Ergen's Power Play

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At EchoStar Communications Corp.'s press conference in Nashville Aug. 2, chairman Charlie Ergen joked with reporters that once News Corp. chairman Rupert Murdoch closed his deal to merge Hughes Electronics Corp. with SkyGlobal Networks, Ergen would have to give up his business and move to a cabin in Alaska.

Apparently Ergen had a back-up plan. Three days later, he fired off a "bear-hug" letter to Hughes owner General Motors Corp., offering to buy DirecTV Inc.'s parent in a $32 billion all-stock transaction.

When asked at the Satellite Broadcasting & Communications Association convention in Nashville what he intended to do with the $1 billion he had raised, if it wasn't for a DirecTV takeover bid, the notoriously frugal Ergen said that perhaps now his employees would no longer have to share hotel rooms when traveling on business.

Given last week's announcements, EchoStar personnel may have to continue to buddy up for a while. It will take every bit of the company's cash reserves and more than a little of Ergen's signature good luck for the takeover bid to succeed.

Sources close to the satellite industry were not surprised by Ergen's last-minute moves to thwart Murdoch's attempts to gain a DBS foothold in the U.S. But there was disagreement over how serious the EchoStar bid was.

"It's a long shot," Pegasus Communications Corp. chairman Mark Pagon said. "It's a bit of a Hail Mary play."

The official bid did not include a cash component, one of several requirements that GM has said it wants in a Hughes sale. The automaker also wants a tax-free transaction, a condition both Murdoch and Ergen seem willing to meet, but one that's kept other media giants out of the bidding.

The proposed deal would leave Hughes shareholders with two-thirds of the combined company and EchoStar with one-third. Ergen would be the single largest shareholder and would assume management control.

Ergen's bid offered an 18 percent premium for Hughes stock when valued at EchoStar's Aug. 3 share price of $30.44. By late last week, the stock price had dropped slightly, shaving a bit off the premium.

Ergen also argued that the stock price for a combined DBS company would increase significantly once cost savings from shared bandwidth, programming discounts and lower subscriber-acquisition costs kicked in.

On the flip side, Hughes shareholders don't expect an immediate premium from a Murdoch takeover. It's hard to say for sure, because the specifics of the deal have never been made public. It's not yet clear which of Murdoch's assets would be folded into SkyGlobal, which is not yet publicly traded. And to complicate matters, many of the division's international holdings are partnerships with other companies.

"As a [Hughes] shareholder, I would much prefer, for my long-term benefit, that DirecTV and EchoStar get together," Alpert & Associates president Mickey Alpert said. "The arguments are so compelling."

If Ergen's motive for taking his attempt to buy DirecTV public was to gain support from Hughes shareholders, he may be on the right track. According to published reports, several shareholders have filed suit against GM to put pressure on the company to auction Hughes off to the highest bidder rather than accepting an offer that some shareholders believe favors GM over Hughes.

"If the deck is stacked against you, then you spread the cards on the table," Ergen told analysts last Monday in New York, explaining why he took his deal directly to the GM board — and the public — rather than continuing his talks with DirecTV and Hughes executives.

But if EchoStar was hoping to force GM into immediate negotiations — or Murdoch into tipping his hand — Ergen was still waiting for that to happen at press time last week.

GM spokeswoman Toni Simonetti confirmed the company would take a look at the EchoStar proposal, "as we should," but offered no update on when a decision would be made.

Spokesmen for News Corp. declined comment throughout last week.

EchoStar may have succeeded, however, in slowing down the negotiations between GM and Murdoch, which DirecTV officials said early this month were "rounding the corner." Before the EchoStar bid, many had predicted a Hughes-SkyGlobal deal to be announced by the end of this month.

DELAY COULD AID CABLE

A slowdown in that deal could be good news for both EchoStar and cable operators, in that it would distract DirecTV for longer than otherwise necessary. It comes as the industry enters the fall selling season, typically a critical period for DirecTV's National Football League promotions.

"Charlie [Ergen] doesn't need this deal to work for him to benefit from it," Tellus Venture Associates president Steve Blum said. "If it works, he gets Hughes. If it doesn't, he gets the fourth quarter."

Lehman Brothers analyst Bob Berzins said that while he believes Ergen sincerely wants to own DirecTV, the odds are stacked against him.

"The biggest problem here is not with the regulatory [approval] side, but with GM," Berzins predicted.

Analysts disagreed over whether the government would ultimately allow a merger between DirecTV and EchoStar, but even those who think it could go through admit that it would not be a sure thing and could take some time to proceed through the regulatory process. That uncertainty, and a likely delay in the deal's closing date, could be enough to tip the odds in Murdoch's favor.

Ergen was quick to point out last week that a Murdoch takeover of DirecTV would face government scrutiny, too.

SBCA past president Chuck Hewitt agreed. "Either one is going to have regulatory issues they would have to deal with," he said, adding that the satellite industry would remain competitive whether there's one DBS provider or two.

Cable & Telecommunications Association for Marketing president Char Beales said cable operators are less threatened by DBS than they were a few years ago because they've had a chance to upgrade their businesses and roll out more services.

Ergen stressed last week that the EchoStar deal should be seen not as the merger of two DBS companies, but as a combination of the No. 3 and No. 7 multichannel-video providers.

When compared with a possible combined AT&T Broadband-Comcast Corp. or AOL Time Warner Inc., Ergen said, the DBS industry would still be a small fish in a big pond.

"Cable is getting stronger and consolidating as an industry," Ergen said. "We have to be proactive and make sure our industry gets a fair shake."

BIG BANDWIDTH PLANS

By combining the satellite bandwidth of DirecTV and EchoStar, DBS could offer more high-definition television, local channels and interactive programming, as well as cheaper two-way broadband via satellite, Ergen said. That would be especially helpful in rural markets where cable companies are unlikely to offer those advanced services, he added.

EchoStar is careful to position the merger as beneficial to small-town America because that's the one place where having fewer DBS choices could affect consumers the most. Ergen has offered a guaranteed national pricing policy so rural subscribers would never pay more for programming than their suburban counterparts.

Cox Communications Inc. vice president of video-product management Lynne Elander questioned whether the government would allow a DBS merger, given both companies' national footprint, when compared with even the largest MSOs' service territories.

Both Murdoch and Ergen would be strong competitors to cable, Elander said. But she suggested that because News Corp. owns programming interests that it sells to cable, "it puts them in a very interesting position."

That's a point Ergen is likely to play up if his bid for control of DirecTV is fought in the press or on Capital Hill.

"We really want to be Switzerland," Ergen told analysts. "We're probably not going to run sports teams or studios or create content."

With no vested interests in helping MSOs, he argued, EchoStar would compete more aggressively against the cable incumbents.

BOX SWAPOUT NEEDED

EchoStar has always positioned itself against cable as the low-cost provider, promising cheaper monthly programming fees. Ergen said he plans to pass at least some of the operational savings that come from a combined DBS entity on to his customers.

But before EchoStar can realize much of those savings, the company would need to shift its subscribers to a common technology platform, which could take several years and billions of dollars.

Ergen indicated that DirecTV boxes would most likely be swapped for set-tops with a newer conditional-access system and an updated compression standard.

Elander said she expects consumer confusion surrounding an equipment-swap could play into cable's hands.

"Ten million customers would be forced to make a decision" about their video service, Elander said. "Maybe four or five years ago, their cable companies didn't offer digital, but now they do."

Until a set-top box swap is completed and dishes are repointed, EchoStar would need to transmit duplicate signals of popular channels — as DirecTV and Dish Network do now.

The companies are each planning to launch next-generation spot-beam satellites to send duplicate local broadcast channels. Ergen wants GM to decide on a merger agreement before those satellites are launched.

If GM takes its negotiations with EchoStar to the next level, many expect the automaker to ask Ergen for cash. He told analysts last week that he would be willing to raise cash if required, and that he had proposed $5.5 billion in cash as part of a merger plan he'd discussed earlier with DirecTV and Hughes executives.

EchoStar spokeswoman Judianne Atencio would not comment on any talks the company might be having with potential investors or partners.

According to published reports, Swiss business mogul Andre Kudelski is willing to pump $1 billion in cash into a transaction on the belief that he would significantly increase sales of his NagraVision signal security technology, which EchoStar uses. DirecTV employs NDS, a division of News Corp. that's likely to be folded into SkyGlobal, for its conditional-access system.

EchoStar could also sell some of the Hughes assets to help satisfy GM's cash requirements. As a consolation prize, Murdoch could end up with DirecTV's Latin American and other international interests, which Ergen said last week he does not intend to operate. It might also sell PanAmSat Corp. and Hughes Network Systems.

Other fallout from a combined DBS company could hit DirecTV's interactive-television and technology partners, such as TiVo Inc. and Microsoft Corp.'s UltimateTV division. EchoStar now develops its own personal video recording technology in-house.

Ergen noted that a side benefit of a large-scale set-top box swap would be the opportunity to deploy more PVRs into customers' homes.

It's too early to say how DirecTV's retailers and product manufacturers would be affected by a merger, although EchoStar may cut down their subsidies if it no longer needs to compete with DirecTV for subscriber acquisitions.

Consolidating the DBS industry would hurt the consumer, Blum contends.

"Competition between DirecTV and EchoStar is good for the marketplace," he said. "It gives them each a competitive focus. It's hard to focus on cable because it's so amorphous."

Stanley E. Hubbard, a former DirecTV partner as chairman of U.S. Satellite Broadcasting Corp., doesn't believe the EchoStar offer will be accepted.

"As the largest private shareholder [of Hughes stock], we have confidence in Hughes and DirecTV, and we're supportive of their management," Hubbard said.

Many Hughes shareholders have said they would prefer a pure spin-off of Hughes from GM rather than a merger with either EchoStar or SkyGlobal.

"I have real faith in the [Hughes] management team, but a spin-off wouldn't give GM the cash it wants," Blum said.

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