Financial and operational challenges have spurred DirecTV Latin America LLC to begin a restructuring that ultimately could lead to a merger with News Corp.-backed satellite TV rival SKY Latin America or to bankruptcy.

AlixPartners, a turnaround management company, was hired to assist Ft. Lauderdale, Fla.-based DirecTV Latin America in seeking financial concessions from suppliers, lenders and business partners. DirecTV Latin America, a unit of El Segundo, Calif.-based Hughes Electronics Corp. [GMH], is the largest provider of direct-to-home satellite television service in Latin America and the Caribbean. But it has struggled financially.

Recent economic weakness, especially in Argentina, has caused the company’s financial condition to deteriorate. The company already has significantly reduced general and administrative expenses and headcount, and eliminated all non-essential business activities and capital expenditures, its officials said.

In the search for a solution, Michael A. Feder, a principal at AlixPartners, was named chief restructuring officer for DirecTV Latin America, reporting directly to Kevin N. McGrath, chairman of the Latin American satellite TV operator. A key priority is for Feder to obtain improved financial terms from the company’s business partners, suppliers and programmers.

“If the discussions do not result in a reasonable agreement in the near future, we would consider other options available to the company, including restructuring the company under Chapter 11 of the U.S. bankruptcy law,” McGrath said last week.

The restructuring is a “positive” for Hughes and could help facilitate a merger between its Latin American unit and Sky Latin America, said William Kidd, a satellite analyst with Lehman Brothers. The revamping also is expected to address ongoing losses and other obligations

PanAmSat’s Peril?

The deterioration of DirecTV Latin America is a negative for Hughes’ subsidiary PanAmSat Corp. [SPOT], Kidd said. The restructuring of DirecTV Latin America could lead to a renegotiation of its transponder contract with PanAmSat, said Kidd, who cut his valuation of PanAmSat by $1 a share to $16 a share Jan. 8 to reflect the risk.

PanAmSat’s exposure to DirecTV Latin America is “significant” and involves $57 million in annual revenues and $589 million in backlog among the more than $1 billion that the satellite operator indicated last September was at risk of nonperformance, Kidd explained in a Jan. 8 research note.

In PanAmSat’s Form 10-Q filing with the Securities and Exchange Commission last Sept. 30, the company disclosed that six of its top 25 customers accounted for $1.06 billion of its backlog and were at risk of future non-performance of their contractual obligations.

DirecTV Latin America most likely is the second biggest source of PanAmSat revenue and its largest backlog customer, Kidd said.

A reduction in the terms of DirecTV Latin America’s transponder leasing obligation to PanAmSat would be the “greatest facilitator” of a merger with News Corp.’s [NWS] SKY, Kidd predicted.

A large restatement of the DirecTV Latin America backlog and a small rate reduction are highly likely, Kidd wrote in a research note to his clients. PanAmSat also would be affected if DirecTV Latin America merged with SKY Latin America, another of its transponder-leasing customers.

If DirecTV Latin America can renegotiate the length f its PanAmSat contract, currently estimated at about ten years, the satellite TV provider would improve its chances of arranging a merger with SKY Latin America, Kidd explained.

Joseph Wright, PanAmSat’s CEO, said his company is supportive of DirecTV Latin America’s efforts to remedy its problems and better position it for future growth in the market.

“We are a critical supplier to DirecTV Latin America and a fundamental part of its overall operations, which should position our company well in this process in the short and long term,” Wright said.

PanAmSat currently cannot determine how its 2003 revenues or contractual backlog might be impacted by DirecTV Latin America’s situation, Wright said. DirecTV Latin America continues to meet substantially all of its obligations to PanAmSat and is paying in a manner consistent with past practices.

Concessions Requested

PanAmSat is far from the only company DirecTV Latin America is soliciting for concessions.

DirecTV Latin America is asking programmers, suppliers, lenders and business associates to participate in wringing out “excessive fixed costs” that pose a substantial debt burden during a time of economic deterioration throughout Latin America, McGrath said.

“There are some significant contracts that need to be realigned with the realities of the marketplace,” McGrath said. “We will also continue to encourage programmers and suppliers to share directly and appropriately the risks of exchange rate fluctuation and currency devaluation.”

The current financial condition of DirecTV Latin America is unsustainable and an effective solution must be executed “urgently,” McGrath said.

The restructuring should not negatively impact the company’s business operations to its customers in Latin America and the Caribbean, McGrath said. No plans exist for any of the local operating companies of DirecTV Latin America to seek bankruptcy court protection. Even if DirecTV Latin America does seek bankruptcy court protection, its local operating partners should continue normal services to customers, McGrath added.

Double Whammy

In the past 18 months, the devaluation of Latin American currencies and economic weakness in markets served by DirecTV Latin America have forced the company to improve business efficiencies, while cutting operating costs and cash requirements. For example, the company trimmed its workforce more than 60 percent during that time span from 325 employees to 126 workers, said Veronica Diaz, the company’s director of communications.

Venezuela also has been a place of weak consumer spending due to a political crisis that has involved strikes by various groups to protest the country’s leadership. That unrest has reined in spending in that country and contributed to DirecTV Latin America’s anemic performance.

“We feel that we currently are a very lean organization and we are appropriately staffed,” Diaz said.

Instead of further job cuts, DirecTV Latin America is eyeing the negotiation of new contracts with its partners to ensure all of them bear the business risk of collecting subscriber revenue in local currencies. DirecTV Latin America’s need to pay its obligations in U.S. dollars with devalued local currency in the markets where it operates has left it financially bereft.

Steve Blum, president of the Tellus Venture Associates satellite broadcasting consultancy in Marina, Calif., said DirecTV Latin America’s troubles largely are due to “tough economic times” affecting South America. The substantial currency risk incurred by the company also has been a problem for satellite operators operating in Asia during the past five years, he added.

Potential Suitor?

“Restructuring and renegotiating are good things,” Blum said. “You often don’t get anywhere in negotiating unless you’re threatening bankruptcy. In the last Hughes conference call, it was clear things could not continue the way they are going at DirecTV Latin America. If you can clean up the program contracts and eliminate some of the overhang on the company with the currency risk and other issues, you effectively are dressing the bride for a potential suitor.”

DirecTV Latin America likely will operate much differently at the end of the year than it does now, Blum said.

“When you are looking at the operations at Hughes, DirecTV Latin America is a prime candidate for sale,” Blum said. “News Corp would be at the top of the list of potential buyers.”

Jimmy Schaeffler, a satellite industry analyst who heads The Carmel Group, in Carmel-by-the-Sea, Calif., also predicted a merger between the two Latin American satellite TV providers.

“What once were three players in Japan is now one,” Schaeffler said. “What once were two players in Britain is now one. It looks like we are headed in that direction for Latin America.”

Mickey Alpert, president of Washington-based satellite broadcasting consultancy Alpert & Associates, said DirecTV Latin America’s current condition would weigh against a merger.

“The obvious move would be to combine the company with SKY Latin America. But why would News Corp Chairman Rupert Murdoch seek a merger now? If DirecTV Latin America goes out of business, the only company left to pick up the business would be SKY Latin America. From Hughes’ perspective, DirecTV must restructure and gain a stronger position to either go it alone or ultimately merge with SKY Latin America, if Murdoch acquires the rest of Hughes. In this environment, it is very difficult for two satellite TV companies to survive in Latin America. One combined company could become viable.”

DirecTV Latin America is a multinational company owned by DirecTV Latin America Holdings, a subsidiary of Hughes, Darlene Investments LLC, an affiliate of the Cisneros Group of Companies, and Grupo Clarin.

-Paul Dykewicz

(Veronica Diaz, DirecTV Latin America, 954/958-3381; Kathryn Lancioni, PanAmSat, 203/261-8649; Steve Blum, Tellus Venture Associates, 831/582-0700; Jimmy Schaeffler, The Carmel Group, 831/643-2222; Mickey Alpert, Alpert & Associates, 202/872-8605)

DirecTV Latin America At A Glance

• 1.6 million Subscribers
• Established on Feb. 13, 1995
• Serves 28 Countries
• Currently offers service in Argentina, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Puerto Rico, Trinidad & Tobago, Uruguay, Venezuela and several Caribbean island nations
• Operates offices in Buenos Aires, Argentina; Sao Paulo, Brazil; Cali, Colombia; Mexico City, Mexico; Carolina, Puerto Rico; Fort Lauderdale, Fla.; and Caracas, Venezuela.
• Introduced DirecTV Interactive in 2000 to give customers access to banking and customer service applications, video games, e-mail and four interactive channels

Source: DirecTV Latin America