It could have been worse
Cable operators say better Ergen in charge of DirecTV than Murdoch
By John M. Higgins -- Broadcasting & Cable, 11/4/2001 7:00:00 PM
As satellite TV rivals, EchoStar and DirecTV grabbed 20% of the multichannel video market and virtually halted cable's subscriber growth. Now EchoStar Chairman Charlie Ergen is threatening to cut more deeply into cable with his deal to combine with DirecTV.
Looking for howls of protest? Try sighs of relief. Cable operators are actually chipper about the $30 billion deal. By dramatically snatching DirecTV away from nemesis Rupert Murdoch, Ergen not only continued his record of besting the Australian media mogul but also removed what cable operators had seen as a potential nightmare.
"Deep, deep down, Rupert scares me more," said the CEO of one cable operator. "He could be one big, bad competitor."
Said another industry executive, "If you're cable, you're thrilled. Rupert had content. As a cable operator, you just had the best day of your life."
For months, MSOs have dreaded the prospect of the hardball-loving News Corp. chairman's running their biggest competitor. They were bracing for Murdoch to use his regional sports networks and national sports rights against them, making some of that product exclusive to DBS.
The same goes for cable networks, whose executives feared that they could find themselves on unfavorable tiers if their product competed directly with some current or future Fox network.
Ergen, of course, owns no networks, no sports rights. So assuming the deal clears antitrust review—which is far from certain—cable operators see all kinds of other reasons to be happy.
Suddenly, operators foresee at least two years of DBS disarray: 12 to 18 months of regulatory review followed by 12 to 18 months of integrating DirecTV into the ultra-frugal EchoStar.
To do the deal, EchoStar will probably boost its leverage past seven times cash flow, leaving the company with little ability to borrow money. So Ergen may choose to shift gears from his heavy, expensive push to add new subscribers and instead milk his existing customer base for profits. That would suit cable operators.
And finally, if Ergen's bid succeeds, he'll have to execute a massive $2 billion, three-year switchout of DBS equipment, trading Dish Network and DirecTV dishes and receivers for gear that can receive a combined service. When many of those customers initially signed up, MSOs didn't have digital cable packages to equal what DBS could deliver. Operators will try to pounce on the dislocation the DBS switchout will create.
"The bottom line is, I think it's great for Charter," said Charter Communications CEO Carl Vogel. "I've been through these FCC wars, which I find somewhat entertaining. We'll enjoy watching the Washington gymnastics on this one."
Comcast President Brian Roberts was more measured but still happy that News Corp. lost the bidding. EchoStar "will be interested in running a profitable distribution company, not perhaps a less profitable distribution company and a profitable programming company," he said. "At the very highest level, it's slightly better than the alternative."
Ergen insists that cable operators should be plenty worried. Combining DirecTV and EchoStar will allow him to widely fix DBS's biggest Achilles heel: the dearth of local broadcast signals that cable customers are accustomed to getting. Currently, the DBS services offer "local-in-local" packages of broadcast stations in about 40 markets. However, Ergen said, after combining under the DirecTV brand, he will be able to offer local signals in 100 markets, representing 86% of the nation's 105 million TV homes.
And because, ultimately, he won't have to carry ESPN twice or MTV twice, he can further loosen up spectrum to add services, such as near-video-on-demand or high-speed Internet.
"We've always had a vision at EchoStar of competing with cable," Ergen said. "We're excited now that we can compete on an equal, level playing field."
Ergen's victory is an outrageous one, and a bitter defeat for Murdoch. For years the TV, film and newspaper mogul has lusted for a U.S. DBS play to fit with his British Sky Broadcasting, Asia's Star TV and Sky Latin America.
But it's hard to argue against Ergen's logic, that the efficiencies of combining two U.S. DBS operations will throw off more cash and create more value than Murdoch's plan of combining DirecTV with DBS assets in England and China.
Since February 2000, Murdoch has been trying to snag DirecTV and its parent, Hughes Electronics. Because Hughes is a tracking-stock subsidiary of General Motors, he had to persuade two boards of directors, first, to sell the operation and, then, to sell to him.
His proposal: merge Hughes into a newly created company, Sky Global Networks, which would combine all the DBS assets. It would also hold a big stake in interactive TV guide Gemstar.
When they started the process, GM and Hughes executives probably could have unloaded Hughes for $50 billion to $60 billion. But they pondered and delayed and studied so long that the market collapsed. To keep his proposal tax-free, Murdoch would have had to strip assets out of Sky Global because Hughes's stock value was dropping so dramatically.
Ergen had been trying to get in the door to negotiate with a proposal of his own. Although GM and Hughes executives last week lauded EchoStar as a compelling match, they had been rebuffing his approaches for months.
So in August, Ergen—a gambler banned from some casinos for counting cards at the blackjack table—offered a "bear hug." He faxed an offer first to GM and Hughes, then to the press. By rallying GM and Hughes shareholders into calling for a bidding war, Ergen embarrassed GM into negotiating with him.
When GM's board spent the weekend before Halloween reviewing the bids, Ergen couldn't even lock down his financing. The carmaker wanted assurances that he could come up with $5.5 billion in cash on top of the $23 billion in EchoStar stock.
News Corp. had cash commitments from Microsoft and Liberty Media. Ergen needed to borrow but could secure only a bridge loan for half the cash. Ergen, who is notorious for chiseling investment-banking fees, couldn't come to terms with UBS Warburg, which had helped get him to the table.
GM's board accepted a personal guarantee against Ergen's EchoStar holdings to cover the dangling $2.75 billion. "He doesn't even have the cash," said a frustrated News Corp. executive. "They had to backstop him, and they still took the deal."
In a "you-can't-fire-me-I-quit" move, Murdoch withdrew his offer, and the GM board signed off Ergen's plan.
To keep the deal tax-free, current Hughes shareholders will retain majority ownership of the combined companies, about 53%. EchoStar shareholders will own 36%, and GM keeps 11%. Ergen will be chairman of the combined companies and have 18% of the equity. DirecTV founding CEO and now Hughes executive Eddy Hartenstein said he may have a management role in the combined companies.
That's if the deal survives antitrust scrutiny. While that would be a failure for GM officials, it wouldn't necessarily be so bad for Ergen. EchoStar would benefit from the same disarray that cable operators are anticipating. Other than having to pay a $600 million breakup fee, "he wins if he loses, he wins if he wins," said one cable CEO. "I'm not sure he wants to close."
| Where they stand | ||
|---|---|---|
| DirecTV | EchoStar | |
| Note: A cable system typically generates $45-$50 a month in revenues per subscriber, $20-$22 in cash flow per subscriber * Excludes subscribers in NRTC franchises.Source: Morgan Stanley; company reports |
||
| Headquarters | El Segundo, Calif. | Littleton, Colo. |
| Owner | Hughes Electronics; GM | Public; Charlie Ergen owns 50.1% of equity, 97% of shareholder votes |
| Top execs | Jack Shaw, Hughes chairman; Eddy Hartenstein, Sr. VP | Ergen, chairman; Mike Dugan, president |
| Subscribers | 8.6M* | 5.3M |
| 2001 sales (est) | $5.6B | $3.6B |
| 2001 cash flow (est) | $197M | $391M |
| Monthly revenue/sub | $54.70 | $49.20 |
| Monthly cash flow/sub | $1.84 | $6.14 |
| Cost to add new sub | $555 | $550 |
| Where Echostar would rank | ||
|---|---|---|
| Cable and DBS by millions of subscribers | ||
| Source: EchoStar; Kagan Media |
||
| 1 | AT&T | 15.1 |
| 2 | DirecTV-Echostar | 14.9 |
| 3 | AOL | 12.7 |
| 4 | Comcast | 8.3 |
| 5 | Charter | 6.9 |
| 6 | Cox | 6.2 |
| 7 | Adelphia | 5.7 |
| 8 | Cablevision | 3.0 |
| 9 | Insight | 1.4 |
| 10 | Mediacom | 1.0 |
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