EchoStar Dishes It Out Once Again

By Thomas Watts

EchoStar Communications [Nasdaq: DISH] continues to outpace the competition, as shown by its second quarter results. EchoStar’s DISH network added 270,000 net new subscribers in the quarter, more than the entire cable industry plus DirecTV combined. Just in the direct broadcast satellite (DBS) world, EchoStar captured 67 per cent of the net new subscribers, leaving only 33 per cent for DirecTV.

The future also looks bright. Particularly in our no-job growth economic recovery, we expect consumers to flock to DISH’s value-oriented offering, which is typically priced at a substantial discount to both cable and DirecTV. Also, with DISH rolling out local-into-local programming in an additional 30 markets by year-end, we expect subscriber growth to accelerate.

Though some believe that the DBS market is almost fully saturated, we expect DBS penetration to approach 25 per cent of U.S. TV households by 2010, from just under 20 per cent today. At least three factors should drive subscriber growth, including expansion of local-into-local programming and increased penetration of digital video recorders (DVRs).

First, both EchoStar and DirecTV have plans to expand into more local markets by the end of this year, with both companies reaching over 100 markets. Both companies experience higher gross additions and lower churn in markets where local is offered. We expect EchoStar’s DISH network to capture many of the subscribers in these rural areas as the National Rural Telecommunications Cooperative (NRTC) distributors continue to experience poor performance.

Second, while DVRs are not yet the “must have” of the mulitchannel world, the word is spreading quickly – and the potential as a replacement for the VCR, which has 80+ per cent penetration is quite substantial. Of course the cable companies will argue that video-on-demand (VOD) is the way to go. But if that’s the case, then why is it that only one out of five households with VOD available actually use the service? At the end of 2002, 7 million digital households had access to VOD programming and, by 2006, we project that VOD will reach 38 million digital homes. This suggests that only about 7 to 8 million will use the service. Maybe this is because of the price? VOD is more expensive in the long run. The service requires a digital cable set-top box (average cost $4.50 per month), the price per movie is $4 on average, and the subscription fee per month can run up to about $30. DVR recorders, on the other hand, cost only about $265 upfront, with no cost to record, and a monthly service fee (i.e., $4.95 for standard TiVo customers).

As shown on the chart, DVR unit sales are expected to increase to over a half a million by the end of the year, while the average unit price is expected to decrease.

Also, the DBS companies are starting to offer SVOD (subscription VOD) to strike back at cable. For example, DirecTV, in conjunction with TiVo, has partnered with Starz Encore in offering a SVOD feature for subscribers. Those who subscribe to the Starz Super Pak and have a DirecTV/TiVo receiver can receive the SVOD service at no additional cost. The service allows the automatic download of pre-selected movies that subscribers can watch at their leisure. We believe this type of service is more attractive to the consumer and will ultimately lead to a larger market share for the DBS companies.

Both EchoStar and DirecTV are pushing their DVR offerings beginning at the end of this month. We view this as a way for EchoStar and DirecTV to differentiate their services from cable, and also, a way to minimise churn.

Third, as a way to compete with cable’s bundling of video/broadband, both EchoStar and DirecTV have begun teaming up with U.S. telcos. Recently, EchoStar struck a deal with SBC [NYSE: SBC]. We believe this has the prospect to add further subscribers in the next few years that EchoStar otherwise would not have signed up. Moreover, the deals should help EchoStar to improve its cash flow profile with lower subscriber acquisition costs and lower churn, even though EchoStar will have to give up a share of revenues to SBC. In the near future, we expect Verizon [NYSE: VZ] to partner with DirecTV.

With expansion into more local markets, further penetration of DVRs and a bundled broadband solution, we expect the DBS companies to continue “dishing” it out to their rival cable companies.

Thomas W. Watts is managing director at New York-based SG Cowen Securities. He can be reached by e-mail at [email protected].