Dollars And Sense: Broadband: The Next Big Thing?

by Armand Musey

Throughout the next couple of years, satellite-based consumer services should make significant headway in the market for broadband connectivity. We expect demand will initially be strongest in the United States, driven by rural America’s appetite for broadband Internet access. We estimate there are roughly 20 to 30 million U.S. households that will not be served by cable modem or DSL in the foreseeable future. DBS growth in rural areas has been consistently strong due to a lack of viable alternatives. Broadband satellite services should achieve similar levels of household penetration. The success of VSAT has proven there are also significant opportunities to service businesses in these regions. We are projecting there will be 5 million U.S. broadband satellite subscribers by the end of 2005 generating total revenues of $4.5 billion, up from an estimated 75,000 subscribers and revenue of less than $55 million in 2000.

The broader rollout of consumer broadband satellite services in North America will occur in two stages. The first stage, which is already upon us, is two-way Ku-band services that use leased capacity on existing satellites. The two consumer services now available in the United States are DirecPC, from Hughes, sold through DirecTV dealers, and Starband, from Gilat, sold through Echostar dealers and Radioshack. The problem with these services is that they are not as robust as cable modems or DSL (offing roughly 500 kbps on the downlink and 50 to 150 kbps on the uplink) and at $60 to $70 per month, are more expensive. This is because Ku-band satellites broadcast on a single dedicated beam to all subscribers, which is an inefficient use of spectrum. Therefore, these services must ration bandwidth to customers in high density areas, particularly on the uplink. Hughes’ acquisition of DSL reseller Telocity to service its largely urban subscriber base is evidence of this shortcoming.

The second stage of the rollout will follow the launch of new Ka-band satellites that utilize spotbeam technology to focus signal transmission on areas with higher population densities. This more efficient use of bandwidth increases the effective capacity of the satellite and in theory will not only permit these services to offer competitive performance, but also lower the cost per user and increase the profitability of the services. Two Ka-band services with strong backing are targeting introduction in the 2002 to 2003 timeframe: Wildblue, which is an independent company with ties to Echostar, News Corp. and Liberty Media, and Spaceway, which is being developed by Hughes. Wildblue plans to launch two satellites covering North and South America. Spaceway is planning to launch three satellites for full North American coverage.

With the support of Hughes, the DirecPC and Spaceway Ku-band and Ka-band offerings would appear to have the advantage over Starband and Wildblue, at least for now. Not only will DirecPC and Spaceway benefit from Hughes’ strong brand name recognition and distribution network, HNS offers strong in-house capability for producing consumer equipment efficiently and in mass quantities, and DirecTV’s Home Service Network can insure proper installation on a national basis. Spaceway should also benefit from the transfer of some of Hughes’ “blue-chip” VSAT customers to Spaceway enterprise solutions. Finally, Hughes has committed a reported $1.4 billion to financing Spaceway’s development. Given the fact the chief hazard facing broadband satellite services is the large amount of capital that will be required before they are self-sufficient, having a deep-pocketed parent is a critical advantage.

Starband and Wildblue are facing greater financing challenges. We estimate that both will need at least $250-$300 million in additional equity financing in the next year. Both had planned to be public companies by this point. However, both have been facing a negative bias surrounding these types of companies as far as the public markets are concerned. This backdrop also has to do with the contraction of the market for technology and telecom issues. Not only is this making it hard for these companies to find financing at a critical juncture in their development, it could further erode their competitive position. Ultimately, we think the U.S. market is large enough to support two broadband satellite service providers, just as it supports two DBS providers, and that DirecPC will have an independent public competitor.

While the initial development of broadband satellite services will occur in the United States, we believe there is an even larger market opportunity outside the United States. Europe is likely to be the next major market to develop, where there are opportunities due to lower fiber penetration in key urban areas, a slower rollout of cable modems, and wide acceptance of satellite dishes. In the longer-term, developing markets in Asia and Latin America offer even greater growth potential. Pent-up demand exists in regions where terrestrial networks are inadequate and the per-capita incomes do not justify the necessary infrastructure investment. We are projecting 3.4 million broadband satellite subscribers outside of the United States by 2005, up from under 25,000 at year-end 2000. After 2005 we expect international subscriber growth to begin outstripping U.S. demand. In the next decade we expect broadband satellite services will become as ubiquitous as DBS on a global basis.

Armand Musey is the satellite communications analyst at Salomon Smith Barney (“SSB”). He can be reached at 212-816-6008. The foregoing article should not be considered as a recommendation with respect to any security. SSB 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.