News

Sorry, Charlie

10/13/2002 8:00 PM Eastern

The powers that be on Earth have now declared that Charlie Ergen will not rule the heavens.

After months of controversy, the Federal Communications Commission last Thursday effectively killed the merger of EchoStar Communications Corp. and DirecTV Inc. parent Hughes Electronic Corp. as a massively anticonsumer transaction, setting the deal up for a hearing before an administrative law judge — a process tantamount to a death sentence, because it can tack on months, if not years, of delay.

EchoStar chairman Charlie Ergen — whose bold move to acquire DirecTV last October triggered a lobbying assault by News Corp. chairman Rupert Murdoch, religious broadcasters, the potent National Association of Broadcasters and small cable operators — claimed he would press ahead despite the FCC's rejection.

"We will continue to work aggressively within the context of this FCC process to achieve approval of the merger," EchoStar and Hughes said in a joint statement.

Had the FCC approved the deal — and had it proceeded to close — Dish Network parent EchoStar (the No. 2 U.S. satellite provider) and DirecTV (the No. 1 player) would have been in position to control about 17 million pay TV subscribers, with no serious direct-broadcast satellite competitor.

While critics said the deal would create a DBS monopoly, EchoStar and DirecTV emphasized that they would control about 20 percent of a pay TV market dominated by cable operators, and an even smaller share of a giant entertainment sector.

Blunt rejection

FCC chairman Michael Powell, who addressed reporters but refused to take questions, was blunt in his assessment that the merger represented a huge reduction in competition with absolutely no here-and-now offsetting benefits.

The pay TV market, he said, would have shrunk from three providers to two in markets served by cable, and from two firms to one in non-cable markets.

The FCC estimated that between 4 percent and 22 percent of U.S. households are not passed by cable-TV wires.

"The case against approving the transfer application is particularly compelling with respect to residents of rural America who are not served by any cable operator," Powell said.

Powell's rural assessment was ironic in that one chief aim of the merger was to propel rural America into the digital future.

EchoStar and DirecTV promised to offer over-the-air TV stations in all 210 TV markets within two years, provide 12 channels of high-definition TV, and roll out a national high-speed Internet access service that would penetrate into areas that cable and phone companies could not afford to serve.

The FCC examined whether the merger was necessary to realize those putative benefits, and found that it wasn't. Powell said that each company intended to provide local signals to up to 85 percent of U.S. households "in a very short period of time."

"In short, the very premises upon which this proposed merger rest are themselves without foundation," Powell concluded.

Implausible options

In theory, Ergen could strike a deal with the Justice Department, and then bring that arrangement to the FCC within 30 days. But FCC sources ruled out that scenario as implausible. "I think that that possibility is slim to none," an agency source said.

Why? Because any deal with Justice — such as one that included Cablevision Systems Corp. — would necessarily involve giving up a big chunk of spectrum that the companies said from the outset they would need to retain in order to realize various efficiencies.

In other words, the point of the merger becomes more and more dubious with each concession made to regulators to get the deal approved.

FCC Media Bureau chief Kenneth Ferree — who joined Powell in raising doubts about the merger before the record was even established — said the "consumer-welfare losses from this combination were staggering," based on confidential data turned over by EchoStar and DirecTV. He also indicated the companies were probably incapable of mending those harms to the public interest.

"They have a very steep hill to climb," Ferree said. "It's not clear to me that there is any easy or quick fix to that."

January deadline

Technically, EchoStar and DirecTV can still pursue regulatory approvals until Jan. 21, the previously agreed-upon "drop dead" date from the original merger. But at last week's Sky Forum conference in New York, both Ergen and DirecTV CEO Eddy Hartenstein appeared to be at odds as to whether they would continue their efforts beyond that.

At the conference, Hartenstein said it was likely the two parties would walk away from the deal if approvals weren't obtained by that date. To Ergen, the deadline appeared less important.

"I make decisions based on the information I have," Ergen said. "I don't spend a lot of time on decisions I don't have to make. If it comes down to Jan, 21, we'll have to sit down with GM [General Motors Corp., Hughes' parent] and decide what to do."

The DBS merger provoked an unusual response from consumer groups, which routinely oppose media mergers. But their backing of the DBS merger appeared to be a case of hating cable more than loving EchoStar and DirecTV.

"The [Bush] Administration lets cable monopolies flourish while it crushes potential competition from satellite," said Mark Cooper, research director of the Consumer Federation of America, referring to the pending merger between AT&T Broadband and Comcast Corp.

Government sources said they expect the cable merger to be approved by the FCC, especially because the companies have taken steps to extricate themselves from the Time Warner Entertainment L.P. partnership.

Most Wall Street analysts believed that despite EchoStar and DirecTV's insistence that they will fight the FCC ruling in court, there is little chance that the merger will survive.

"I can't see how this [FCC decision] gets reversed," said Janco Partners Inc. cable and satellite analyst Matt Harrigan.

Even if EchoStar and DirecTV agree to give up satellite slots — especially to Cablevision, which said it wants to start its own competitive DBS service — Harrigan said the chances of creating a viable alternative to the two satellite powers were minimal.

Both EchoStar and DirecTV would have a 17-million-subscriber jump on a new entrant, a hurdle that would be nearly impossible to surmount in today's economic climate.

Cablevision has asked the FCC for 17 transponder slots from EchoStar. Added to the Bethpage, N.Y.-based MSO's existing spectrum, it could offer 276 channels of programming.

Entry hurdles

But the slots — located at 61.5 degrees — wouldn't give Cablevision full coverage of the continental United States, a fact that even Ergen said would make it difficult to compete.

Lehman Bros. Inc. satellite analyst William Kidd was more blunt.

"It's incredibly difficult to launch a DBS business in this market," Kidd said at Sky Forum, adding that a new competitor would need to attract between 3 million and 5 million customers to break even, and must raise $300 million just to launch a satellite.

"It's inconceivable in this market that it would be easy to get [a competing DBS service] off the ground," Kidd said.

Cablevision put in a plug for its plan last Thursday. "Today's FCC announcement provides an opportunity for a restructured plan that will expand competition among facilities-based providers," the MSO said in a prepared statement. "The divestiture of spectrum we have proposed is a reasonable structural remedy that will not only answer concerns about reduced competition, but will also result in more satellite viewers receiving local programming from multiple sources in markets nationwide."

Ergen has proven in the past that he can stomach a protracted battle.

Problems at hughes

Hughes — whose DirecTV subscriber numbers have dwindled as it has let some operational issues fall through the cracks during the merger process — may have a more difficult time.

Earlier this month, Hughes reiterated revenue and cash-flow estimates for DirecTV, but said the company would miss its third-quarter subscriber growth targets by between 50,000 and 90,000 customers.

While DirecTV stressed that it made its financial numbers, Harrigan said the customer growth is more important.

"Cash flow is a bit of a mirage if it goes up when you're subscriber additions go down," Harrigan said. "The real issue is [average revenue per unit] and adding customers."

Harrigan said a protracted legal battle is to EchoStar's advantage.

"This is not hurting EchoStar," Harrigan said. "They are putting up the numbers. I don't think there is a lot of pain at EchoStar for this process lingering on. In a certain sense, he [Ergen] is better off letting this dangle."

General Motors — Hughes' parent — isn't likely to want that to happen. The automaker put DirecTV on the block two years ago to raise cash to fund its shrinking pension fund. And the fact that that issue still remains makes many analysts believe that the company will quickly seek out another buyer.

News-Liberty Nexus

Just who that is remains to be seen, although most analysts believe it will be a combination of News Corp. and Liberty Media Corp.

News and Liberty teamed up for a DirecTV bid last year that EchoStar bested at the last minute.

Although terms of that deal were never disclosed, EchoStar's winning bid was valued at $26 billion at the time. That value has since declined to about $15 billion, as EchoStar's stock price has plunged in the past year.

If News and Liberty were to join the fray again, it would likely be at a much lower price.

"In hindsight, if it is News Corp. and a deal gets done sooner than later, Charlie would have inadvertently done [Rupert] Murdoch a favor," Harrigan said.

At News Corp.'s annual meeting in Australia last week, Murdoch said he was undecided as to whether his company would go after DirecTV again. The comment reflected the chairman's earlier comments at an industry conference Oct. 1, when he said if the company decided to take another look at DirecTV, it would do so "very, very carefully."

Liberty Media chief operating officer Gary Howard, at the Sky Forum, would not fully commit to backing a News Corp. bid, but would not rule out Liberty's participation, either.

"We like the satellite business," Howard said. "We looked at [DirecTV] before with Rupert. This is what we do, we make investments in and buy companies."

Breakup fee

Also in question is whether EchoStar would have to pay a $600 million breakup fee to Hughes, as called for in the contract. At an industry conference last week, the heads of both companies appeared to have conflicting views.

Hartenstein said at the Sky Forum conference last week that the breakup fee was "clearly part of the contract."

But later at the same conference, Ergen said that who pays whom in the event the merger doesn't go through is a matter up for interpretation.

"There are certain circumstances where we would pay as much as $600 million and there are certain circumstances where they would pay as much as $600 million," Ergen said.

If it were determined that EchoStar would have to pay the fee, Ergen added, "We would absolutely honor our contract."

EchoStar also agreed to purchase PanAmSat Corp. — of which Hughes owns 81 percent — for $2.7 billion whether the

DirecTV deal closed or not.

"It depends on the circumstances," Ergen said at Sky Forum.

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