Satellite's Hot Pursuit Of Cable

DirecTV and Dish are rapidly snaring new subscribers. But they're paying for growth

For years, Dave Kappeler, a 47-year-old Oshkosh (Wis.) ad salesman, was a loyal subscriber to Time Warner Cable (TWX ). No longer. "Cable prices just went up and up, every six months it seems," he says. So, not long after the Dish Network began delivering local TV stations and football games featuring his beloved Green Bay Packers -- at $10 less a month, to boot -- Kappeler decided to make the switch. All it took was a phone call to 866-DropCable, the number of a local Dish sales agent.

A lot of folks have been making similar calls as the war for subscribers has grown nastier over the last year. And it sure looks like satellite is winning. Rupert Murdoch's DirecTV Inc. (DTV ) and EchoStar Communications Corp.'s (DISH ) Dish Network racked up an astonishing 820,000 new subscribers in the first quarter, while the cable industry stagnated. The top nine providers, including leaders Comcast Corp. (CMCSK ) and Time Warner, added a mere 13,000 in total. Wall Street has taken note. Shares of the large stand-alone cable companies like Comcast Corp. and Cox Communications Inc. are down around 13% for the year, vs. the 1.3% drop for the S&P 500.

Why is satellite stealing growth from cable? Price, for starters. Cable's rate hikes have made it easy for satellite companies to sell their all-digital service for about $10 a month cheaper than their rivals. What's more, both DirecTV and EchoStar are luring disgruntled cable customers with offers like free set-top boxes, inexpensive TiVo-like digital video recorders, and three months of free service. The result: In markets where satellite has added local TV stations, which now include more than 70% of homes with TVs, cable customers turned in their boxes in droves. And to address satellites' major weakness compared with cable -- the lack of broadband Internet access -- EchoStar and DirecTV are forging links with telecoms to bundle satellite and DSL service. "We are truly firing on all cylinders," says DirecTV's U.S. chief executive, Mitch Stern.

True enough. But satellite companies are burning through cash to foot the bill for those lower prices, freebie services, and all the rest. Thanks to Murdoch's deep pockets, DirecTV is able to look at its $91 million first-quarter operating loss as simply the cost of expanding Fox Corp.'s reach.

IMPLODING MARGINS

EchoStar is another story. To do battle with both Murdoch and cable, EchoStar CEO Charles Ergen is also spending lavishly. He has increased marketing expenses by 22%, spending an average of $604 per new subscriber. That's slightly less than what an average user now pays to subscribe for a year. Yet EchoStar's revenue-per-subscriber has risen by less than 1%. Although the company's cash flow easily covers its interest expenses, operating margins are vanishing. The result: a $43 million loss in the first quarter, compared with last year's $58 million profit. Little wonder, then, that EchoStar's stock fell 6% the day it announced earnings.

EchoStar aims to attract as many subscribers as it can now, and then gradually sell more services and increase prices. But that might not be easy. Despite the stagnant subscriber growth, cable companies are fighting to lock in customers with more of their own high-tech revenue-building services. Comcast now gets an average of $72 per customer a month, up 9% from last year thanks to add-ons like Internet service and high-definition TV.

To peel off more cable subscribers, the satellite companies know they need to match those high-tech services. That's why they're partnering with telecom giants. A key lure: DSL service for as little as $26.95 a month for customers who also buy satellite service. Cable broadband averages around $40. In the first two months of its deal with EchoStar, SBC Communications Inc. (SBC ) signed 40,000 new Dish subscribers, SBC says. In July, DirecTV will launch similar programs with BellSouth Corp. (BLS ) and Verizon Communications Inc. (VZ ).

In the all-out war for subscribers, the satellite industry is clearly winning. Now, though, the big spenders at DirecTV and EchoStar just need to figure out how to grow and make money at the same time. If they can do that, the cable industry will really have something to worry about.

By Ronald Grover in Los Angeles, with Tom Lowry in New York

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