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EchoStar: Still Lots of Dark Spots

By Olga Kharif When EchoStar signed a new contract with Viacom on Mar. 11 to resume broadcasting the media conglomerate's shows, relieved investors drove up the satellite-TV company's stock by 3.6%, to $35.35. No wonder. By then, due to a breakdown in negotiations over a new deal, 17% of EchoStar's 9.4 million subscribers had been obliged to go without channels such as MTV for two days. Consumer complaints snowballed, and analysts were envisioning an exodus of customers.

With peace restored, investors became more forgiving -- so much so that they overlooked the not-so-minor fact that neither Viacom (VIA), nor EchoStar (DISH) would provide details of their new contract. Another similarly overlooked implication, gleaned from programming EchoStar has now agreed to carry: Viacom may have gotten much of what it asked for -- perhaps even 40% price increases for the content it will provide over the contract's duration.

News of the Viacom truce put the Street in such a good humor that investors even shrugged off EchoStar's announcement of a two-week delay in reporting full-year 2003 results while it discussed with the Securities & Exchange Commission a possible restatement of earlier results. On Mar. 15, EchoStar said it wouldn't need to make any restatements and that it should provide its financial results by Mar. 30.

TOO RICH TO DIGEST? Still, any celebration would seem a bit premature. For one thing, the 340,000 subscribers the company added in the fourth quarter represented a slightly lower tally than the figure expected by analysts such as Standard & Poor's Tuna Amobi. That shortfall could indicate that EchoStar's growth is losing momentum.

If that's so, 2004 would represent a marked contrast to the glory days of 2002, when EchoStar added more subscribers than the rest of the pay-TV industry combined. And that could cause second thoughts among investors who have viewed EchoStar as a fast-growth alternative to cable-TV stocks and to Hughes Electronics (HS) and News Corp. (NWS), the owners of rival DirecTV.

At least that's the view of Amobi and other analysts, who argue that EchoStar is probably too rich for investors to touch at prices in excess of $30 a share. In the interim, many analysts are instead recommending Hughes or big cable operators such as Comcast (CMCSA) and Cox (COX).

TUNER OUTAGE. DirecTV, whose subscriber rolls grew by 405,000 in the fourth quarter of 2003, to 12.2 million, might start to outpace EchoStar, in part because of its relationship to media giant News Corp., says Adi Kishore, an analyst with tech consultancy Yankee Group. That gives the satellite-TV provider access to such widely viewed fare as Fox's National Football League games.

DirecTV also hasn't experienced the same shortage of HDTV (high-definition TV) tuners that EchoStar recently has encountered, says Amobi. Since as much as half of new satellite subscribers have HDTV-capable sets, that's hampering EchoStar's growth, he says.

Moreover, DirecTV and EchoStar could both suffer, as cable becomes more competitive. For years, as cable companies bled market share, satellite players bragged of their ability to provide more channels and with better video quality. But in the past year, those cable defections have slowed to about 1% a year, according to Kishore.

BOX IN A BOX. That's because, over the past five years, cable outfits have invested some $84 billion to upgrade their networks to handle as many channels as satellite, says Kishore. The new networks are so good that cable can now offer services, such as video on demand, that satellite players can't provide. While it'll take months to work out the kinks in such services, they could ultimately prove a major advantage for cable players.

What's more, some cable companies are starting to give customers digital video recorders (DVRs) with their subscriptions, something EchoStar already does (see BW Online, 4/11/04, "TiVo's Growth Picture: Still a Little Fuzzy"). By the end of 2004, those devices will become commonplace for subscribers of Comcast and many other cable companies -- though, so far, EchoStar says, it has installed more than a million DVRs -- a larger number, it adds, than any other pay-TV provider.

The cable companies have another card up their sleeves, however. Starting this summer, many TV manufacturers will release sets with, essentially, built-in set-top boxes that will make it possible to start cable service by simply slipping a special card into the TV and plugging in the set. That will let cable companies save on installation costs, since a cable installer won't need to visit the subscriber's home. True, the built-in box will boost a TV's price, but perhaps by only $10 or so. Given that most consumers are paying around $1,200 for an HDTV, Kishore believes they'll hardly notice.

HITTING A TRIPLE. Satellite companies, by contrast, aren't close to integrating and exploiting the functionality of TV set-top boxes. In last year's fourth quarter, the mix of dishes EchoStar installed shifted toward the more complex units required for HDTV -- which cost the satellite provider $25 more apiece than the traditional variety, plus an extra $25 for installation, estimates Craig Moffett, an analyst with Bernstein Research in New York (Bernstein owns certain cable company stocks).

Meantime, Comcast and Cox are further upping the ante by selling what they call a "triple play": a bundle of phone, high-speed Internet, and pay-TV services. Such bundles, which are sold to customers at a discount, vs. buying the services individually, tend to reduce customer churn by 30% or more, according to studies by telecom consultancy Management Network Group.

Satellite companies can't match such bundles because Net access and making phone calls via satellite are in their infancy or, for now, technically impossible. EchoStar's response came in the form of a deal it cut in July, 2003, with SBC Communications (SBC) to provide its customers pay TV at a discount. "Through SBC," says an EchoStar spokesperson "we're going to reach customers we might not have reached before."

TRAFFIC TIEUP. Still, the SBC deal -- which investors have lauded -- could turn out to be a lemon, says Moffett. Unless at least half those who sign up are new to EchoStar, the offering could cannibalize its existing subscriber base, he says.

Finally, satellite companies have yet to solve a problem that has arrived with HDTV: Current broadcasting methods leave EchoStar and DirecTV hard-pressed for the bandwidth needed to deliver high-def programming -- a hindrance cable operators don't face, Moffett says. Many investors expect DirecTV and EchoStar to team up in an effort to unclog this logjam. Yet because of the technical differences between the networks, resolving the problem could take time, says Moffett.

These issues have fed speculation on Wall Street that EchoStar could be acquired by a content company or a phone carrier. Among the potential suitors often mentioned are Disney (DIS), Viacom, and General Electric (GE), which owns NBC. EchoStar's shares have advanced partly because of such hopes, says Moffett. Now, however, Comcast's efforts to take over Disney could put some of that speculation on the back burner.

DARK STAR RISING? Despite all these hurdles, EchoStar's revenues are likely to grow by around 15% annually for the next two years, vs. 10% to 11% for major cable companies, estimates S&P's Amobi. Its profitability has improved as well: For the nine months ended in September, EchoStar reported income of $222 million, vs. a loss of $228 million in the same period of 2002. Not bad, except that many investors have been expecting revenues to grow by 20% a year.

It could be yearend 2004 before it's clear which number is more likely. EchoStar says its planned expansion into several dozen new local markets this year will help speed growth. And Dan Prislin, portfolio manager at Transamerica Investment Management, whose funds have owned EchoStar shares for several years, remains optimistic. "Maybe [competition from cable] is a little bit tougher," he says, "but not to the point where EchoStar is substantially disadvantaged."

Another bright spot is EchoStar's Mar. 15 multiyear agreement with overseas satellite player SES Global to provide international capacity to EchoStar. Many analysts believe the global expansion will give EchoStar much-needed bargaining power, notably absent during its negotiations with Viacom.

Still, the threats to EchoStar are rising -- and that could mean some investors will heed analysts' urgings to avoid the stock until they can get it for less. Kharif covers the markets for BusinessWeek Online from Portland, Ore.

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