Greenwich, Conn.-based satellite operator PanAmSat [Nasdaq: SPOT] is facing a number of challenges and its potential growth opportunities may not provide any immediate relief.

The status of the fixed satellite services (FSS) operator was highlighted recently when Lehman Brothers downgraded the company’s rating from “market performer” to “underweight.” PanAmSat’s future as an independent company also is unclear after the purchase of its parent company Hughes Electronics [NYSE: HNS] by News Corp [NYSE: NWS], which has no clear commitment to the FSS business.

As a result, PanAmSat’s growth prospects are under pressure and its new owner seems lukewarm at best about keeping the company. News Corp CEO Rupert Murdoch explained last September that he does not really need PanAmSat, but acknowledged that it is well managed and offers strong cash flow.

However, Lehman Brothers described PanAmSat’s current cash flow as artificially high during a period when the company has been scaling back its investment in new satellites. Ultimately, the in-orbit satellites in the company’s fleet will need to be replaced due to their normal life span of about 15 years. Lehman Brothers also warned that PanAmSat’s fleet includes a number of satellites that could suffer in-orbit anomalies before the end of their scheduled lives.

Vijay Jayant, a satellite analyst at Lehman Brothers, explained his downgrade of PanAmSat in a Jan. 14 research report by noting the company’s current reward-risk profile does not justify a stock price higher than $21 a share, a mark it reached on the day of his report. PanAmSat’s prospect for “organic” revenue growth is challenged by industry-wide overcapacity. In addition, its profit margins appear likely to weaken as it expands its role in providing government services that typically offer “significantly” lower margins than commercial FSS, Jayant noted.

“Potential satellite anomalies, contract termination due to customer credit, customer mergers and customer alternative strategies pose additional uncertainty,” Jayant explained.

In addition, the recent sales of New York-based Loral Space and Communications’ [OTCBB: LRLSQ] North American satellite assets to Washington-headquartered Intelsat and of London-based mobile satellite services leader Inmarsat to financial buyers both ranged between 5-7 times EBITDA (earnings before interest, taxes, depreciation and amortization). PanAmSat’s shares currently trade 6.5 times Jayant’s 2004 EBITDA estimate.

High Hurdles

According to Jayant, PanAmSat’s outlook is dimmed further by:

• Winnowing backlog of transponder orders;
• Shrinking demand for video services;
• Acquiring relatively low-margin government services businesses;
• Transitioning sister company Hughes Network Systems’ VSAT customers to its new SpaceWay satellite platform;
• Consolidating two independently operating News Corp-owned satellite TV services in Latin America; and
• Disappointing short-term demand for HDTV services.

Despite Jayant’s gloomy outlook for PanAmSat’s stock price, the company is positioning itself to tap into growth opportunities. For example, PanAmSat is planning for the future through the acquisition of profitable government services businesses, expanding into new value-added services and controlling costs to ensure continued profitability during a time of weak FSS demand.

PanAmSat plans to release its fourth-quarter 2003 financial results Feb. 3, when an updated view of the company’s performance would be available. Until those results are announced, PanAmSat officials declined to respond to Lehman Brothers’ negative report.

Vince Walisko, CEO of Vienna, Va.-based Global Satellite Exchange, praised the steps PanAmSat is taking to seize future growth opportunities.

In Walisko’s view, Lehman Brothers’ Jayant and other Wall Street analysts have not accounted for several positive trends in the FSS marketplace.

“There are significant opportunities in developing and selling new value-added services that touch the end customer from the edge of the network,” Walisko said. “We see applications such as VoIP [voice-over-IP], broadband-by-the-bit and even some military applications in significant demand right now. It seems that [PanAmSat] has undertaken to add some of these services to its portfolio through internal development and a campaign of acquisitions.”

Although FSS capacity is oversupplied and “relatively cheap,” PanAmSat is embracing growth avenues and pursuing them in a timely manner, Walisko said. Now is the time for PanAmSat to be executing its strategy to touch customers with applications on the edge of the network, he added.

“While the inclusion of this strategy in the [PanAmSat] bag of tricks won’t make all the other issues go away, I don’t see it, and the significant associated market potential, accounted for by many analysts,” Walisko said.

Tom Watts, a Wall Street analyst at SG Cowen, also sees areas of promise for renewed growth in the FSS sector. Intelsat’s recent data-network contract wins show the promise of satellite Internet services. High definition also offers long-term growth, although the impact in the United States may be modest, he added.

The challenge in evaluating these prospects is a dearth of data points, Watts said. None of the growth areas have translated into an industry-wide upturn. “Without the upturn, growth in 2004 could be quite modest,” he said.

PanAmSat should be expected to continue to augment its organic growth with targeted acquisitions. “Industry-wide, we expect the consolidation of smaller regional players to continue, which should benefit the industry leaders, such as SES Global [Luxembourg: SES], Intelsat and PanAmSat,” Watts said.

Steve Symonds, who heads the Wilton, Conn.-based satellite-consulting firm Symonds Associates, offered a pessimistic view of PanAmSat’s future.

“While it is true that the FSS sector has experienced a ‘nuclear winter’ for the past few years, the recent downgrading of PanAmSat by Lehman is, in my opinion, more a function of problems that are unique to the company than part of an industry trend,” Symonds said. “Harsh winters typically do result in a ‘winnowing of the herd’ — and that’s what we are now seeing in the satellite market in general. We are already starting to see this with Loral’s bankruptcy, a slow-motion train wreck that’s been coming for years. Others will follow as the industry begins a wave of consolidation.”

Another satellite operator would be the top candidate to buy PanAmSat, said Symonds, who predicted that the company would be sold by News Corp to cut its debt load.

“Three to six months from now I think the future will be a lot clearer for the FSS industry as a whole and for PanAmSat, in particular,” said Tim Logue, a consultant in the Washington office of the Coudert Brothers law firm. “News Corp likely will give some indication within that time frame of what it sees as the future of PanAmSat as it digests the acquisition of Hughes and its affiliates.”

Clearly, the FSS sector has suffered along with the rest of the telecommunications business over the last two years, Logue said. However, the overcapacity situation is not new and there are real signs that parts of the sector are picking up, he added.

–Paul Dykewicz

(Vince Walisko, Global Satellite Exchange, 202/448-9667; Kathryn Lancioni, PanAmSat, 203/210-8649; Tom Watts, SG Cowen, 212/278-4260; Steve Symonds, Symonds Associates, 203/834-2766; Tim Logue, Coudert Brothers, 202/736-1816)