Rainbow DBS Growth Forecasted

Wall Street analysts are not convinced that fledgling satellite TV provider Jericho, N.Y.-based Rainbow DBS would be able to build a sizable enough subscriber base to develop into a profitable stand-alone business. Its chief competitors have a combined 20-million subscriber base.

Rainbow DBS, the newly minted direct broadcast satellite (DBS) unit of Bethpage, N.Y.-based Cablevision Systems [NYSE: CVC], seems to lack a viable business model, according to Rich Bilotti, a cable analyst with Morgan Stanley. He thinks the most likely scenario is that Rainbow DBS would be sold when its subscriber base reaches 3 million to 4 million. The sale would include its one satellite, orbital slot and spectrum allocation, he forecasted.

Rainbow DBS’ new service, called Voom, is scheduled for commercial rollout nationwide Oct. 15. Voom’s thrust will be to develop a high-end satellite TV service by offering 39 high-definition television channels, including an exclusive 21 HDTV channel package that would be supplied by Cablevision subsidiary Rainbow Media.

To date, U.S. satellite and cable TV operators have offered no more than seven syndicated HDTV channels. In addition, the Voom service would include as many as 88 cable channels in standard-definition format, along with local digital broadcast programming, company officials said.

Based on what has been revealed thus far, Bilotti is uncertain whether the amount of HDTV programming Rainbow DBS will offer would allow it to charge premium prices.

Rainbow DBS plans to differentiate itself from the other providers by adopting compression-friendly MPEG-4 technology in the fourth quarter of 2004. The two entrenched U.S. DBS providers, DirecTV and EchoStar Communications [Nasdaq: DISH], also could upgrade their services to MPEG-4 technology from MPEG 2 but not without an expensive and “operationally challenging” replacement of their existing set-top boxes, Bilotti said. Voom’s set-top boxes are designed for upgrading to MPEG-4 from MPEG-2.

Rainbow DBS will not hold any advantages in channel capacity, will likely have limited local channels, and may lack enough HDTV programming to entice the high-end, early- adopting consumers the company is seeking, Bilotti said.

At the same time, Rainbow DBS is pursuing a promising growth market by focusing on HDTV services, Bilotti acknowledged. He estimated there would be approximately 6.5 million HDTV households in the United States by the end of 2003, reaching 15 million within the next five years.

“If there is one competitive advantage Voom may have in the future, in our view, it is capitalizing on high-definition,” Bilotti said. Ultimately, cable operators may be best positioned to benefit from high-definition growth, if they free-up capacity to do so through their ongoing conversion from analog to digital technology, he added.

“We believe a more targeted marketing approach with premium pricing would likely compete more with DirecTV over the next three to five years,” Bilotti wrote in a research note. A more aggressive discounted approach would have a bigger affect on cable operators and EchoStar, he added.

Despite his doubts about Rainbow DBS becoming a long-term player, Bilotti likes the venture’s prospects well enough to value the business unit at $1.5 billion or roughly $5 for each share of Cablevision’s stock.

“Under most sets of assumptions, funding the business over a 5-7 year period will be difficult,” Bilotti said. “It will likely begin service with enough cash for 2-3 years of operation.”

The viability of Rainbow DBS is relevant because Cablevision plans to spin-off the venture, and its cinema business, by year-end. To do so, Cablevision needs a favorable opinion about related tax issues from the Internal Revenue Service, Bilotti noted.

If the spin-off proceeds as planned, Cablevision has committed to provide Rainbow DBS with an additional $450 million in capital. In total, Cablevision has spent or will contribute $864 million to the launch of Rainbow DBS.

“The critical problem will be scaling the business to a subscriber base that can generate enough cash flow to pay down the debt incurred building that base,” Bilotti said. “Securing financing will likely be an issue.”

Bilotti’s base line forecast is for Rainbow DBS’ Voom service to amass 1.25 million subscribers by year-end 2006.

DirecTV and EchoStar likely will react to the entrance of Rainbow DBS by speeding up their own rollout of HDTV services, said Tom Watts, a satellite analyst with SG Cowen. A key for Rainbow DBS to succeed will be to differentiate its programming, he added.

Rainbow DBS launched its only in-orbit satellite July 17. The high-powered, A2100 model spacecraft, lifted into orbit from Cape Canaveral, Fla., on a Lockheed Martin [NYSE: LMT] Atlas V rocket, features 24 MHz Ku-band high-power transponders with a combination of 135 watt and 65 watt power amplifiers. Manufactured by Lockheed Martin Commercial Space Systems, of Newtown, Pa., the spacecraft has an expected service life of 18 years and is located at the 61.5 degrees West Longitude orbital position. That orbital location will pose challenges for the satellite to send signals to receiving dishes on the West Coast.

Rainbow DBS officials declined to provide further details about how they would mitigate that technical obstacle. A further explanation from the company could come when the Voom service is formally launched.

–Paul Dykewicz

(Rich Bilotti, Morgan Stanley, 212/761-7162; Tom Watts, SG Cowen, 212/278-4260; Kim Kerns, Cablevision, 516-803-2351)