News

Ergen Gets The Prize

11/04/2001 7:00 PM Eastern

Rupert Murdoch has learned — for the second time in four years — to never underestimate Charlie Ergen.

News Corp. chairman Murdoch was favored to win the hand of General Motors Corp's Hughes Electronics Corp. — and its DirecTV Inc. direct-broadcast satellite unit — after 18 months of negotiations. GM's board appeared poised to finally approve the deal on Saturday, Oct. 27.

Instead, GM went with a lately sweetened $25.8-billion bid from Ergen's EchoStar Communications Corp.

Ergen's two-month quest for Hughes and DirecTV had seemed doomed a week after a key banker withdrew support. But when Ergen put up $2.75 billion of his own EchoStar stock to fill the gap, GM — which earlier in the day had told News Corp. executives they
had the winning bid — extended talks with the bidders. A frustrated News Corp. dropped out, and Ergen had won.

"We have no option but to withdraw immediately our fully negotiated and financed proposal," Murdoch said in a release. "Hughes would have been an excellent strategic fit for our global platforms, and we are disappointed with the [GM] board's inaction in the face of an as-yet-unfinanced counterproposal."

The deal was a surprising coup for Ergen, whose $32 billion August bid was derided by many as a tactic to make the deal more costly for Murdoch.

Now, Ergen will get prize Hughes assets — especially DirecTV's 10.3 million direct-broadcast satellite subscribers — and catapult into the No. 1 spot among multichannel video service providers.

With 16.7 million subscribers, the combined EchoStar-Hughes will control about 17 percent of the multichannel video market. Cable has about 80 percent.

LIKED ERGEN ALL ALONG

Although GM was thought to be leaning toward News Corp. because it feared major regulatory hurdles in an EchoStar merger, top executives at the automaker sang a different tune last week.

"This is a powerful combination," GM president Richard Wagoner told reporters and analysts in New York last Monday. "This is a triple win for all three sets of shareholders involved. We think it's important that the transaction creates a very strong competitor to cable."

Hughes CEO Jack Shaw said that at a confidential meeting a few months ago, several of the satellite company's executives were asked which proposal provided the best value.

"To a person, each one said EchoStar," Shaw said. "Charlie Ergen built a remarkable company and he expects to win. The fact that we're standing together today is testament to that."

With DirecTV almost in hand, Ergen is on the cusp of creating what he called the only true competitor to cable.

"I've always had the vision of trying to compete with cable," Ergen said at the press conference. "This is the first time we can put a company together to do that at all levels."

The combined company — which will retain the EchoStar name but market under the DirecTV brand — will be the largest single provider of multichannel video, outpacing AT&T Broadband's 13.7 million customers. EchoStar presently sells its service under the Dish Network name.

It will have the scale to demand deep discounts from programmers. And it will have the spectrum to offer local broadcasting channels, high-speed data and high-definition TV more efficiently than it can now.

"There's no way we would be able to do that unless we put these two companies together," Ergen said.

TICKING OFF SAVINGS

According to Ergen, EchoStar will extract about $5 billion in synergies from the merger by 2005, including between $900 million and $1.2 billion in equipment-related savings; $750 million to $850 million from reduced churn; $600 million to $700 million in reduced programming costs; and $400 million to $450 million in reduced general and administrative expenses.

The merger would bring another $2.2 billion in revenue synergies, including $900 million to $1 billion in advertising; $700 to $800 million in local services; $75 million to $125 million in video-on-demand and pay-per view revenue, and $50 million to $100 million in high-definition television, Ergen figured.

Before EchoStar could realize much of those savings, the company would need to shift subscribers to a common technology platform — which, according to Ergen, will take four years and cost $2.5 billion.

That could also create some customer confusion, and an opportunity for cable to take advantage of the situation and win back some of those subscribers.

EchoStar "has not explained the logistics of how that is going to occur," Banc of America Securities analyst Doug Shapiro said. "But it is clearly a pretty massive undertaking. The potential benefits for cable is No. 1 it's going to take a lot of resources; a lot of customer-service allocations toward swapping out subscribers, which will reduce resources for adding new subscribers. They're giving a lot of subscribers an excuse to churn."

At least one analyst believes EchoStar can avoid higher churn if it is careful to educate the public on the switchout.

"If they position this right, they can sell this to the consumer as an upgrade," CIBC World Markets cable and satellite analyst Jeff Wlodarczak said. "It's a major undertaking. The important thing is they are going to have time to do it."

Wlodarczak said EchoStar will also face a massive integration issue — the combined company will have about 20,000 employees — but Ergen is up to the challenge.

"Any merger of this size, the integration risks are high," Wlodarczak said. "Charlie has shown himself to be a great manager."

NOT HIS FIRST SETBACK

Murdoch has been down this road before: In 1997, worried about angering the cable operators that distribute his programming services, Murdoch bailed out of a deal to merge News Corp.'s nascent ASkyB American satellite operations with EchoStar, opting to instead invest $1 billion in the cable-backed PrimeStar satellite-TV venture.

Federal regulators blocked the PrimeStar deal, and Ergen filed a $5 billion breach of contract suit against News. A humbled Murdoch settled up with Ergen.

News and partner MCI WorldCom traded their American satellite operations — including the rights to a valuable orbital slot — for $1 billion in EchoStar stock.

"I think he embarrassed News Corp. in that deal," one Wall Street observer said last week. "Betting against [Ergen] has historically not been a profitable exercise."

No one is counting Murdoch out. The canny Aussie could wait quietly in the wings, ready to re-emerge if the government blocks the merger.

The deal still has to receive regulatory approvals and a go-ahead from Hughes shareholders. EchoStar shareholders — Ergen is the largest and controls the majority of the vote — have already approved the deal.

DEAL POINTS

EchoStar will exchange 0.73 shares for every Hughes share. GM also gets $4.2 billion in cash and options for about 100 million shares of EchoStar stock, worth another $1.3 billion.

The deal valued Hughes at about $18.44 per share, 20 percent above over its Oct. 26 close of $15.35.

Both prices have fallen, trimming that valuation to about $16.93 per Hughes share, still a 23 percent premium over Hughes's $13.75 close last Wednesday.

Hughes shareholders will end up with 53 percent of the combined company; GM will own 11 percent. EchoStar shareholders would control the remaining 36 percent.

Prior to the close of the transaction, GM also has the right to exchange 100 million shares of Hughes stock.

Ergen remains as chairman and CEO, and his board of directors will have nine members, five of whom will be independent. DirecTV chairman and CEO Eddy Hartenstein will serve as a consultant until the deal closes, possibly in nine to 12 months.

EchoStar agreed to a $600 million breakup fee, should Washington regulators shoot down the deal. It's buying Hughes's 81 percent interest in satellite-network owner PanAmSat Corp. for $2.7 billion.

MSOS REACT

While a combined EchoStar-DirecTV has the spectrum to significantly upgrade its service, some cable operators last week said that the combination wouldn't alter their strategies.

"We've been prepared for this," Cox Communications Inc. president Jim Robbins said in an interview. "For us, the grail is voice, video and data. If you have good customer service on top of that, you shouldn't have any problems."

Robbins also pointed out that the deal wasn't done. "I don't think News [Corp.] is out of it yet," he said.

Comcast Corp. president Brian Roberts told analysts he thought the outcome could have been worse for cable had Murdoch prevailed and forsaken near-term profits in order to vastly expand the reach of News Corp.'s programming services.

"I think that deep down, [EchoStar] will focus on trying to run a profitable distribution company, not a less-profitable distribution company and a profitable content company," the Comcast chief told analysts during an earnings call. "It's slightly better than the alternative."

Although Ergen and his team downplayed potential regulatory problems, other observers are not so convinced that the deal will pass through with little scrutiny.

"I will enjoy watching the Washington gymnastics on this one," Charter Communications Inc. president Carl Vogel, a former PrimeStar and EchoStar executive, told analysts.

Murdoch, who put intense pressure on Washington regulators prior to dropping out of the bidding, could continue to try to stymie Ergen on Capitol Hill.

But Wlodarczak said his sources have told him that News Corp. would strike a low profile on the regulatory front.

"I've heard he [Murdoch] is not going to be that aggressive fighting this," Wlodarczak said. "He's obviously very angry — this is the second time he's lost out to Charlie — but I don't think he's going to be that aggressive on Capitol Hill trying to fight it, because he figures it's going to come back to him."

Insight Communications Co. CEO Michael Willner said he thought cable was still in a strong position.

"I still think that cable has the best platform and putting two satellite companies together doesn't change that dynamic," he said. "We have a very efficient multi-revenue stream.

"But any cable operator that tells you DBS is not a factor hasn't been out there lately," Willner added. "They are very effective marketers, and they have the advantage of being able to market their brands nationally. They do hold some cards in their hand that we don't hold."

September