DirecTV Outmaneuvers EchoStar

DirecTV will pay more than it originally planned for its DirecTV 7S satellite, but it successfully used creative deal-making skills and legal arguments to thwart archrival EchoStar Communications [Nasdaq: DISH] in its effort to buy the bird off the factory floor.

Littleton, Colo.-based EchoStar unsuccessfully tried to grab the satellite from DirecTV by using the bankruptcy proceedings of New York-based Loral Space & Communications [OTCBB: LRLSQ], the parent company of the satellite’s manufacturer Space Systems/Loral (SS/L).

To convince the court to reject EchoStar’s offer, El Segundo, Calif.-based Hughes Electronics [NYSE: GMH], the parent of DirecTV, agreed to sweeten its compensation to Loral and its creditors by offering more cash and additional satellite contracts.

EchoStar gamely tried to match the Hughes counteroffer by promising even more cash, but the Bankruptcy Court for the Southern District of New York decided in favor of DirecTV and authorized SS/L to complete and deliver the satellite to DirecTV in January.

Charles Ergen, chairman and CEO of EchoStar, said, “We’re disappointed by the judge’s [DirecTV 7S] ruling, as we believe we had a superior bid for the satellite assets. We have had a long productive relationship with Loral and we look forward to continuing to work with them as they emerge from bankruptcy.”

The court also approved binding authorizations to proceed (ATPs) for SS/L to build two additional DirecTV satellites, DirecTV 8 and DirecTV 9S, and one satellite, Galaxy 16, for DirecTV’s sister company PanAmSat [Nasdaq: SPOT]. The Wilton, Conn.-based fixed-satellite service operator further agreed to take an option from Loral to build an in-orbit spare for one of the operator’s existing satellites.

The value of the three new awards from the Hughes companies tops $320 million, Loral officials said. DirecTV will make advance payments of $25 million on each of its two new satellite orders, while PanAmSat will also pony up an advance payment of $25 million for its order.

EchoStar’s unorthodox attempt to buy the nearly completed DirecTV 7S satellite was hurt by Loral’s opposition. DirecTV also helped to protect its previous $120 million investment in DirecTV 7S by agreeing to increase the total contract value for the satellite’s construction by $25 million to approximately $165 million.

After the court ruled against EchoStar, the satellite TV provider pulled its $1.85 billion offer to buy all of Loral and its separate $1.029 billion offer just for Loral’s North American satellite assets. Before withdrawing its proposals, EchoStar forced Intelsat to hike its original $1 billion bid for Loral’s North American satellite assets to $1.1 billion.

DirecTV’s Defense

Responding to the bankruptcy court ruling, Bob Marsocci, vice president of corporate communications at Hughes, commented, “We are pleased and gratified that the judge granted our motion in court today. We look forward to the delivery of our satellites from Space Systems/Loral.”

DirecTV had threatened legal action against Loral and EchoStar if the DirecTV 7S satellite it had contracted to buy had been sold to its rival.

Jimmy Schaeffler, a satellite broadcasting and media analyst who heads The Carmel Group, said, “The bankruptcy court obviously had to grapple with a common sense result vs. what the law says about delivering already-contracted assets to the highest bidder. One favors existing vendors and the debtor’s good name, the other serves creditors and the vendors’ competitors. Apparently, common sense won out.”

Roger Rusch, a consultant who heads the Palos Verdes, Calif.-based TelAstra satellite consulting firm, said, “EchoStar tried to use [the bankruptcy court proceeding] to compete with DirecTV and put its rival at a disadvantage.”

Maury Mechanick, an attorney in the Washington office of the White & Case law firm, said that apart from any assessment of the relative financial merits of the competing offers, it appears the court may have been influenced by the legal uncertainties that approving the EchoStar offer would have entailed. Those uncertainties included the competitive and intellectual property concerns raised by DirecTV in its court papers.

DirecTV’s strongly worded arguments submitted to the judge in advance of the Oct. 22 court date characterized Loral’s decision to accept the improved offer as “sound business judgement.” DirecTV warned that acceptance of EchoStar’s offer would have prompted it to file a claim of $200 million against SS/L and Loral.

Legal Quagmire

“It would also drag the estate into an intellectual-property and antitrust quagmire,” DirecTV’s attorneys explained. “The DirecTV 7S satellite was custom-designed for DirecTV, by DirecTV, and consists of DirecTV proprietary intellectual property in manifold critical respects.”

The sale of the satellite to EchoStar or any other DirecTV competitor would implicate SS/L in misappropriation of DirecTV’s intellectual property, the attorneys warned. EchoStar’s offers to buy the satellite for more than its “value” in order to thwart DirecTV’s expansion would make SS/L a participant in restraining competition and potentially leave it liable for treble damages under state and federal law, they argued.

“In an effort to regain its footing in the industry, SS/L has elected to pursue a course which allows it to complete its nearly finished work on DirecTV 7S, while also providing a substantial immediate cash influx and long-term business opportunities,” DirecTV’s attorneys said.

EchoStar ultimately offered $200 million to buy the DirecTV 7S satellite and match the commitments by DirecTV and PanAmSat for new satellite orders. In addition, EchoStar offered to indemnify, defend and hold SS/L harmless from any claims against it by DirecTV.

“The EchoStar counteroffer is overwhelmingly superior to the DirecTV counteroffer and is the best and only offer that the debtors may accept if they are to fulfill their fiduciary duties owed to their creditor constituencies,” EchoStar’s attorneys argued.

However, EchoStar acknowledged that DirecTV previously had paid $120 million for construction of the DirecTV 7S satellite and only $20 million was left to be given to SS/L to fulfill the original contract price of $140 million.

Despite that, EchoStar claimed that SS/L had a duty to “maximize the value” of any assets sold under section 363 of the bankruptcy code, which calls for accepting “the highest and best” offer. Specifically, the EchoStar counteroffer is the “only choice” for the debtors and Loral’s board of directors to accept if they are to fulfill their fiduciary duties, EchoStar’s attorneys argued.

–Paul Dykewicz

(Bob Marsocci, DirecTV, 310/726-4656; Steve Caulk, EchoStar, 303/723-2010; Jimmy Schaeffler, The Carmel Group, 831/643-2222; Roger Rusch, TelAstra, 310/373-1925; Maury Mechanick, White Case, 202/626-3635)