Dollars And Sense: Awaiting The Fate Of Hughes Electronics
To tie the knot with the Aussie media mogul, Rupert Murdoch, or not to tie the knot. That is the question facing the GM board, which controls the fate of Hughes Electronics. Speculated terms of a deal between Hughes, the operator of DirecTV (the largest DBS broadcaster in the United States with more than 9.5 million subscribers), and News Corp. were recently reported by the press. We believe someone on the GM board got cold feet and may have been behind the leaks. These leaks, and the subsequent stock plummet, have caused further speculation, widely reported in the press, of an alternative consolidation play. Under this scenario, Murdoch is out of the picture and DirecTV is merged with EchoStar, and possibly Pegasus, to form a single nationwide DBS provider.
The speculated terms of a transaction between Hughes and News Corp. were convoluted. Reports had Hughes issuing new shares to acquire News Corp.’s satellite distribution properties, collectively known as SkyGlobal. Reportedly, News Corp. would have sold these properties to Hughes under a scheme that valued them at roughly 35 percent of a combined entity. The press also reported that Microsoft and Liberty Media would have subsequently stepped-up to the plate with cash infusions, giving each roughly a five percent interest in the new company. Hughes would have then used the cash from the Microsoft and Liberty Media investments and its ability to leverage itself, to buy-down GM’s stake, retiring the shares it purchased from GM to make Murdoch the controlling shareholder.
We believe GM’s board would have had a hard time getting GMH shareholders to accept this transaction (which would likely have been necessary under the bylaws of the company) as it did not provide the premium for which they had hoped. What would shareholders have really gotten for their 35 percent dilution? The largest piece of SkyGlobal is Murdoch’s 44 percent interest in GemStar, a company he will not control for another four years, and which currently has very little in the way of revenues or profits. GemStar’s $17 billion- plus valuation is based on the notion that its IPG patents are broad enough that nearly every other broadcaster will be forced to license its technology and that income from licensee revenue streams, (which currently contribute very little), will generate substantial revenues.
The next largest component of SkyGlobal is New Corp’s 38 percent interest in the European satellite broadcaster, BSkyB, another company that Murdoch does not control, and which is also not a profitable entity. It is true that SkyGlobal’s NDS technology could accelerate DirecTV’s rollout of interactive services. Significant synergies could also be generated if News Corp.’s Star TV was combined with the Latin American operations of DirecTV Latin America. However, neither of these prospects would generate results warranting a $60-plus billion merger. Finally, it is not clear that Murdoch would be motivated to run the company entirely in the best interest of minority shareholders. If he controlled DirecTV, some speculate that Murdoch could force it to pay top-dollar for News Corp. content, in effect, cross-subsidizing his other less profitable businesses. This is the whole logic behind the vertical integration of the media industry.
GM’s board is in somewhat of a bind. GM clearly wants to sell Hughes. Although the News Corp. transaction is perhaps not the richest transaction, it does satisfy GM’s two principal requirements. First, it would likely permit GM to avoid paying a heavy tax bill, and second, it is also an all-cash deal to GM, which is key since GM has no desire to take News Corp.’s shares (or any other company’s equity) in return for Hughes. GM needs to keep roughly $7 billion to $8 billion in cash on its balance sheet at all times to maintain its debt rating.
We believe that GM board members recognize their dilemma and they may be behind speculation of a consolidation play. From an operational standpoint, a merger of DirecTV and EchoStar is very compelling. We believe a merged entity could achieve a 10 percent increase in pre-marketing cash flow margins by leveraging programming costs, distribution channels and back-office operations. Our back of the envelope calculation estimates this amount at $750 million annually. This idea has been explored before, but was never seriously pursued due to anti-trust concerns. However, the new administration and its “less activist” DoJ and FCC is unlikely to oppose such a transaction, as a combined entity would not have a dominant market share except in rural markets, which could easily be regulated.
Even if the FCC blocked a merger between DirecTV and EchoStar, the six months required to go through the process would at least buy the GM board enough time to round up other potential bidders for a real bake-off.
Armand Musey, CFA is a satellite communications analyst at Banc of America Securities LLC (BAS) . This article does not necessarily reflect the views of the Via Satellite editors and should not be considered as a recommendation with respect to any security. BAS and its affiliates may maintain a long or short position in, act as a market maker for, or purchase or sell a position in, securities of referenced entities and may also perform investment banking, advisory, or other services for any such entity.