The sale announced last week of the set-top box (STB) manufacturing operations of Germantown, Md.-based Hughes Network Systems (HNS) by The DirecTV Group [DTV] included a long-term business deal with the buyer that significantly boosted the sales price. The purchase price the France-based Thomson [TMS] media-services company agreed to pay upon closing is $250 million but it could rise to $400 million if future order levels warrant.

That arrangement, making Thomson the lead supplier of DirecTV STBs with a 50-percent market share, follows an earlier transaction involving Wilton, Conn.-based PanAmSat [SPOT], when the value of the outgoing assets were increased through a large-volume contract with the DirecTV Group’s parent Fox Entertainment Group [FOX]. If the same pattern holds with the DirecTV Group’s expected sale of the rest of HNS in the coming months, a deal potentially could be arranged for DirecTV to lease part of the capacity that HNS would have when it launches its SpaceWay satellites later this year.

The SpaceWay satellites are powerful and flexible enough to do practically anything “but sing and dance,” Pradman Kaul, president and CEO of HNS, told Satellite News Senior Analyst and Senior Editor Paul Dykewicz in an exclusive interview.

“DirecTV Group is looking at how some of that capacity could be used by DirecTV for local-into-local services,” Kaul said. “It is something we looked at six to nine months ago,” prior to News Corp buying Hughes Electronics and before it was renamed The DirecTV Group.

SpaceWay, designed to provide broadband services for enterprises, would use Ka-band capacity to improve upon the current-generation Ku-band DirecWay VSAT data service now offered by HNS to businesses around the world.

Although the ultimate fate of HNS will be determined by The DirecTV Group, Kaul said last week that HNS would remain a good business if it were sold. However, the HNS business prospects would be “stronger and healthier” if the SpaceWay project would be kept as part of HNS, he added.

The $1.8 billion SpaceWay project, aimed at providing satellite-broadband services over North America, is fully funded; $1.6 billion already has been spent to prepare the service for commercial launch later this year, Kaul said. Skeptics question whether SpaceWay will be launched but Kaul confirmed last week that it would be deployed.

SpaceWay was created to increase the size of the addressable market for satellite broadband, since many applications cannot be handled in the bandwidth-constrained Ku-band, Kaul said. With SpaceWay operating in the Ka-band, the addressable market would expand by 10 times the size of what could be offered in Ku-band, he added.

Aside from serving a much larger market with Ka-band capacity, HNS also would be able to keep the space-segment profit margins of 70 percent to 80 percent that otherwise would be paid to a satellite operator, Kaul said.

HNS executives envision emulating the DirecTV model of providing an end-to-end service through satellites that the company would own and operate, Kaul said. Instead of providing a satellite-TV service for consumers, HNS would offer satellite broadband for enterprises.

The sale of the STB operations to Thomson leaves the remaining parts of HNS focused on DirecWay and its SpaceWay project.

“We now are a much more focused company,” providing network services and products through its remaining VSAT business, Kaul said.

HNS also is coming off a markedly improved first quarter of 2004, when it boosted its overall revenues by 35 percent from the same quarter last year.

“I think corporations are beginning to spend more money,” Kaul said.

HNS also improved its profitability in first-quarter 2004 by 30 percent, compared with the same period a year ago, Kaul said. Margins are improving, in part, due to reduced costs, along with heightened revenues, he explained.

With the performance of HNS on the rise, now may be an especially good time for The DirecTV Group to sell the company. That possibility rises when one considers that satellite- data services are not part of The DirecTV Group’s core business of providing satellite- TV services.

The core HNS business is “very strong and healthy,” with a 60-percent share of the VSAT market, Kaul said.

DirecTV Group officials are evaluating “different alternatives” for the remainder of HNS, Kaul said. The sale of the HNS STB manufacturing operation reportedly would leave slightly more than 2,000 employees with the company; the transaction is expected to close by July 1, following customary regulatory reviews and approvals.

The deal would include the transfer of an HNS STB manufacturing in Baja, Mexico, that currently employs 350 full-time workers and as many as 500 part-time workers, depending on the volume of orders, Kaul said.

An additional 100 HNS employees involved in the set-top business also will be affected. Thomson is making offers to some of those employees who supported that product line and who now are based in Germantown, Md., Kaul said. Thomson will decide which employees stay and where they might be relocated, once the transaction closes.

A Goldman Sachs research note last week concluded the deal would generate $4 billion in revenue to Thomson during the pact’s five-year life, Kaul said.

“It is not just us purchasing assets, but the supply agreement that gives Thomson a 50-percent share of the DirecTV STB business,” said Tom Bracken, vice president of worldwide marketing at Thomson Video Network Solutions Division, Thomson’s STB unit. Before adding the HNS STB manufacturing capacity, Thomson has between 25 percent and 30 percent of the DirecTV equipment market.

The STB manufacturing business generates double-digit percentage margins for Thomson, industry sources said. The purchase agreement also includes an option to extend the pact. Another benefit of the deal for Thomson is that it would be involved in the technical development of all new STBs going forward, ranging from HDTV digital video recorder and other technology development.

“We will continue working with DirecTV to enhance the experiences and satisfaction of their customers,” Bracken said.

During October 2003, Thomson formed a strategic supplier arrangement that gave the company preferred-provider status with News Corp across all its businesses, Bracken said.

HNS Resilience

HNS itself has been sold twice in the past, Kaul said. Its management stayed through those transitions and the company rose to greater heights after each transaction, he added.

“In each case, we came out stronger, more vibrant and more together,” Kaul said. In addition, the same basis senior management team has been together for more than 20 years, he added.

Gary Arlen, president of the Bethesda, Md.-based consulting firm, Arlen Communications, said STBs are becoming a commodities business. Dozens of manufacturers in Asia and elsewhere can crank out those “cheap boxes,” he added. –Paul Dykewicz

(Pradman Kaul, Hughes Network Systems, 301/428-5534; Tom Bracken, Thomson, 805/445-7293; Gary Arlen, Arlen Communications, 301/656-7940)