Hughes Electronics [NYSE: GMH] reported one of its strongest recent quarters last week with results that outperformed the expectations of Wall Street analysts across a range of financial metrics.

Rising revenues and a surge in net income at Hughes’ U.S. satellite TV unit DirecTV drove the robust results. DirecTV sister companies, PanAmSat [Nasdaq: SPOT] and Hughes Network Systems (HNS), also contributed to the enhanced financial performance.

Hughes offers an “improving growth story” and attractive valuation, according to Karim Zia, a satellite and cable analyst at Deutsche Bank Securities. Likewise, Benjamin Swinburne, lead satellite analyst at Morgan Stanley, praised Hughes for achieving “strong” results across all business units.

El Segundo, Calif.-based Hughes boosted its 2003 first-quarter revenues by 10 percent to $2.2 billion, up from $2 billion for the same quarter last year. A turnaround was achieved in operating profit that grew to $41.9 million during the first quarter, compared with an operating loss of $87.7 million during the January-March period in 2002. This result marks the first quarterly operating profit that Hughes has notched during the past four years. Jack Shaw, Hughes’ president and chief executive officer, credited DirecTV for spurring the improved results.

DirecTV recorded first-quarter revenues of $1.7 billion, up more than 16 percent from $1.47 billion for the same period last year. Operating profit at DirecTV climbed to $106 million during the quarter, compared to only $8.6 million a year ago.

Cost cutting, higher-margin revenues from sales of local channel packages, and fees from customers with multiple set-top receivers aided the bottom-line performance, company officials said.

These improved results are likely to please News Corp [NYSE: NWS], which earlier this month agreed to buy Hughes and its prized DirecTV unit. News Corp’s Fox Entertainment Group [NYSE: FOX] subsidiary will end up with a 34 percent stake in Hughes held by General Motors [NYSE: GM] and certain GM shareholders for $6.6 billion (SN, April 14).

Hughes’ officials said the announcement of the long-awaited deal has removed uncertainty about the company’s future and answered questions about its ownership structure. Hughes went back on the acquisition market after the Federal Communications Commission and the U.S. Department of Justice last year rejected EchoStar Communications’ [Nasdaq: DISH] effort to acquire it.

Breakthrough Performance

DirecTV President Roxanne Austin described her company’s first-quarter performance as “truly breakthrough.”

One key to DirecTV’s success is that it offers a better TV value than cable industry alternatives, Austin said. She explained that the company’s standard digital-programming package, priced at $39.99 a month, is “well below” what cable charges for digital TV service.

The launch of a new satellite is intended to double the number of markets to which DirecTV provides local TV stations. With the satellite, DirecTV will provide local stations to 102 markets in the United States. DirecTV is doing well right now in gaining new customers in markets where the company is able to provide local stations, Austin noted.

The Hughes unit is seeing broad subscriber growth from all of its distribution channels, especially independent dealers and direct sales efforts. In addition, consumer electronics giants continue to remain an important source of business for DirecTV, she said.

DirecTV also achieved its lowest quarterly subscriber churn rate in the past four years during the first quarter. Austin said the churn rate dipped to 1.5 percent a month and she did not expect it to go above an average of 1.6 percent a month for the full year. “Our effort to attract and retain high quality subscribers is paying off,” she added.

DirecTV is “aggressively attacking” cable companies to lure subscribers, Austin said. “We are the number two multi-channel service provider” in the United States with an 11.4 million subscriber base, she said. “Cable is not delivering on its digital promise and we are,” she said. “We are all digital.”

The cable industry’s efforts to offer a bundled service of video, high-speed Internet and voice over IP services is not resonating with consumers, she said. “If digital and bundling works, why is their churn rate so high? Of course cable’s talking about bundling. They have to. We’re kicking them on digital video.”

While DirecTV gained 701,000 new subscribers in the first quarter, it lost 426,000 existing subscribers, resulting in a net new subscriber gain of 275,000.

Despite the challenge of keeping subscribers, DirecTV boosted its guidance to between 800,000 and 850,000 net new subscribers for 2003, up from its previous estimate of 750,000 to 800,000.

Cable Ready

The cable industry is not about to concede the battle for subscribers to DirecTV or EchoStar. In fact, cable TV industry representatives say they have technical advantages compared to their satellite rivals.

“Competition is alive and well,” said Brian Dietz, senior director of communications at the Washington, D.C.-based National Cable & Telecommunications Association. “We take competition from satellite companies very seriously. We do believe that cable has a superior platform for launching enhanced services, and the number of new consumers to the cable marketplace that have signed up for these services is a testament to that platform.”

Since 1996, U.S. cable companies have spent $70 billion to upgrade their systems to develop new broadband platforms for advanced services, Dietz said. Those services include high-speed cable Internet, which has 12 million customers. The cable industry has 2 million customers using its voice over IP phone services.

“Prior to the $70 billion investment by the cable industry, satellite did have a technological advantage,” Dietz said. “We do believe now that cable has caught up and surpassed satellite in terms of advanced technology.”

Exploiting Cable

The weak cable providers are vulnerable and have been losing customers to DirecTV and EchoStar.

One example is Charter [Nasdaq: CHRT], which recently filed its annual 10-K document with the Securities and Exchange Commission. The company’s 2002 numbers were unimpressive. Indeed, its analog TV subscriber base fell 357,000 last year, company officials reported.

Charter President and CEO Carl Vogel said in a conference call last week that he would use a bundled offering to stem the loss of subscribers to satellite. He also said the company would end its practice of deeply discounting the price of its service because subscribers who sign up for discounted offerings are the most likely to leave.

PanAmSat Power

PanAmSat, Hughes fixed-satellite service subsidiary based in Wilton, Conn., incurred a loss of revenue during the first quarter compared to the same period a year ago. But it still posted increased operating profits through cost cutting and reduced satellite depreciation expenses.

PanAmSat’s first-quarter revenue of $199.8 million was down from $207.1 million during the same quarter last year. The dip primarily stemmed from reduced occasional-use business and a one-time $7.7 million termination fee received by the company in the 2002 quarter from one of its video customers, company officials said. The revenue decline was partly offset by increased network service revenue and revenue from PanAmSat’s newly acquired G2 Satellite Solutions division formed from the acquisition of the former Hughes Global Services.

Reduced demand for satellite services caused PanAmSat’s backlog to shrink by the end of March to $5.46 billion, down from $5.55 billion at the end of 2002.

PanAmSat President and CEO Joseph Wright expressed his continuing interest in pursuing expansion opportunities that offer good returns at low risk. The company will move strategically into profitable areas, while maintaining “solid financial results,” Wright said.

PanAmSat’s first-quarter financial numbers “exceeded our forecasts” and were at the high-end of management’s expectations, said Merrill Lynch satellite analyst Marc Nabi. The company is benefiting from continued cost controls, he added.

PanAmSat’s management revised its financial forecast for the entire year to include incremental revenues expected from Hughes Global Services. Revenue estimates for 2003 rose by $10 million to $20 million to a new range of between $800 million and $840 million.

Merrill Lynch boosted its 2003 estimates for PanAmSat to $824 million in revenue, up from previous estimates of $812 million, in response to PanAmSat’s good results for the first quarter and its rising guidance.

With PanAmSat’s stock price hitting $15.60 early last week, the company’s stock is trading at 6.1 times Merrill Lynch’s revised 2003 EBITDA (earnings before interest, taxes, depreciation and amortization) estimate of $600 million. On the assumption that PanAmSat does not lose any material bookings because of its service contracts with bankrupt DirecTV Latin America and others, Nabi retained his neutral rating on PanAmSat’s stock.

Overall, PanAmSat’s 12-percent free cash-flow yield, combined with the “somewhat defensive nature” of video-centric FSS sector, should support the share price, Nabi advised his clients. However, the company’s “upside potential” is limited by its top-line weakness, he added.

SpaceWay Effect

The outlook for Germantown, Md.-based HNS is dependent on its proposed broadband service offering SpaceWay.

“While we currently value HNS at approximately $1 billion, it is extremely sensitive to the ability to migrate VSAT subscribers to the SpaceWay platform and significantly improve margins,” wrote Morgan Stanley’s Swinburne.

Pradman Kaul, HNS chairman and CEO, said during Hughes’ April 14 conference call with analysts that the first launch of a SpaceWay satellite would take place by year-end. Commercial service by SpaceWay is expected to begin in mid-2004, he added.

The initial response to HNS customers about the planned Ka-band broadband service SpaceWay would provide is encouraging, Kaul said. HNS remains on track to become the first company to put a dedicated commercial Ka-band satellite into orbit, Kaul said.

Winning Formula?

“All indications are that SpaceWay will be a winner for both our customers and for Hughes,” Kaul said.

HNS managed to grow its revenues slightly during the first quarter to $247.4 million, up from $242.8 million in the same quarter last year. This rise resulted from increased sales of DirecTV receivers and a mild bump in its DirecWay two-way broadband subscriber base. HNS is working to complete contracts to provide capacity to Thuraya Satellite Communications and Inmarsat. DirecWay’s subscriber totals hit 152,000 by the end of March, compared with 111,000 at the same time a year ago.

The company sustained an operating loss during the quarter of $39.8 million, compared to an operating loss of $48.5 million a year ago. Improvement stemmed from reduced losses in the consumer DirecWay business and a $6 million charge caused by a workforce reduction in 2002, company officials said.

–Paul Dykewicz

(Bob Marsocci, DirecTV, 310/662-9986; Joseph Wright, PanAmSat, 203/210-8606; Pradman Kaul, Hughes Network Systems, 301/428-5534; Brian Dietz, National Cable & Telecommunications Association, 202/775-3629; Benjamin Swinburne, Morgan Stanley, 212/761-7527; Karim Zia, Deutsche Bank Securities, 212/469-7114; Marc Nabi, Merrill Lynch, 212/449-2468)