On Nov. 25, 2003, Standard & Poor's raised its ratings on Hughes Electronics Corp. (GMH) and subsidiaries, which are analyzed on a consolidated basis. The corporate credit rating was raised to 'BB from 'B+' and remains on CreditWatch, where it was placed with positive implications on April 25, 2003.
The upgrade is based on Hughes' improving operating and financial performance, while the positive CreditWatch status reflects potential ratings upside following News Corp. Ltd.'s (BBB-/Stable/--) pending acquisition of 34% of the company in a transaction likely to close by the end of 2003 or in early 2004. The ratings on the senior secured bank loans and debt of DIRECTV Holdings LLC and PanAmSat Corp. also remain on CreditWatch positive pending further review of security documentation and appropriate legal opinions to determine if notching above the corporate credit rating is warranted.
Subscribers, revenue, and EBITDA at the U.S. DIRECTV direct to home (DTH) satellite TV business continue to grow at double-digit percentage rates, which is translating into good discretionary cash growth, as indicated by a roughly 28% conversion ratio of EBITDA to discretionary cash flow for the 12 months ended Sept. 30, 2003. Expanded availability of local broadcast signals and multiple set subscriptions are primary factors driving the company's operating momentum. These offerings, together with recently introduced digital video recorders, are helping decrease churn. DIRECTV and its DTH rival, EchoStar, have also initiated joint marketing deals with regional Bell operating companies (RBOCs) to replicate cable company video, data, and voice bundling capabilities.
Despite DIRECTV's good operating performance, the company still faces intense competition from EchoStar, which competes heavily on the basis of price, and from rebuilt cable operators, which offer highly profitable and popular high-speed data services not readily available from the satellite companies. Although DIRECTV continues to expand its local channel offerings into smaller markets, it has less capacity to offer as many channels as cable and also will be more limited in its ability to offer high definition (HD) channels as they become more popular. In order to boost channel capacity, capital spending for satellites could remain elevated.
Hughes still faces challenges at its unprofitable 74.7%-owned DIRECTV Latin America (DLA) subsidiary. This unit is experiencing regional economic weakness that is eroding the subscriber base and has made U.S.-dollar denominated programming contracts uneconomic. The U.S. parent of DLA, DIRECTV Latin America LLC, filed for Chapter 11 bankruptcy protection in March 2003, in part to facilitate renegotiation of programming agreements and other obligations. Negative effects of the bankruptcy filing on subscriber levels, as well as weak economies, continue to weigh on DLA and could further delay DLA from achieving sustainable profitability.
Hughes Network Systems (HNS), a provider of very small aperture terminal networks (VSAT) for enterprise customers and DIRECTV set-top boxes, has begun to generate modestly positive EBITDA because of increased set-top box sales and growing subscribers in the consumer and small-office broadband segment. HNS does not yet generate positive free cash flow. The unit still needs to spend an additional $300 million to launch its Spaceway broadband communications platform service in mid-2004, after spending roughly $1.5 billion on this project to date. Standard & Poor's attaches considerable uncertainty to the level of demand for this business because of weak telecommunications industry conditions.
Soft telecommunications demand has resulted in relatively flat revenue and EBITDA in 2003 at fixed satellite operator PanAmSat Corp., which is 81% owned by Hughes. This business benefits from long-term video customer contracts, and generates EBITDA margins above 70% and healthy discretionary cash flow. Hughes does not have access to cash at this unit.
Hughes' consolidated EBITDA margin was modest compared with that of cable and telecommunications peers, in the low-teens percentage area. Margins should improve as losses are reversed at DLA and HNS. Consolidated lease-adjusted debt to EBITDA in the low 4x area as of Sept. 30, 2003, is acceptable for the rating level.
Following completion of the News Corp. transaction, Standard & Poor's expects to review Hughes' operating and financial plans under its new ownership, which could lead to a ratings upgrade.
Liquidity: Only the U.S. DIRECTV unit and PanAmSat currently generate cash, which is not readily available to Hughes. Excluding $380 million cash at DIRECTV and $552 million at PanAmSat, Hughes should have ample liquidity from a roughly $1.75 billion cash balance as of Sept. 30, 2003. This cash is expected to fund declining negative discretionary cash flow at HNS and DLA, including about $300 million in remaining capital expenditures required to launch Spaceway. Hughes also will use its cash to pay a $275 million dividend to General Motors Corp. upon the split off. In addition, the company will incur a $105 million change-of-control benefit obligation. Under the 5x debt to EBITDA covenant at the DIRECTV level, there is an appropriate level of cushion for operating softness and meaningful capacity for additional debt, which could be dividended to Hughes under certain circumstances. Debt maturities are manageable through 2008. From Standard & Poor's RatingsDirect