A major report from Merrill Lynch’s satellite analysts issued July 3 suggests the two major uncommitted global satellite players – PanAmSat and Loral Space & Communications – make interesting investment opportunities. While the report, Eye in the Sky, comes firmly down on SES-Astra as its favourite FSS stock globally, they state many investors “are attracted to the substantial cash-flow generated with good visibility that is inherent in the FSS model.” The bankers go on to say they believe the privatisations of Intelsat and Eutelsat will themselves play an important role in driving further consolidation.

Currently the only global players are Loral (through its global alliance), PanAmSat, Intelsat, SES-Astra (on the basis of the GE Americom deal) and Dutch-based New Skies Satellite.

Merrill Lynch says there are different models for taking industry consolidation to its next stage, also bearing in mind the radically different state of the two businesses generally considered to be on the sales slab. Loral, for example, has been financially stretched to the near-limit this past year or so thanks to its Globalstar involvement. “Growing liquidity concerns and unconvincing evidence of synergies realised from vertical integration assets could provide impetus for acquisition of its FSS assets,” says Merrill Lynch’s blunt report.

Loral is also a pair of businesses. The satellite-building side (Space Systems/ Loral) is projected to record 2Q01 revenues of some $250 million about now, down 16 per cent from the same period last year. The other side of the business (FSS) has fared better, with its SkyNet income for 2Q 01 expected at some $136 million, up 21 per cent on last year ($112m). The difference in the two businesses is shown by their EBITDA margins, barely 9 per cent on the satellite construction side but a much healthier 65 per cent EBITDA on the FSS division and these margins are forecast to improve to nearer 70 per cent over the next three to four years.

Merrill Lynch’s view is that Loral’s management will separate or sell these two business units. Thus far Loral has announced just two satellite contracts although it says it expects six to seven wins in total this year. On the FSS side, Loral’s upside is that its fleet is young with an average age of three to four years and by any measure it remains one of the few remaining independent operators with good orbital spots and capacity available to grow. However, Loral only owns 49 per cent of its SatMex partner and 47 per cent of Europe*Star and these very investments might get in the way of a deal. Loral’s market value is about $880 million.

Meanwhile, PanAmSat’s predicament revolves around the uncertainty of what might happen to its impressive fleet of assets as a result of a potential Hughes transaction with either News Corp or Echostar. Already PanAmSat’s stock price is hitting the $43 ‘fair market’ price suggested by some analysts, and well ahead of its 52-week low-point of $26. Some might argue that at $26 or thereabouts the company was at ‘bargain basement levels’ in terms of its valuation. Its market capitalisation stands at about $5.2 billion.

But Merrill Lynch also takes a contrary view of what could happen within the FSS sector. It suggests that upcoming mergers could include asset break-up of global constellations. Segregating in-orbit assets by region may “better unlock shareholder value for all parties as it would help fill in regional service gaps for major FSS operators.” It is the usual ‘sum of the parts’ being worth more than the whole, argument. This option, they say, has to be considered while the number of likely bidders is so small and there are few [businesses] that would be able to afford to purchase an entire global fleet. Boeing, says Merrill Lynch, has expressed interest in increasing its satellite focus in Asia, which could involve an FSS partnership.

Merrill Lynch also provides a useful aide-memoire as to why the FSS business should be treated more favourably by investors. It states that a typical 40-ish satellite costs around $250 million to build, launch and insure. With $2 million per annum as a typical transponder rental, and a 40 per cent pre-sale of those transponders building up to 100 per cent occupancy over a four-year period, and with amortisation of those costs over ten years (even though 14-15 years life is not uncommon), the resultant EBITDA margin is around 75 per cent, or $725m in revenues generating $540 million in EBITDA over the life of the craft – and maybe more.

In Merrill Lynch’s view, Ka-band licences and satellites make an attractive argument. “Industry pundits will cite the same reasons used by Ku-band opponents years ago (rain fade, etc.) when justifying the slow roll-out of Ka-band transponders. We believe,” says Merrill Lynch, “that over the next five years the Ka-band frequencies will follow the lead of its Ku-band predecessor although at an even greater rate due to the increased demand for high bandwidth applications.”