By Stephen A. Blum

The U.S. DBS industry is at a crossroads, at least in terms of trend analysis. Recent results in general, and DirecTV’s 2003 guidance in particular, point towards lower than expected subscriber growth in the near term, and faster market saturation at a somewhat lower overall penetration level in the long term.

The central issue is whether 2002 was an anomaly, or an indicator of future trends. Based on year end totals from DirecTV and estimates of EchoStar Communications’ [DISH] year end subscriber figures, the U.S. DBS industry appears to have added 2.1 million net new subscribers in 2002. That’s the lowest growth figure since 1997, which was the first full year that both EchoStar and DirecTV were in the marketplace.

U.S. DBS subscriber growth peaked in 2000, with a net gain of 3.3 million subscribers. The introduction of retransmitted local television stations into DBS programming line-ups boosted satellite’s competitive position versus cable and accelerated growth. This trend held firm through 2001, when subscriber totals grew by 2.8 million.

Last year saw a distinctive slowing in this growth trend. The two U.S. DBS companies added only 2.1 million net new subscribers. DirecTV, which added just over a million net new subscribers in 2002, is even gloomier about 2003. Its recently released financial guidance calls for subscriber growth of between 750,000 and 800,000 in the coming year.

One explanation could be that a sluggish economy and the distractions of a failed merger created unique conditions that made 2002 an exceptionally bad year. Under this scenario, the expectation would be that the U.S. DBS industry will resume its pre-2002 growth track and add 2.7 million net new subscribers in 2003. DirecTV’s guidance could be cynically explained away as low ball figures aimed at satisfying the gloomy and skeptical mood on Wall Street today, and creating an aura of wonderfully exceeded expectations later on.

A closer look at the numbers suggests a second, more plausible explanation, however. Back in the 1990s, before local stations were added to DBS program line-ups, the industry was on a much shallower growth curve. In the beginning of 2000, adjustments were made to the Tellus Venture Associates DBS projection model to account for the expected added subscriber boost created by the growing availability of local television stations. These adjustments accurately predicted U.S. DBS growth for the next two years. Then came 2002 and the ensuing subscriber slowdown.

If the enhanced gains of 2000 and 2001 are treated as a short-lived phenomenon, rather than a permanent trend, and the assumed incremental boost from local station availability is eliminated, the model accurately (if retrospectively) predicts 2002’s results. Viewing 2002 subscriber figures through this analytical framework leads to the conclusion that 2000 and 2001 were the real anomalies, and 2002 was the year that the U.S. DBS industry got back on the growth track it had followed for six of the past eight years.

This growth scenario leads to an outlook for 2003 that is still quite aggressive, particularly given DirecTV’s current financial guidance. But it is in line with 2002’s results, as well as expectations that the death of the EchoStar/DirecTV merger will allow both companies to refocus on doing battle in the consumer marketplace rather than in Washington. A gradually improving economy should also help. Given these assumptions, the Tellus Venture Associates forecast is for the U.S. DBS industry to add 2.2 million net new customers and finish 2003 with a total of 21.7 million subscribers.

Farther down the road, the U.S. DBS industry should hit the 30 million household mark within six years, but only if it can maintain its competitive position versus cable. That task might be harder than it sounds. The U.S. cable industry has been justifiably criticized for over promising and under delivering on digital services, but even so, it is making progress.

According to the National Cable Television Association (NCTA), 23 percent of U.S. cable subscribers are currently receiving some level of digital television service. Even though the penetration rate of cable modems is only at about 9 percent of U.S. television households, 71 percent of U.S. homes could get broadband Internet service if desired, at least according the “homes passed” standard followed by the NCTA.

In short, the cable industry is slowly closing the large digital television gap between it and the DBS platforms, while opening up a substantial lead in broadband data service. Consumers do not like dealing with complicated service comparisons and multiple vendors. The path of least resistance could be to accept somewhat less attractive television service in exchange for a high speed Internet connection with a simplified billing and service proposition.

At the same time, the U.S. DBS companies have gained a foothold in the interactive broadband sector. DirecTV is offsetting the limitations of its aging non-DVB compliant transmission system with thin client transactional services supported by Wink. It also unsuccessfully tried offering DSL service. Its sister company, Hughes Network Systems, has seen sluggish growth in its DirecWay satellite Internet service, and the promise of the follow-on SpaceWay Ka-band system is still in the future.

EchoStar has been more aggressive in pursuing the interactive marketplace, but even its results have been mixed. It has pulled out of the StarBand’s two-way Ku-band Internet service offering and the newly reinvigorated Wild Blue Ka-band project.

On the other hand, EchoStar has pushed ahead with offering interactive services via its DVB compliant system and OpenTV middleware. Currently, it offers thirteen one-way interactive services (in other words, applications and information that is downloaded to and accessed via the set top box, without a return link to the service provider) and a single two-way customer support feature that allows subscribers to pay bills and change programming packages via the telephone modem built into the set top box.

Although EchoStar’s interactive offering can be very attractive to customers who value convenience and simplicity over fat, data rich pipes, it lags behind DBS platforms elsewhere in the world that offer home banking, shopping, gambling, and e-mail service. And it’s no match for a high-speed Internet connection.

The next 10 million U.S. DBS subscribers will be much harder to acquire than the first 20 million. Consistently improving television programming line-ups give DBS platforms a strong competitive base, but effective positioning versus cable’s increasing broadband capabilities will also be necessary in order to capitalize on it.

Stephen A. Blum is president of Tellus Venture Associates, a Marina, Calif.-based satellite consulting firm. He can be reached at email or by phone at 831/582-0700.