Whatever It Takes To Get Ahead

News Corp. plays to win with DBS service

With 13.5 million subscribers, DirecTV has pushed ahead to become the second-largest multichannel provider in the country, behind only Comcast. But in an extremely competitive environment it's going to need every bell and whistle to wrest subscribers from cable and EchoStar's Communications' rival Dish TV.

Rupert Murdoch's News Corp., which since January has owned 34% of DirecTV, isn't backing away from the battle. It is out to win, and win big. DirecTV is pouring money into upgrading its service, offering everything from TiVo to NFL game packages to upgraded HDTV capability in order to woo subscribers.

DirecTV's partnership with TiVo allows customers to get a digital video recorder that is integrated into their receivers. DirecTV research shows that customers who have DVRs buy more premium services and also turn over, or churn, at a lower rate.

“One of the reasons DBS has gained so much share from cable is because it's frankly a more attractive consumer offering,” says Todd Mitchell, media and entertainment analyst for Blaylock & Partners. “That's due to two components: more channels for less money, and more variety. And their set-top boxes are just better than cable's. They got DVRs out first and theirs are better.”

DVRs are so important to DirecTV's strategy that CFO Mike Palkovic says, “Rolling a truck in and giving a customer a DVR upgrade is a good thing to do. It costs you money during the quarter, but you get an increased revenue stream immediately.”

As DirecTV pushes into more high-definition offerings, it has started to offer subscribers an HD DVR for $999 retail. Sales of the box are currently slow, but HD remains a technology that has yet to catch on.

DirecTV is banking on HDTV. It has plans to launch satellites that will provide customers with their local broadcast stations in high-definition. Two satellites previously used to offer business-to-business broadband are being converted to video satellites, and service should be available from those satellites by next summer or fall. By 2007, DirecTV will have two more local HD satellites up and running. All that comes at a cost of $1 billion—not cheap, but worth it, says Stephanie Campbell, DirecTV's executive vice president of programming.

“It's the competitive factor,” Campbell says. “We see high-definition as the way forward.” DirecTV assumes that cable will carry stations' high-def offerings and is preparing now for the competitive onslaught.

One big question: How much content will eventually be broadcast in high-def?

“It's a complicated process to get started,” Campbell says. “We'll have to go market by market and figure out who is broadcasting in digital and how much of that is high-def.”

In the meantime, DirecTV isn't shuffling its feet waiting to implement new features to give it a competitive advantage over cable and EchoStar. That's because virtually every new DirecTV customer is being wooed away from a competitor.

Earlier this month, DirecTV announced a five-year, $3.5 billion extension of its deal with the National Football League. DirecTV offers NFL Sunday Ticket, which gives premium subscribers every NFL game every week throughout the season for a $265 annual rate.

Analysts say the deal is too expensive to be profitable. “This announcement, we believe, is a short-term negative for the equity for several reasons,” says Morgan Stanley analyst Benjamin Swinburne in a research note. “First, it likely dilutes near-term [cash-flow] growth and long-term [cash-flow] margins, at least through the end of the new contract.

“Second, it signals to the market that DTV management may not be focused on profitability, but rather has a more narrow-minded focus on subscriber growth. Third, it feeds the 'bear' thesis on DTV that controlling parent Fox is focused on building as large a subscriber base as possible to the benefit of its programming assets. Finally, it implies the market will have to wait longer than previously expected to see evidence of DirecTV's earnings power.”

Palkovic disagrees with Swinburne and says DirecTV always has at least broken even or profited from its NFL package.

“Some of the customers who take that package are our best customers,” he says. “I'm not only breaking even, I'm protecting my most lucrative customer: the high-end sports fanatic that's got the lowest churn and the highest [average revenue per user] in the industry.”

With NFL Sunday Ticket secured, DirecTV now wants to add original channels; it's building studios at its Los Angeles headquarters so that it can create its own programming.

“I don't think we are going to be producing episodic dramas like The Shield. But we're not going to be afraid to produce content that we need,” says Eric Shanks, senior vice president of advanced services and content.

Besides the Sunday Ticket channel, DirecTV also will launch three “Mix” channels in 2005 as guides to various genres. For example, the News Mix channel will show mini-screens of CNN, Headline News, MSNBC, Fox News Channel and other news channels offered with the service. The subscriber will use a remote to select the desired channel from those screens. DirecTV also is launching Kids and Sports Mix channels.

“In an effort to really rise above the crowd in terms of providing the best television experience, we found that the more choices you give people, the harder it is for them to find what they want to watch on television,” Shanks says. “So we are deploying a number of services that help them organize their day and give back the most valuable thing they have, which is time.”

DirecTV is working to stay competitive by teaming with phone companies Verizon, Bell South, Qwest and Cincinnati Bell to offer a voice, high-speed data and video bundle in one package.

Those agreements are just starting to kick in, but in the third quarter, the telcos brought an additional 75,000 subscribers to DirecTV. Now, however, some telcos are dipping into the television business as well, making potential partners into potential competitors.

DirecTV still likes the tie-in with telcos. While DirecTV and EchoStar each have had relationships with telcos over the years, “it's different this time around,” says Steve Cox, DirecTV's executive vice president of sales and distribution. Some phone companies, he says, will bundle DirecTV with phone service “with minimal to no upfront cost [to customers]. And when we originally launched with the telcos, we didn't have local channels.”

Palkovic is bullish on the telco connection, too. “Cable has an advantage today by delivering a single network connection into your home,” he says. “Are they having success with it? We saw from our numbers this quarter there are 1.1 million customers that came to our platform. So the cable bundle isn't getting it done for everyone.”

Analysts are uncertain that consumers will ultimately prefer the DirecTV/telco package to cable's offering. “With all three products coming in through the same pipe, it's easier to converge those things. It's more difficult for the satellite guys to converge their offering with the phone infrastructure,” Blaylock's Mitchell says.

But according to DirecTV, it's far too soon to tell. “I've always had a lot of confidence in our ability to keep up with the competition technologically,” says DirecTV's Campbell, “especially with the talent that News Corp. brought to the table and the entrepreneurial spirit that they have. We're going to stay in it by hook or by crook.”