Boeing's Wobbly Satellite Orbit

Its new unit must exploit unproven technology

Just south of Los Angeles International Airport in El Segundo, tucked between two glass towers, is a sprawling, windowless yellow building that's crucial to Boeing Co.'s (BA ) strategy of expanding far beyond commercial aircraft. A former Nash Rambler auto factory, it's now where a big share of the world's communications satellites are meticulously assembled one by one by teams of workers in white gowns and then shipped out at about $100 million a pop.

Last year, Boeing paid Hughes Electronics Corp. (GMH ) $3.75 billion for this satellite-making operation. According to the flight plan, the deal would not only put Boeing into the satellite business but eventually into high-margin, space-based services such as linking airline passengers with the Internet, digitally delivering movies to theaters, and whatever else its engineers could think up. Today, however, satellite manufacturing is losing altitude while the payoff from the services side remains distant and iffy. That's not helping Boeing's goal of becoming more than just an aircraft maker, an aim underscored by its planned move this August to Chicago from its Seattle manufacturing base.

Boeing executives brim with confidence that eventually the payoff from services will be huge. James F. Albaugh, CEO of the Space & Communications Group, which includes the satellite unit, cautions skeptics that focusing just on the low-margin satellite-manufacturing operation misses the point of why Boeing bought Hughes. He says Boeing bought the intellectual capital of Hughes--the people who developed the fast-growing DirecTV satellite television service and other technologies. And Boeing intends to leverage that brain- power into new space-based businesses--most of them not yet discovered. "We are going to use the brains of El Segundo to help us get into the services arena," Albaugh says.

PHONE PROBLEMS. For now, though, satellite manufacturing is the unit's breadwinner, and Boeing didn't get into the business at the best time. Demand for commercial satellites is declining, and excess production capacity worldwide now hovers around 35%. That's largely due to the financial failures of satellite-phone companies Iridium, New ICO, and Globalstar, which wrecked the market for low-orbiting satellites. And satellite-communications outfit Teledesic LLC, backed by billionaires Craig McCaw and William H. Gates III, is sharply cutting back plans for a 288-satellite constellation, probably to about 50 satellites. One problem: Financing for those costly birds is drying up, prompting some analysts to ratchet down 10-year forecasts for commercial-satellite orders by more than a third.

Meanwhile, just as demand is falling, the competition is getting tougher. Last year, European rivals Alcatel (ALA ) and Astrium grabbed more than half of the worldwide orders for commercial satellites, up from just 16% the year before. One reason is that tougher U.S. export rules give the European competitors an advantage in winning overseas orders. Plus Boeing is no longer assured orders from Hughes's PanAmSat, Spaceway, and DirecTV units. Now, it must compete for that business against U.S. rivals Lockheed Martin Corp. (LMT ) and Loral Space & Communications Ltd. (LOR ), as well as the European upstarts. The result: The Boeing unit received just seven commercial satellite orders last year, down from 13 in 1998.

Albaugh sees the market differently. Demand for low-orbiting satellites may be dropping, but he says the company is well-positioned to capitalize on a growing number of government contracts. Boeing recently snagged a $5 billion Defense Dept. contract to build next-generation spy satellites under a classified project called the Future Imagery Architecture. And the satellite unit has a nice backlog of 35 commercial and government orders for large, geostationary satellites, worth $6 billion. "A lot of people bad-mouth the satellite business," Albaugh says, "but we feel pretty good about the market."

Even if the market improves, though, Boeing has other headaches. Some of its satellites have been losing control or power in orbit, a quality problem inherited from Hughes. At least six have gone dead or will be prematurely shut down because customers say they are unreliable. Insurance will cover most of the cost, but the lost credibility may hurt future orders.

One big problem, however, was resolved in April when Boeing put its own man in charge of the unit. Satellite President Tig H. Krekel and Executive Vice-President Joseph M. DeSarla, both Hughes holdovers, abruptly quit after differing with higher-ups over the unit's direction. Boeing was quick to fill Krekel's job with a NASA veteran, Randy Brinkley, who joined the unit last year.

At NASA, Brinkley was credited with helping to get the troubled international-space-station project back on track.

The $2.1-billion satellite unit historically churns out 8% margins, but Boeing is looking for double-digit margins, and that's where space-based services come in. Execs gush about plans for using satellites to beam the Internet down to jetliners--a projected $5-billion-a-year business within 10 years. They talk eagerly about delivering first-run movies to theaters via satellites, horning in on the billion-dollar-a-year market for film distribution. And satellites are the centerpiece of an air-traffic-control system that Boeing plans to unveil later this month. Says Boeing Chairman and Chief Executive Philip M. Condit: "That integration is a pretty exciting task."

NO TAKERS YET. But turning these initiatives into profitable, high-growth businesses is another matter. Even Condit acknowledges that these projects are at best five years away from producing steady revenues--if they survive. Boeing's effort to beam the Net to jetliners, which it calls Connexion, has yet to attract a firm customer. The unit is under pressure to line up one by the start of the Paris Air Show on June 17. Then there's Boeing's Air Traffic Management plan to alleviate airport congestion, which faces regulatory hurdles as well as competing systems from an IBM-Lockheed team and the Federal Aviation Administration. And Boeing's digital cinema must overcome skeptics in the movie industry and high costs to convert theaters. Boeing did successfully transmit the movie Spy Kids to a California theater in March and argues that it can cut distribution costs while improving film quality.

Still, the strategy faces high odds. "Although it's not impossible to convert intellectual capital to bottom-line earnings growth, this kind of transformation is tricky to pull off," says Robert E. Friedman, an aerospace analyst for Standard & Poor's Equity Group. Boeing has to prove it can invade Hollywood and master the Internet if it's going to avoid getting lost in space.

By Stanley Holmes in Los Angeles

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