Pegasus Flaps Its Wings Harder

The satellite service company has a new digital broadband system that could revive the industry's sagging fortunes -- eventually

If at first you succeed with digital, you might as well stick with it. That's satellite service provider Pegasus Communications's (PGTV ) mantra for the launch of its latest satellite service, Pegasus Express, which will beam broadband service to subscribers for their computers. Since going public in 1996, the company's annual revenues have risen from about $30 million to more than $600 million in 2000 by delivering 200 digital channels via satellite to rural customers. Until satellite, most of these customers were limited to plain old broadcast TV or, if they were lucky, a 25-channel analog cable system. CEO Mark Pagon believes Pegasus can capture 50,000 to 100,000 broadband customers by the end of 2001 (see BW Online, 4/17/01, "This Is Only the Bottom of the First").

Pegasus' service has relaunched hope that high-speed Internet connections could be the Next Big Thing for the satellite industry. Modest forecasts from Bear, Stearns & Co. suggest that two-way broadband offerings will rope in 500,000 subscribers in 2001. That number is projected by the firm to grow to 4.6 million by the end of 2004, making the market worth $2.1 billion.


  That's good news for the satellite industry, which in recent months has taken a hit on Wall Street. Analysts fear that the market for digital video via satellite has reached its saturation point. Hughes (GMH ), the parent of DirecTV, is down 50%, to $19, from its high of about $40 last May. EchoStar (DISH ) has lost more than half its value: The stock is hovering around $30 from a record of $70. Pegasus has fallen hardest: It's lingering around $21 a share, down from a 52-week high of $75.

But satellite broadband faces a tougher ramp-up than satellite TV. The services could do well in the rural areas, like the ones Pegasus serves, where satellite is the only game in town. But technical obstacles and cable's firmly entrenched customer base in metropolitan areas means the satellite companies will have to push other types of interactive services to continue growing in the manner to which they have become accustomed, many analysts believe (for a look at another high-speed alternative, see BW Online, 4/17/01, "Broadband: Profits at 51,000 Feet?").

For Pegasus, providing broadband service is a natural. In 1994, rural areas were the launching pad for its digital broadcast services (DBS). By 2000, there were more than 14 million DBS subscribers -- 7.5 million from rural areas, even though only 30% of U.S. households are located outside metropolitan areas. That percentage of rural users will become increasingly disproportionate as Pegasus targets the less sparsely populated regions of the U.S.


  By 2006, Pegasus predicts that 50% of 33 million rural customers will get video service from satellite, shrinking cable's overall market share from 185 million to about 115 million. The reason? Small cable systems will start to go out of business. With fewer than 1,000 customers, it's not economically viable to upgrade a cable network for digital services such as broadband, interactive TV, and the much-hyped 500-channel services. Since cable-video service costs about the same as satellite, customers have no reason to stick with a cable company that offers fewer and less sophisticated entertainment options. "For Pegasus, broadband is a layup," says S.G. Cowen Securities analyst Rob Kaimowitz.

But outside of rural areas, satellite broadband cannot hope for the same success, analysts say. Here's why: Satellite technology by nature is not designed for two-way service. What satellites do best is distribute one signal to many points. That's why satellites work so well for television. Millions of people receive the same 200 channels. Internet access requires point-to-point distribution. An individual doesn't send an e-mail to everyone on the system but generally to one particular recipient. To do this, the information is beamed 22,300 miles up to the satellite, then directed via transponders on the dish. The transponders target points of high-density spectrum to the recipient of the e-mail.

Each transponder can serve only so many customers at a time before the speed of the connections begins to slow. First-to-market StarBand Communications, a satellite-broadband provider backed by Microsoft (MSFT ), EchoStar, and Israeli satellite manufacturer Gilat, has managed to serve only 5,000 customers per transponder, instead of the 10,000 it had promised in its business plan. So far, that's not an issue. Since it launched the service in late 2000, StarBand claims to have signed up about 30,000 customers. Even at the current rate, it has enough capacity to serve 120,000. But the problem does suggest that if satellite broadband were to take off as hoped, the technology might not be robust enough to support demand.


  More transponders can be dedicated to an oversubscribed area. But the front-end costs are high. Satellite companies worry that, without huge demand, they may be launching the next Iridium, the now-defunct $5 billion satellite system backed by Motorola (MOT ).

If satellite broadband is to become mainstream, the future lies in a new technology called Ka band. Each Ka-band satellite will carry what is, in effect, a telephone "switchboard-in-the-sky." This will allow the satellite to operate like a telephone network -- offering point-to-point circuits to both business and individual users at a cost far lower than that available via satellite today. But so far, neither Hughes, Gilat, nor upstart WildBlue has scheduled launch dates for the new, higher-capacity birds. Hughes will probably be the first to deploy, but no earlier than 2003.

Other challenges reamain as well, especially in rural areas. Satellite service is much more expensive than DSL or cable. Both StarBand and Pegasus charge about $70 a month for DSL. Add to that a $499 charge for the dish and about $200 for installation fees, and you start to wonder whether rural communities really will embrace broadband.

Pegasus's Pagon and others dismiss the naysayers: "I think rural customers might be more likely to pay for it. The value of a broadband connection -- even a narrowband connection -- will be a very liberating thing for people in rural areas," says Pagon.


  Maybe. But satellite broadband service will be mainstream only with the requisite new technology. It's a classic chicken-and-egg scenario, says Jose del Rosario, a strategic analyst at market researcher Frost & Sullivan: The service hasn't taken off yet, so there's no way to justify the investment in expensive next-generation satellites. Without new hardware, the service can't compete with reliable fiber systems.

Vicious cycles of this sort often plague the technology industry. Think about high-definition television. In theory, there's a demand for it. But the equipment costs are too great and the system too unproven to launch a technology revolution. So it is with satellite broadband. The technology will no doubt find a place. But satellite companies will have to work out some tricky logistics first.

By Jane Black in New York

Edited by Douglas Harbrecht