No Death Star

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News Corp.'s pending $6.6 billion acquisition of a controlling stake in Hughes Electronics Corp. — parent of direct-broadcast satellite giant DirecTV Inc. — should strike fear into the hearts of cable operators, but for the most part they've taken it in stride.

With finalization of the deal, News would become the second-largest multichannel video provider in the country with 11.2 million subscribers, behind only Comcast Corp. and its 22 million customers.

Moreover, combined with its British Sky Broadcasting plc satellite unit, News controls about 100 million households worldwide. And as one of the largest content providers in the U.S. — Fox network, Fox News Channel and FX are part of its stable and it owns or has stakes in 23 regional sports networks — News can potentially muscle operators into carrying its content for higher fees.

But to paraphrase several MSO executives, it isn't quite the "Death Star."

"It might have been that five years ago, but it doesn't look that way now," said one MSO executive who asked not to be named.

Death Star (a nod to Darth Vader's Star Wars
super weapon) was the ominous moniker given to the failed 1997 merger between News and EchoStar Communications Corp., a union that was expected to crush cable. But News backed out of the deal about two months after it was announced, some say in deference to cable operators who carried the company's programming networks.

According to the deal announced last Wednesday, News will acquire General Motors Corp.'s 19.9 percent stake in Hughes Electronics Corp. for about $3.8 billion in cash and stock. News will also make a tender offer for 14.1 percent of Hughes shares from public shareholders, GM's pension fund and other benefit plans, for $2.8 billion in News securities.

Hughes, which had been a tracking stock, will convert to an asset-based security upon the close of the deal. It values Hughes at $14 per share, a 22 percent premium over its April 9 closing price of $11.48 each.

News will then transfer that 34 percent interest to Fox Entertainment Group Inc., its 80 percent-owned subsidiary, in exchange for a $4.5 billion promissory note and 74 million shares of Fox. As a result, News will increase its stake in Fox to about 82 percent.

News will effectively control Hughes with the 34 percent stake — the GM shares are super-voting and have more than half of the shareholder votes. It would also get Hughes' 81 percent stake in satellite operator PanAmSat Corp. and broadband satellite services company Hughes Network Systems.

News chairman Rupert Murdoch will also become the Hughes chairman. Former News executive Chase Carey has been tapped as president and CEO, while Hughes corporate senior vice president Eddy Hartenstein will become vice chairman.

Street reactions

Investors reacted badly to the complicated deal, driving down the stocks of all three companies.

News stock was down 6 percent, or $1.77 per share, to $25.45 each; and Hughes dipped 9 percent ($1.12) to $10.36 per share. Fox Entertainment Group shares were down 17 percent ($4.65) to $22.60.

Although a combined DirecTV-News is a formidable competitor, most operators say that times are vastly different than they were back in the early 1990s, when cable was struggling to upgrade its infrastructure and satellite was able to offer a digital video service with hundreds of channels.

But today, with cable dominating new services like video-on-demand and high-speed data, satellite services providers are playing catch-up in those areas.

"We've got the competitive edge," Comcast executive vice president and treasurer John Alchin said. "The fortunate thing is that this didn't happen two years ago. But 97 percent of Comcast systems will be two-way and 92 [percent] or 93 percent of [the Comcast-owned former AT&T] Broadband systems will be two-way by the end of the year.

"That means that much of a footprint — 34 million or 35 million homes passed — will have access to the bundle of video and data. That's very compelling."

Alchin pointed to the way cable stocks have been reacting to the deal. With the exception of Charter Communications Inc. stock – which was down

6 cents to $1.04 per share on April 10 – all of the publicly traded MSO stocks showed gains the day after the deal was announced.

"Who would have thought that the day that Rupert finally gets DirecTV that our stock would be up 50 cents?" Alchin said. "It says a lot about how we are now positioned."

Murdoch maneuvers

But some observers expect Murdoch, who has been a fierce competitor in the TV and publishing businesses in the past, to touch off a price war with cable operators to gain market share. However, most cable operators believe such predatory pricing would hurt News as much as its rivals.

"If anything, Murdoch is pretty rational," Mediacom Communications Corp. CEO Rocco Commisso said.

Bruce Leichtman, analyst and president of Leichtman Research Group, also doubted that Murdoch would start a price war with either cable operators or EchoStar, currently the low-priced competitor. Instead, he believes News will continue DirecTV's strategy of competing in terms of service, rather than on price.

"That's one thing DirecTV has done very well — carve out that high-end niche."

Sanford Bernstein & Co. media analyst Tom Wolzien said News could cut prices for satellite, but that cable could counter with a bundle of video, voice and data, adding in bandwidth-intensive HDTV.

"It'll be a consumer choice: Price versus package," Wolzien said.

The deal must pass federal regulatory scrutiny, a stage that Murdoch feels he has addressed by pledging to make News programming available to all suppliers. But some observers cite News's past history, adding that the company could play hardball with operators.

According to one programming executive, News' regional sports channels have lost some luster in the wake of Cablevision Systems Corp.'s highly public fight with the Yankees Entertainment & Sports Network, and as other operators like Time Warner Cable took a hard line on sports prices, dropping some Fox services for a few months in Minnesota and Florida.

With DirecTV in the News fold, that all changes, the executive said. News could launch a massive anti-cable campaign in markets where its sports channels are dropped and DirecTV carries the services.

Regarding higher license fees for News' networks like Fox News Channel, News could threaten to have DirecTV launch a major marketing campaign, saying it is carrying the highest-rated all-news channel and cable is not.

"There certainly would be some incremental leverage News Corp. would have over cable operators in terms of regional sports-network rights fees," Kagan Associates sports analyst John Mansell said. "There's greater chance of YES-type situations — only it'll be Fox [networks], and they'll be even more inclined to go out and promote DirecTV in regions where the cable operator doesn't pay up."

Added the programming executive: "He'll [Murdoch] use every ounce of his leverage to beat up cable operators who don't carry his content."

For his part, Commisso, an outspoken opponent of high programming costs in the past, said that unless News agrees to end its retransmission-consent status, agrees to make available all of its programming to all distributors — including the

National Football League's lucrative "NFL Sunday Ticket" out-of-market pay-per-view package — and keeps its own programming fees in line, "it's going to be a war."

Odyssey over

Snagging DirecTV marks the end of a three-year odyssey for Murdoch. News was within a hair's length of landing DirecTV in 2001 — after a year of negotiating — but was trumped at the last minute by a larger bid from EchoStar.

The Federal Communications Commission blocked the EchoStar deal in December 2002, citing anti-competitive reasons. That left the door open for News, which outlasted competing bidders Liberty Media Corp., SBC Communications Inc. and Cablevision Systems Corp.

In a conference call with reporters, Murdoch joked about his lengthy courtship with DirecTV.

"For those of you who have been eagerly on hold," Murdoch told reporters, "try it for three years."

Murdoch quickly got down to business, adding that the combination of News' content and DirecTV's distribution strength would provide more serious competition to cable.

"More programming options, greater efficiencies, richer content, better customer service and compelling new technologies will give satellite television its best chance to break cable's still dominant hold on viewers," Murdoch said.

While the deal gives News the U.S. distribution arm it has craved for years, DirecTV is not the same company it was just two years ago. In 2000 it was the growth leader in the industry, adding more than 3 million subscribers that year.

Now that market appears to have matured. DBS growth rates are slowing: DirecTV added about 1 million subscribers in 2002, down from the prior year. And EchoStar, the perennial runner-up, surpassed DirecTV in subscriber additions last year with 1.4 million. According to several analysts, EchoStar has about 58 percent of the growth in DBS.

Murdoch denied that the DBS market is maturing. He added that EchoStar and DirecTV added a combined 2 million subscribers in 2002, while the cable industry lost 1 million customers.

"I wouldn't think there had been any maturing at all," Murdoch said.

News said that it expects to extract cost savings from the deal, but declined to be specific.

Carey said DirecTV already is focused on reducing subscriber churn and lowering programming, marketing and subscriber-acquisition costs. News would be able to help those initiatives along, he said.

"We would be able to help them take those savings beyond where they've been and to where we think they should be," Carey said on the conference call.

Kent Gibbons, Linda Moss and R. Thomas Umstead contributed to this story.

<p>Sub Scorecard</p><p>Should the deal for DirecTV Inc. close, News Corp. would become the second-largest subscription-based TV distributor.</p>

Comcast

22.0 million

News Corp.

11.2 million

AOL Time Warner

10.8 million

EchoStar

8.2 million

Charter

6.6 million

Cox

6.3 million

Adelphia

5.3 million

Advance/Newhouse

2.1 million

Mediacom

1.6 million

Insight

1.3 million

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