Dollars And Sense The Value Is In The Subscriber Base

By Marc Crossman and Aileen Chen

For investors of companies that provide direct-to-home (DTH) broadcasting, net subscriber additions during a period are commonly used as an indicator of the health of the business. Similarly, for Hughes Electronics–whose domestic DTH broadcast unit (DirecTV) has the largest share of its market–its monthly net subscriber addition numbers have been a focus point for investors and analysts. During its second quarter earnings conference call, Hughes indicated it will begin reporting these numbers on a quarterly instead of a monthly basis. Although the change will reduce the frequency of this “progress report” of the DirecTV business, it is positive for the unit and for Hughes for many reasons.

Firstly, DirecTV’s closest competitor, Echostar, recently changed to quarterly reporting. Moving to quarterly reporting will give Echostar less insight as to the success of DirecTV’s various promotions. Secondly, because Echostar has already moved to reporting on a quarterly basis without showing signs of slowing subscriber growth, Hughes will receive less criticism from the investment community because of this change. Hughes will be perceived as following Echostar’s example. And lastly but most importantly, the switch allows investors and analysts to focus less attention on the added net subscriber numbers each month as an indicator of health at DirecTV, in favor of the total number of subscribers–the company’s main value driver.

The health of both companies is good. Hughes DirecTV reported overall strong second quarter results with revenues of $1.13 billion, an increase of 45 percent over last year’s second quarter. The solid revenue growth was fueled by record subscriber net additions during the quarter. DirecTV added 452,000 net new customers during the second quarter, versus 369,000 during the same period last year. In addition, DirecTV converted 430,000 subscribers from Primestar, which was acquired last year. Echostar, which at press time had not reported results, is also expected to report another record quarter of revenue and subscriber growth.

For the year 2000, Hughes and Echostar combined should add at least 4 million new subscribers to their respective systems. This would represent a greater than 30 percent increase over the number of subscribers added in 1999. With this level of subscriber growth, it is no wonder Hughes and Echostar are trading well above last year’s levels. But what has really been driving record numbers of consumers to purchase DBS systems? A few years ago the most important factor was increased programming selections followed by increased picture quality and superior customer service. While customer service and picture quality may still be a differentiating factor, we would argue that programming selection is becoming less of a differentiating factor as the cable industry slowly rolls out digital cable.

Times have changed and new factors are driving consumers to purchase DBS systems. If we assume that programming selection as a differentiating factor has been decreasing and not increasing, then how has the industry been experiencing record subscriber growth levels so far in 2000? First, the rapid demise of Primestar and the slow death of C-band. Both services have been losing subscribers to DBS. Even after excluding the effects of Hughes’ purchase of Primestar and Echostar’s quasi purchase of Superstar, both businesses have been experiencing larger than normal customer attrition to DBS. Second, the introduction of local programming into local markets has allowed the DBS industry to tap a new market of buyers that otherwise would not have bought a DBS system.

As we enter 2001, gaining an incremental DBS subscriber will be increasingly difficult for several reasons. First, DBS companies have gotten large enough that churn is becoming a formidable number. For instance, at DirecTV, we estimate that in 1999 less than 1 million subscribers turned off their service. In 2000, we estimate that number will grow to 1.5 million, and in 2001 we estimate that number will grow yet again to 2 million. This means that in 2001, DirecTV must sign up 2 million subscribers just to maintain its subscriber base at the same level it exits 2000 with.

Second, at the end of this year all of the Primestar subscribers and a substantial portion of the Superstar subscribers will have migrated to one of the two DBS platforms. In other words, the easy pickings will be gone. Third, in November (summer 2001 if you include all launched markets), we will reach the one-year anniversary of the introduction of local-into-local programming into the DBS market. We are not suggesting that local-into-local will not continue to be factor. We just believe that pent up demand for local programming will be satisfied and sales won’t grow as a direct result of local-into-local.

As a result of the above mentioned factors, in 2001 the DBS industry may experience flat to negative year-over-year net subscriber additions growth while their subscriber bases are still growing. For example, we are estimating that DirecTV subscriber net additions will decrease 10 percent from an estimated 2.1 million this year to an estimated 1.9 million in 2001. However, this would imply that DirecTV’s subscriber base grows 23 percent, from 9.9 million estimated subscribers at year-end 2000 to 11.8 million estimated subscribers at year-end 2001.

Given that investors don’t like to see negative numbers, we believe that the DBS companies are smartly turning investors’ attention away from net subscriber additions in favor of the growth of the total subscriber base, where the ultimate value of the DBS industry lies.

Marc Crossman and Aileen Chen are satellite analysts at J.P. Morgan in New York City. These views are those of the authors and do not necessarily reflect the views of the Via Satellite editors or J.P. Morgan.