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Dollars And Sense: How Low Can They Go?

By | August 1, 2002

      by Armand Musey

      Investors in satellite and satellite-related stocks went through some tough times in the first half of the year that left plenty of investors and industry observers alike wondering if the second half would be any better. We think so, and would argue that after June’s sell-off many of the satellite stocks were oversold, or in other words, trading at levels that we believe could be justified by valuations based on very conservative assumptions about underlying business prospects. However, now, as then, we caution investors that share prices may continue to be weak, as near-term catalysts remain elusive.

      Our satellite stock index fell 52 percent in the first half of the year after many stocks sunk to new 52-week lows. This weakness reflected several factors, including increasing competitive pressures, concerns about underlying valuation assumptions, high levels of leverage for several of the companies and worries about certain companies’ ability to continue funding growth. We also pointed out the fairly significant impact caused by the disruption of Echostar’s prolonged attempts to merge with Hughes.

      We feel that underlying much of this weakness is a prevailing lack of investor confidence. Across the board, investors are making increasingly critical assessments of companies’ business plans and questioning many of the underlying projections in management’s forecasts. Many are now running valuation models, which assume far more conservative scenarios, and in highly competitive and highly levered sectors they are questioning the viability of many companies and are expecting consolidation and structural changes in the competitive landscape.

      We believe that competitive pressures and a tight capital market call for conservatism. Pricing pressures early in the year reinforced negative market sentiment and caused investors to question underlying valuation assumptions. This pricing pressure does not seem to be going away either. As a result, in late June we lowered our long-term pricing assumptions for the DBS and FSS industries.

      At the same time, we maintained our forecasts for pricing in several other industry segments, but noted that they were subject to review. Finally, we continued to be cautious about multi-year subscriber projections for satellite radio, although we suspect that the service’s pricing was relatively inelastic.

      By the end of June we were convinced that many of the stocks were oversold. We felt most valuations could be supported by modest assumptions. While we conceded that the DBS business model was very sensitive to small changes in forecasts, at then current levels, we argued that valuations implied a level of business model deterioration that we just did not foresee. Likewise, we believed the satellite radio and tower stocks were trading at significant valuation discounts, although those companies’ weak balance sheets will always work against share prices in a soft market.

      Despite our assertion at the end of June that satellite stocks were oversold, we noted that they could remain under pressure over the rest of the summer and into fall for a lack of catalysts. Specifically, we said we would look for a resolution of the proposed merger of Echostar and Hughes and evidence of a stable business model to precede a rebound in DBS stocks. We also felt that the satellite radio stocks were likely to rebound only after XM Radio’s OEM rollout on 23 GM models proved to be as strong as expected.

      For the rest of the group we indicated that the future is a lot less clear.

      In general, we thought most companies’ share prices were unlikely to rise unless sentiment improved over the summer. Nevertheless, if many of these stocks are still trading in the sub-$2.00 range, we would argue that several represent an attractive option play, although only for investors with very large appetites for risk. Our readers here tend to know more about the satellite industry than the investing public as a whole. As you read this, you might want to think about how the market is doing. If it has firmed since the end of June and the outlook is positive, you might want to utilize some of your industry knowledge to do some bargain hunting.

      Armand Musey is the satellite communications analyst at Salomon Smith Barney (SSB). The foregoing article should not be considered as a recommendation with respect to any security. SSB and its affiliates may maintain a long or short position in, act as a market maker for, or purchase or sell a position in, securities of referenced entities and may also perform investment banking, advisory, or other services for any such entity.

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