Ergen's Message to D.C.: I'm Best Hope vs. Cable

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Charlie Ergen is confident a combined EchoStar Communications Corp.-DirecTV Inc. will be a hit in rural America. But before he gets that far, he has to sell the deal to regulators and elected officials in Washington.

To do so, he must effectively argue that it's more important to create a potent alternative to cable than it is for rural residents to have a choice in satellite carriers.

Last week, Ergen's EchoStar announced a $25.8-billion merger with Hughes Electronics Corp., owner of DirecTV — the largest direct-broadcast satellite provider in the U.S., with 10.3 million subscribers.

Ergen, a former Las Vegas card counter, is gambling a $600 million deal breakup fee that his powers of persuasion can help get the transaction approved in about a year.

After adding EchoStar's 6.4 million subscribers to the mix, the new company would serve 16.7 million video subscribers, more than any single cable company in the U.S., though far fewer than the 70 million subscribers served by the entire cable industry.

One potential problem with the deal is that the number of major players in the DBS market would shrink from two to one, reducing DBS competition to an estimated 6 million U.S. homes — mostly in rural areas without access to cable.

"The presumption is against it, based on reluctance of antitrust regulators to see a concentrated market lose an independent player, particularly when it means going down from three to two in cable markets and from two to one in rural markets," said Schwab Washington Research media analyst Paul Glenchur. "Having said that, I don't think it is impossible."

Ergen, EchoStar's chairman and CEO, said last Monday that the deal should be viewed not as a threat to rural America, but as the creation of a national competitor with the heft to do battle with the dominant cable industry.

"It is a shame that after seven years, we have not been able to stop the two and three times greater than inflation price increases in the cable industry," Ergen said. "I think that this combination will go a long way to finally stopping those kinds of increases."

That comment — despite failing to account for the expansion of cable's channel capacity — might carry more weight after AT&T Broadband last Friday announced plans to raise rates for its 14 million subscribers by 5.5 percent starting next year.

Ergen said the merger would allow the company to slash programming costs that could be passed on to consumers, roll out broadband data access to rural America and establish a leading video-on-demand platform.

Unlike the America Online Inc.-Time Warner Inc. merger approved in January, the EchoStar-DirecTV deal will not require any foreign approvals, an EchoStar spokeswoman said.

But in the U.S., the deal has to clear the Federal Communications Commission and either the Justice Department or the Federal Trade Commission. Odds are the Justice Department will get it, based on its review of prior DBS deals.

In 1998, the Justice Department killed an attempt by PrimeStar Inc. — the medium-power DBS carrier owned by major cable MSOs — to purchase a key DBS license owned by News Corp. and MCI Communications Corp.

Last week, the FCC put the regulatory machinery in place when chairman Michael Powell created a nine-member review team headed by Cable Services Bureau chief W. Kenneth Ferree.

"Given the significant concentration that would result from this transaction, it will be rigorously scrutinized by this team and the commission," Powell said in a statement notable for saying nothing positive about the deal, despite his pro-market leanings.

Currently, the FCC has no rules to limit the size of a DBS company. But the agency has the affirmative duty to ensure the deal is in the public interest.

FCC member Kevin Martin — like Powell, a Republican — said although the deal would get a careful review, it would not be exposed to a protracted analysis in which merger opponents can pile on conditions that are unrelated to competitive harms.

"It's that kind of rigorous analysis that, I think, will make sure that you don't get too far off track and just have people coming in and asking for things that relate to their pet-peeves about a potential company," Martin said.

Closed-Door Process

The Justice Department performs its review behind closed doors: There are no hearings, no public filings and no company records posted on the Internet. The process gives parties the chance to blast away at the deal with almost total confidentiality.

The AOL-Time Warner deal drew massive opposition at the FTC, particularly from The Walt Disney Co. Last week, Disney would not comment on the EchoStar-DirecTV merger.

But the National Association of Broadcasters called for a tough regulatory review.

"In our view, Congress, the executive branch, and federal regulators should review this proposal with a high level of scrutiny," NAB president Edward Fritts said in a statement, adding that the merger would create "the world's largest monopoly video-delivery system."

The cable industry, which has seen three big mergers gain approval from Washington regulators since 1998, has claimed for years that cable and DBS operators are fighting it out for subscribers — a view that supports Ergen's belief that the DBS market cannot be divorced from the cable market.

But the National Cable & Telecommunications Association at least hinted that the EchoStar-DirecTV deal wasn't a slam dunk.

"In virtually every market, consumers currently have the choice of at least three multi-channel video providers," a NCTA spokesman said. "How antitrust authorities will view the combination of the nation's No. 1 and No. 2 satellite providers is difficult to predict."

While the DBS deal is pending before regulators, the U.S. Court of Appeals for the 4th Circuit is expected to rule on whether DBS carriers have to carry all local TV stations in any market where they provide local signals as of Jan. 1. The outcome in the case could affect the merger review and the scope of any conditions.

Justice Department watchers noted that it not only stopped the PrimeStar deal, but also blocked the merger between WorldCom Inc. and Sprint Corp. In the latter case, it feared excessive concentration in the long-distance telephone market.

Legg Mason Inc. media analyst Blain Levin said WorldCom and MCI argued that any reduction in competition posed by their merger would be offset by the Baby Bells' entry into the long-distance market. Levin said Justice rejected that argument then — and would likely do so again were a similar argument advanced in the EchoStar-DirecTV proceeding.

"We question whether the DOJ will allow a monopoly in markets without cable because it increases competition in markets with cable," said Levin, who went on record saying it was "more likely" the deal "will be blocked" than approved with conditions.

A PROMISE TO RURALS

Ergen promised to work with regulators on rural issues and proposed a solution: ensuring that rural customers are offered effectively the same deal as urban customers who can opt for cable if they are turned off by DBS.

"We will work with regulators and the Congress to make sure that we don't disenfranchise those customers," Ergen said. "If this isn't good for consumers across the board, then this isn't going to make sense."

The role of Pegasus Communications Corp. — the 10th-largest pay-TV provider, which has exclusive rights to distribute DirecTV programming in rural areas — might mitigate the rural competition issue. Pegasus has 1.5 million subscribers scattered in 41 states.

Pegasus spokeswoman Yolanda Robins said the company was pleased the merger was announced after protracted negotiations. "We are confident in our contractual rights to exclusively provide Hughes-DirecTV services within specific geographic areas," Robins said, adding that current EchoStar subscribers in Pegasus markets would have to be notified that Pegasus was their new DBS provider.

The Justice Department's antitrust division is headed by Charles James, successor to Joel Klein, the Clinton Administration's competition czar. It was Klein that engineered the rejections of PrimeStar and WorldCom-Sprint and the attempted breakup of Microsoft Corp.

Perhaps signaling a new, lenient approach in the antitrust arena, James last week reached a settlement in the historic Microsoft case. But he is having trouble gaining the approval of attorneys general from 17 states, who fear the settlement is too weak.

Last Tuesday, Ergen and DirecTV chairman and CEO Eddy Hartenstein made the rounds in Washington, including a stop at the office of House Energy and Commerce Committee chairman Billy Tauzin (R-La.), a DBS industry supporter who fought for its access to cable-owned programming in 1992.

Although Tauzin hasn't formed an opinion on the deal, he is clearly worried about the impact on rural customers who would lose a DBS alternative.

Tauzin spokesman Ken Johnson said the chairman would likely support some type of price protection for rural DBS subscribers.

"Our biggest concern is the impact of having just one satellite company providing multichannel video programming," Johnson said.

With pricing safeguards in place, Johnson indicated, the deal could have compelling

features to ensure that DBS has the bulk to challenge cable nationally.

"The realities of the 21st-century marketplace dictate that companies have tremendous resources to compete with the entrenched cable giants," Johnson said. "Simply put, we are not concerned with the quantity of competition, but with the quality of competition."

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