By Jimmy Schaeffler

Retention of the 20 million U.S. satellite TV subscribers is becoming an increasingly important priority for the two companies that serve them.

Hughes Electronics Corp. [GMH] reflected that trend in its quarterly analysts’ call on Jan. 15. The call projected 2003 results for its DirecTV Inc. satellite TV unit.

DirecTV will work to reduce churn, while spending more to attract fewer subscribers and generating minimal revenue growth per subscriber.

Strong pressure from cable TV is keeping the heat on DirecTV. The strain is causing the unit to spend more hard-to-come-by funds in order to acquire subscribers and grow its business.

DirecTV is also facing pressure from one-time suitor EchoStar Communications [DISH]. EchoStar, by our recent estimates, closed 2002 with nearly 8.2 million total subscribers, boosting its share of the U.S. satellite TV market to 42.2 percent.

Seven Key Factors

Seven challenges face DirecTV in 2003:

1. Subscriber growth is projected to be flat or below 2002. A figure of 750,000-800,000 net new subscribers is forecasted.
2. Subscriber acquisition costs (SAC) are expected to rise approximately 8 percent to 9 percent to around $585 per new subscriber.
3. Average revenue per unit (ARPU) is projected to rise no more than one percent to around $60-$61 a month.
4. Churn is expected to fall to between 1.5 percent and 1.6 percent a month.
5. Cost cutting will continue to be a priority.
6. Struggling DirecTV DSL will be shut down to conserve the parent company’s cash.
7. There will continue to be a push for the sale of Hughes; a decision will be made with the next 30 to 60 days.

Subscriber Data

For 2002, The Carmel Group estimates the year-end size of the U.S. direct broadcast satellite (DBS) industry at 19.3 million total subscribers. A precise number of subscribers will not be available until EchoStar reports its fourth quarter and full year results in March. Based upon historical data and recent developments, however, we estimate EchoStar’s total subscriber count at 8.2 million versus 11.2 million for DirecTV at the end of 2002.

For December, we estimate DirecTV added 122,000 net new subscribers, compared to EchoStar’s 160,000. Combined, the total estimated net new DBS subscribers for December came to 282,000.

For the fourth quarter, DirecTV reported 292,000 net new subscribers, while EchoStar added an estimated 395,000 net new subscribers. As a result, the estimated total net new subscribers for the fourth quarter came to 709,000, equaling 31 percent of the total 2.3 million added for all of 2002. This again indicates the importance of holiday season sales to the consumer electronics industry.

Slowing Sub Growth

An indication of the competitive pressure EchoStar continues to put on DirecTV and the cable TV industry is EchoStar’s estimated 57 percent share of the total net new DBS subscribers added in December. The year-to-date net new DBS subscribers added from December 2001 to December 2002 is an estimated 1.042 million for DirecTV and 1.345 million for EchoStar. Nonetheless, our estimates show that the U.S. DBS juggernaut is slowing down. The first indication of this is that the overall industry’s net new subscriber growth declined an estimated 18 percent in 2002. That was caused by a 23 percent decline for DirecTV and a 14 percent drop for EchoStar.

Four factors identified by President Roxanne Austin point to a decline in 2003 subscriber growth for DirecTV by as much as 20-25 percent:

1. Increased competition from EchoStar and cable,
2. Price increases of $2 a month on certain packages,
3. Termination of the DirecTV DSL service, and
4. Increased implementation of piracy countermeasures.

Other Hughes Units

For the other units of Hughes, results were varied. The successes or failures of other Hughes units affect where the company will direct its capital.

The planned shutdown of DirecTV DSL will cost Hughes an estimated $100 million. Most of the subscribers will be transferred to Verizon [VZ], SBC [SBC] and BellSouth [BLS]. The move will help to avoid a continuing drain on Hughes resources.

Germantown, Md.-headquartered Hughes Network Systems’ (HNS) DirecWay service now accounts for 158,000 satellite broadband customers. Rather than beef up 2003 marketing, the company’s goal will be to minimize the cash expenditure for the unit and maintain the subscriber base. That cash saving will help preserve the parent company’s capital for other uses.

On the set-top side of the business, HNS shipped a record 939,000 DirecTV receivers during the fourth quarter. Sales of very small aperture terminals (VSATs) continue to help HNS mark a high ground for Hughes. HNS claims a majority of sales in that sector.

HNS’ SpaceWay broadband service is expected to focus on the commercial sector and fully launch during the 2003-2004.

Miami, Fla.-based DirecTV Latin America is plagued by a troubled Latin America economy, frequent currency devaluations and unstable political regimes in certain countries.

In addition, long-term programming agreements often fail to take these macro changes into account. The Latin unit’s management is attempting to renegotiate many of these agreements. In the event the overall restructuring is not successful during the next two months, Hughes’ management discussed the possibility of DirecTV Latin America declaring bankruptcy to assist with the planned restructuring.

Hughes’ satellite services subsidiary, PanAmSat Corp. [SPOT], will continue to focus on increasing its earnings before interest, taxes, depreciation and amortization (EBITDA). That emphasis will build on PanAmSat’s successes during 2002.

Summary

DirecTV faces big challenges in 2003. Termination of the proposed merger with EchoStar leaves no quick and easy fixes for the Hughes unit.

Lehman Brothers’ satellite analyst William Kidd said it is “counterintuitive” and “disconcerting” that DirecTV finds itself in a position of having to hang more bait on the lure to catch fewer subscribers. One possible solution is to follow through with plans to find a new buyer. That strategy, if carried out, would boost the value per subscriber once the likely sale of DirecTV is consummated. Expect a new deal for DirecTV to be cobbled together this year.

Jimmy Schaeffler researches, analyzes and writes this monthly report. He is a subscription TV analyst at The Carmel Group, a publisher of industry databooks and the monthly newsletter DBS Investor, and a consultancy based in Carmel-by-the-Sea, CA (http://www.carmelgroup.com). The company specializes in telecommunications (e.g., cable, satellite and wireless), as well as computers and the media. He can be reached at e-mail or at telephone number 831/643 2222.