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Looking Ahead To 2009

By | December 1, 2008

      2008 closes with a potential bottom of the financial institutions/credit crisis that began in the summer of 2007 and spread from the subprime mortgage market to the entire financial services industry in the second and third quarters of 2008.

      This crisis has ended the independent existence of all five leading U.S. investment banks, beginning with the spring collapse of Bear Stearns and its distress sale to J.P. Morgan Chase. It continued with the U.S. government bailouts of secondary mortgage market pooling leaders Fannie Mae and Freddie Mac and insurance giant AIG; the bankruptcy of Lehman Brothers; and the distress sale of Merrill Lynch to Bank of America. It culminated with the conversion to commercial bank status of Goldman Sachs and Morgan Stanley.

      If a bottom has been reached, though, it is due not to piecemeal government bailouts and distressed asset sales but to the U.S. government finally recognizing that economic recovery depends on restoration of confidence in the financial services industry generally and forcing leading banks to accept a government equity stake in them. The events followed with dizzying speed and against a background of unprecedented losses and volatility across all major stock indices.

      In the satellite sector, the major financial events were the BC Partners acquisition of fixed satellite service (FSS) operator Intelsat, the approval of the merger of digital audio radio service (DARS) operators Sirius Satellite Radio and XM Satellite Radio, and the attempt by hedge fund Harbinger Capital Partners unilaterally to consolidate and rationalize the mobile satellite service (MSS) sector by entering into a complex arrangement to finance and potentially acquire Inmarsat through Harbinger Capital portfolio company SkyTerra, parent of Mobile Satellite Ventures.

      2009 prospects are dominated by the overall credit and liquidity crisis and transactions on that scale are unlikely. The debt markets that provided critical finance for the private equity acquisitions into and exits from the FSS sector are closed, and that sector is — but for regional players and an interesting hypothetical tie-up between Eutelsat and Telesat — already consolidated. Some of the MSS players may seek consolidation for want of independent finance even without Harbinger Capital action; the MSS sector is divided into those businesses predicated on the rollout of ancillary terrestrial service (ATC) and those that are not, and with ATC still an unproven market and no strategic terrestrial telecommunications operators yet bought in, consolidation in the tighter financing environment may be in order.

      Although some analysts have taken the Sirius-XM approval as a precedent for a renewed look at a merger of direct broadcast satellite (DBS) operators DirecTV and EchoStar, the likelihood of such a deal is low. The U.S. Federal Communications Commission rejected that proposal in 1997, and revival talks in 2006 produced no movement.

      The scale of DirecTV and EchoStar in both absolute and relative industry terms is roughly $57 billion in an overall $74 billion satellite services industry and a $123 billion all-sectors global satellite industry, far outweighing about $2 billion for DARS, means that the precedential value for DBS consolidation based on DARS merger is low, notwithstanding arguments that a variety of competing video sources would provide post-merger competition for DBS, as iPods and other audio devices were deemed to do for Sirius and XM. Also, unlike the case for the DARS operators, there is no case to be made that DirecTV and EchoStar cannot survive independently if merger approval is not granted.

      Satellite manufacturing and launch services are low margin and relatively small subsectors, accounting collectively for about 12 percent of industry revenues, and are replete with "national champion," foreign investment and technology export regulatory hurdles, particularly with their mix of commercial and government/military customer bases.

      What is left is the fragmented satellite ground equipment and services sector, which accounts for roughly a quarter of overall industry revenues. Consolidation, roll-up and rationalization strategies may play a role in this industry subsector going forward. The transactions are mid-market, and the regulatory hurdles are lower. In the absence of leveraged acquisitions and inflated valuations, there should be plenty of opportunities for strategic acquirers using stock as partial acquisition currency with cash, vendor financing and an array of joint venture/partnering deals far from the merger and acquisition cookie-cutter mold.

      The wildcard in all this is the extent to which the U.S. presidential election may provide its own remedy for the credit and liquidity crisis. The crisis obviously is based on overvalued, defaulting assets, but there is a psychological crisis of confidence at play as well. It will be interesting.

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