s just human nature.”

However, Rainbow DBS will need to distinguish its service from DirecTV and EchoStar to have a chance at financial success, said Bruce Leichtman, president and principal analyst at Leichtman Research Group.

“In order to grow at this stage of DBS development, the startup would need to differentiate itself, preferably at the high-end of the consumer satellite market,” Leichtman said. Unless Rainbow DBS taps into the high-end subscriber market, it could have trouble finding a sufficiently large revenue stream, he said. In addition, low-end customers tend to cause higher churn rates, he added.

The new satellite TV service may be able to find a niche by offering local channels to less populated markets that DirecTV and EchoStar have shunned as unprofitable or by offering more high-definition TV (HDTV) programming than the others.

To become a viable business, Rainbow DBS needs a unique programming proposition to the marketplace and HDTV may be its best option, Blum said.

“One thing that works in its favor is the fact that its technology is eight to 10 years newer than that used by DirecTV or EchoStar,” Blum said. “Newer technology mitigates, to a certain extent, its bandwidth disadvantage, and allows the company to offer advanced services, such as HDTV, that can differentiate it from both cable and the incumbent DBS players. That said, its limited transponder capacity and less than optimal foot print are still significant hurdles that must be overcome.”

Rupert Murdoch, the chairman of News Corp [NYSE: NWS], decided roughly six years ago not to launch a satellite TV service from scratch in the United States. Instead, after years of trying, he was able to sign an agreement to buy DirecTV. That deal is awaiting regulatory approvals, but it shows that one of the world’s wealthiest and most successful media moguls thought better of trying to pursue the course that Rainbow DBS is on.

Skeptics Surface

D.K. Sachdev, an engineer and satellite radio pioneer who heads SpaceTel Consultancy, said that room exists for competition in the U.S. multi-channel video market but pointed out that Rainbow DBS is starting with a few handicaps.

“A single satellite cannot match the programming offerings of the multi-satellite clusters of DirecTV and EchoStar,” Sachdev said. “Its orbital location of 61.5 degrees is way off-center from CONUS [continental United States]; it is in fact in an arc more suitable for Latin America. Furthermore, the parent company, Cablevision, is keeping the New York market for itself.”

Cablevision’s 3 million customers in the New York market could grow with an enhanced satellite TV component because the company’s current infrastructure is capable of reaching a total of 4.4 million households in the same territory. The company’s service area includes parts of New York, New Jersey and Connecticut, said Kim Kerns, vice president of corporate communications at Cablevision.

For Cablevision shareholders, the spin-off gives them the choice of investing in Cablevision, Rainbow DBS or both. The spin-off also is expected to provide Cablevision with improved access to capital, as well as lower cost of capital and greater financial flexibility, company officials said.

James L. Dolan, Cablevision’s president and CEO, explained that the transaction would enable his company to focus on its core entertainment and cable operations, especially in the New York area. The spin-off separates the cable and satellite TV operations to let shareholders themselves choose whether to invest in both companies, he added.

Cablevision Chairman Charles F. Dolan will be chairman of the new company, but no other directors or officers will serve at both Cablevision and Rainbow DBS, company officials said. In addition, the spin-off is contingent on Cablevision obtaining final approvals both from its board and regulatory agencies.

Although the spin-off is a good idea, Chuck Hewitt, a satellite-broadcasting consultant who previously was president of the Satellite Broadcasting and Communications Association (SBCA), said Cablevision faces “an uphill battle” in competing with DirecTV and EchoStar.

Rainbow DBS needs a unique service, but nothing stands out as a moneymaker that the two established operators won’t be able to counter. Aside from offering HDTV or serving small and rural markets, Rainbow DBS might consider providing business TV services, Hewitt said.

Should the price of HDTV sets fall to under $1,000 as predicted by Comcast [NYSE: CCZ] CEO Brian Roberts, new programming would be created and a market niche could become more viable, Hewitt said.

“If they are going head-to-head against EchoStar and DirecTV, it is going to be very difficult but not impossible,” Hewitt said.

–Paul Dykewicz

(Karim Zia, Deutsche Bank, 212/469-7591; Bruce Leichtman, Leichtman Research Group, 603/397-5400; Derek Baine, Kagan World Media, 831/624-1536; Chuck Hewitt, Charles C. Hewitt & Associates, 410/544-4108; Steve Blum, Tellus Venture Associates, 831/582-0700; Jimmy Schaeffler, The Carmel Group, 831/643-2222; D.K. Sachdev, SpaceTel Consultancy, 703/757- 5880; Kim Kerns, Cablevision, 516-803-2351; Bob Marsocci, DirecTV, 310/726-4656)