Dollars And Sense: Is The Manufacturing Business For The Birds?

by Armand Musey

The business of building new commercial satellites is severely depressed. A number of factors are driving this slow down. One main factor is that the satellite industry in general has just completed a replacement cycle and most new satellites are more powerful and should last longer than those they replaced, which when combined with a global buildup in wireline communication infrastructure has resulted in a glut of commercial satellite capacity. Demand for broadband satellite services has failed to materialize as envisioned, exacerbating this fact. In conjunction, a closing of the capital markets for funding these sorts of start-up ventures has caused several satellite broadband projects to be scaled back, put on hold or cancelled altogether.

Likewise, the annual number of new commercial satellite orders has steadily declined from a peak of 45 in 1995 to just 22 in 2001, after spiking again to 42 in 2000. The outlook for the near- to medium-term also is not good. There were a total of 99 commercial geostationary satellites under construction or awaiting launch, with a total value of $11.6 billion by the end of 2001, according to figures from Euroconsult. Most of these represented one-off replacement satellites for some of the largest and most well established operators. Among the companies we cover, Hughes and Echostar each have spotbeam satellites under construction that are expected to be launched later this year, and Panamsat has three satellites to be launched before the end of 2003, SES Global four, and Loral four. Intelsat also plans to launch four new birds and Inmarsat has three in development.

We do not expect subsequent new orders for fleet expansion from any of these operators, beyond what is already announced, once these birds are launched. In fact, as of mid- year, we heard of only two new commercial satellite orders. Boeing received an order for a new 702 to be the third satellite in the Thuraya constellation, and the Greek-Cypriot satellite project Hellas Sat has signed a deal with Astrium to acquire its first commercial geostationary satellite.

The drop off in demand for new satellites is causing several of the U.S. manufacturers some very real pain. Boeing recently announced that it would merge its Space and Communications unit with its Military Aircraft and Missiles division. Boeing’s stated rationale for merging these units is the potential for realizing cost savings and operating synergies. However, Jim Albaugh, who headed up Boeing’s space business, expects the unit to be in the red in 2002 and that “commercial space will not turn around for several years, if ever.” This revealed to us the increasing importance of government/military orders to satellite manufacturers, and pointed to a potential competitive disadvantage for those manufacturers without a strong background in military-related applications.

It is clear to us that consolidation in the satellite manufacturing business is necessary. By our estimates there is easily 100 percent excess satellite manufacturing capacity within the industry based on existing satellite manufacturing lines. We note that Lockheed Martin recently announced that it is looking at “strategic alternatives” for its satellite manufacturing business. This is a euphemism for trying to find someone to buy it. However, it is not clear to us that there are any potential buyers. Boeing is probably already too big from an anti-trust perspective, and as we noted above, is not exactly thrilled with the current satellite business. Subsequently, we heard Lockheed Martin is considering merging its operations with Loral’s SS/L satellite manufacturing unit to form a joint venture. If this were to occur, we think it would be a step in the right direction, but we do not think it would be enough to rationalize excess capacity in the industry. We believe Northrop could be a consolidator in the space once it digests its acquisition of TRW, although its management has said it has no interest in being in the commercial end of the business. Given our outlook for demand, this is probably wise.

Armand Musey is a satellite communications analyst at Salomon Smith Barney (“SSB”). Part of the information provided herein includes excerpts, abstracts, and other summary material derived from research reports or notes published by Musey as a member of SSB’s Equity Research Department. For a copy of the full research reports or notes from which such information is derived, please contact an SSB sales person . To view the research-report disclosure required by the NYSE and NASD rules relating to analyst independence and conflicts of interests, private-client investors may visit SSB’s disclosure Web site at http://www.ssbaccess.com and institutional investors may visit the SSB’s disclosure Web site at http://www.ssbgeo.com, or contact an SSB sales person. In addition, valuation methodologies and associated risks pertaining to price targets, as well as other important disclosures, are contained in research reports and notes published on or after July 8, 2002.