Consolidation A Key Driver In Investor Interest

The planned merger of satellite radio operators Sirius and XM is the kind of consolidation that private investors want to see more of, according to a panel of investment bankers.

"Whether it [a merger] happens now or in 18 months, I think it is a probable combination," Malcolm Morris, managing director of Deutsche Bank Securities Inc., said during the "Investment Perspective: What the Money Holders Think" panel in February at SATELLITE 2007 in Washington, D.C.

Other panelists — Mark Piegza, managing director, Media and Telecom Group, Banc of America Securities; Amnon Carr, senior managing director, Bear Stearns & Co.; and James Murray, executive director, Morgan Stanley & Co. — agreed that combining the companies makes business sense. However, they acknowledged that U.S. regulatory hurdles could prevent it.

"This, ultimately, is a question about market definition," Carr said, regarding federal anti-monopoly regulations. The U.S. Department of Justice will tread new ground in determining what sort of competition the companies have, he said. "Historically, [the Department of Justice] has not had reason to look into these markets," he said.

In talking about what drives private investment interest, the panelists underscored the importance of consolidating companies to create synergy in services, something they said happened with Intelsat’s acquisition of PanAmSat, SES Global’s acquisition of New Skies and Loral Space and Communication’s pending combination with Telesat Canada. A merger of XM and Sirius "certainly makes sense from a synergy standpoint," Piegza said, but he cast doubt on whether it would pass regulatory muster, noting that the Bush administration denied a merger request by EchoStar and DirecTV in 2001.

Throughout the satellite industry, executives will have to consider ways they can consolidate, especially in vertical sectors, to retain the confidence of investors and lenders, the panelists said. "The [direct-to-home] guys are struggling with broadband, cable has their wireless play," Morris said. "There needs to be some inter-sector consolidation and people from the outside coming in for spectrum access."

Besides attracting investors, consolidation also diminishes risk to companies, Carr said. "Just think of how damaging NSS-8 would have been to New Skies if it were still independent [of SES]." New Skies’ NSS-8 satellite was destroyed in January when the Sea Launch Zenit-3SL rocket exploded on the platform.

Even with failures like NSS-8, satellites have proven themselves in financial sectors, panelists said. "Now we have equity markets willing to accept satellite equity for the long haul," Morris said. "We’re in a much happier financing market than a year ago. Companies have many different financing alternatives. Now people are willing to say, "I can see in this industry that there could be double-digit growth rates."

While Fixed Satellite Services have drawn more investor attention, interest in Mobile Satellite Services is on the rise and will improve the more investors learn about mobile satellites, Murray said. The sale of Telenor Satellite Services to the French equity firm, Apax, was "largely overlooked," but raises questions of the possibility of more mergers and acquisitions in the VSAT sector, he said. Also, the successful initial public offerings (IPO) of Hughes Network Systems and Orbcomm, although they got off to a slow start, have proven the vitality of MSS, he said. "Investors find it very difficult to value MSS," he said. "There is an unusually high volatility and that’s because investors still are being educated."

Overall, satellite’s continuum of private financing has improved by which valuations that clustered around ten times EBITDA — earnings before interest tax depreciation and amortization, the most reliable measure of a company’s earnings — in the late 90s, then dropped, and now is back up to about nine times EBITDA, Murray said. While valuations were high 10 years ago because of expected growth, today they are rising because of expectations about capital structures, Murray said.

At the same time, interest rates have dropped so that the cost of financing is much better than five years ago. "You’d rather be at seven times EBITDA today than six times five years ago," Piegza said.

The prospects of IPOs, private investments and debt capital, forces companies to consider their reinvestments — something Morris noted is easier for large, merged companies than smaller ones.

And, he added, reinvestments are coming. "We’re in a honeymoon period before we have to reinvest," Piegza said.

— Lisa Daniel