A Congressional hearing about the progress being made toward meeting the goals of the Open-Market Reorganization for the Betterment of International Telecommunications (ORBIT) Act quickly focused on a couple of hypothetical merger scenarios that the five-year old legislation effectively prevents from happening at the moment.

In particular, witnesses at the April 14 U.S. House Energy and Commerce Subcommittee on Telecommunications and the Internet hearing cited the current struggling state of the satellite industry as a key reason the ORBIT Act needs updating to give certain mergers the possibility to take place.

“The market for satellite services over the last five years has evolved into a hyper-competitive state, with substantial excess capacity, sharply falling prices, industry revenues declining in real terms and satellite utilization rates at historic lows,” Daniel Goldberg, CEO of New Skies Satellites B.V. told subcommittee members. “Some operators have responded by cutting spending and jobs and freezing expansion plans.”

In his written testimony, Goldberg noted that from 1998 when the House of Representatives first passed its version of what eventually became the ORBIT Act to the end of 2004, the amount of satellite supply swelled nearly 60 percent, growing from 5,285 transponders to 8,299 transponders. “And this number is expected to increase still further by the end of 2006,” Goldberg said. “This dramatic increase substantially understates the actual expansion of supply, as digital compression and other improvements in transmission technology have resulted in at least doubling of effective transponder capacity, and this is likely a conservative estimate.”

But satellite capacity has not been the only topic to see an increase throughout the life of the ORBIT Act. Goldberg said in his written testimony that “the Federal Communications Commission (FCC) estimates in its 2004 International Circuit Status Report that there was more than 40 times as much submarine fiber capacity in 2003 than in 1998. This fiber capacity is competitive with international satellite capacity for a variety of applications. Indeed the FCC estimates in this same report that whereas satellites carried 10 percent of international traffic in 1997, that amount was cut to just one percent in 2003.”

To put a financial face to the grim description Goldberg offered some examples of how the capacity expansion has impacted New Skies. “Our experience is a good proxy for what is taking place in the international satellite services market more broadly,” Goldberg said in his written testimony. “Our average annual rate for a transponder sold in 2000, the year ORBIT was enacted, was $1.9 million; in 2004, the rate was $1.2 million, a nearly 40 percent decrease. Notwithstanding the fact that the industry has substantially increased capacity since the time ORBIT was passed–investing billions of dollars to do so–industry revenues have actually declined in this period, from $6.8 billion in 200 to an estimated $6.75 billion in 2004.”

Goldberg added in his written testimony that the industry-wide satellite utilization rate was 82 percent at the time of ORBIT’s passage. But that rate has declined and currently stands at around 65 percent, with close to 3,000 transponders in orbit empty.

During his oral testimony, Goldberg summed up the satellite industry in one word: “unhealthy.” He further went on to say that the unhealthy industry represents a “meaningful risk” to U.S. national security interests, particularly given the amount of commercial satellite capacity currently used by the U.S. government and military.

Let’s Be Free To Merge

The state of the industry served as a solid backdrop for what appeared to be the main message of the testimony provided by Goldberg, Phillip Spector, executive vice president and general counsel of Intelsat Holdings Ltd., and Alan Auckenthaler, vice president of Inmarsat Ventures Ltd., that being to amend the ORBIT Act to open the door to any merger possibility with any company.

The three companies represented on the witness panel all share the common roots of previously being a part of intergovernmental organizations. However, as the market evolved and private competitors emerged in the satellite industry, Congress, in an effort to further spur on competition, passed the ORBIT Act requiring the former intergovernmental organizations to privatize and dilute the interest of the government signatories that held ownership interests in the organizations. The act required the companies to issue initial public offerings (IPO) of common stock as a way to dilute that interest, but so far only New Skies issued an IPO since the Act’s passage. However, recent amendments to the Act, in reaction to what has taken place in the market, allowed for compliance to be demonstrated by private equity ownership in lieu of an IPO.

The Act also included prohibitions on any of the intergovernmental organizations from merging with each other. In the case of New Skies and Intelsat, the prohibition period would last for 11 years following the acknowledgement by the FCC that both companies were compliant with the ORBIT Act. New Skies has achieved that compliance and Donald Abelson, chief of the FCC’s International Bureau, suggested during the hearing that Intelsat will be certified compliant with the Act’s requirements in an order “that is expected to be released shortly.”

In testifying that the Act’s prohibition on mergers needs to be altered, Spector told subcommittee members while the merger prohibition “may have made sense in 2000 when the act was passed, at a time when Intelsat was still an intergovernmental organization debating privatization and New Skies was owned by Intelsat’s signatories. But five years later, with both Intelsat and New Skies owned entirely by private investors, the prohibition makes no sense. Indeed, I cannot think of any other statute of the United States that flatly prohibits the merger of two entirely private entities.”

Spector added, “It is also important to emphasize that if Intelsat and New Skies were to agree on a merger, other U.S. statutes provide substantial protection to assure that public policy goals are served. Any such merger would be subject to review and approval by the Justice Department under the anti-trust laws and review and approval by the FCC under the public interest standard and the Communications Act. In the context of both of these processes…all interested parties who conceivably might be affected by the merger– competitors, customer and public interest groups–would have an opportunity to voice any objections they might have.”

In Goldberg’s written testimony, he expanded on the importance of opening the door to a possible merger with Intelsat. “In order to enhance our own competitive position and the quality and breadth of service we offer our customers, one of our objectives is to pursue an acquisition, joint venture, strategic combination or other strategic transaction with another satellite operator as and when suitable opportunities arise,” he said. “Intelsat is one of a number of entities with whom it would be logical for New Skies to consider such arrangements.” Goldberg added that the prohibitions in the act puts New Skies in “an unfair competitive disadvantage” and imperils “what may be an otherwise sensible way to achieve the rationalization the sector sorely needs at this time.” During his oral testimony, Goldberg predicted that the satellite industry is headed toward a period of consolidation.

Aukenthaler also lent his support to the elimination of the merger prohibition rules in the act, noting that those rules also would prevent a merger between Inmarsat and ICO for 15 years.

When queried by Subcommittee Chairman Fred Upton (R-Mich.) whether the industry was ready for this change, JayEtta Hecker, director of the physical infrastructure team at the U.S. Government Accountability Office, told the committee to “just use logic.” She noted that competition is thriving in the satellite industry and the companies covered under the ORBIT Act are fully privatized and there are other mechanisms in place that Spector alluded to that would protect the interests of the public if any of the companies were to enter into a merger transaction.

–Gregory Twachtman