Loud-and-Clear Verdict Rattles EchoStar

The satellite TV operator contemplates next steps after the latest federal court ruling against EchoStar's DVR service

If you're Charlie Ergen, you live by the sword and you die by the sword. The controversial CEO of satellite operator EchoStar Communications (DISH) has made a history of filing—and often winning—lawsuits against competitors, patent holders, and even once against a short-lived merger partner, Rupert Murdoch's News Corp. (NWS).

Now, Ergen is learning what it is like to be on the receiving end of one of those suits. On Aug. 17, a federal district court ruled that EchoStar must turn off its popular digital video recorder service in as many as 20% of the 12.5 million homes to which it supplies satellite TV signals.


  The federal court decision requires EchoStar to pay roughly $90 million in damages as well as to stop selling DVRs that the court had earlier ruled violated patents held by TiVo (TIVO). What's more, the ruling also requires EchoStar to turn off existing DVR service within 30 days. Although EchoStar has won a federal appeals court injunction against the award, it still faces the specter of Dish having to turn off as many as 4 million DVRs, figures Sanford C. Bernstein & Co. analyst Craig E. Moffett. That would make EchoStar customers easy pickings for satellite competitor DirecTV or cable.

And Ergen faces another potential legal nightmare. A federal appeals court in Atlanta has ruled that by Sept. 11 Echostar's Dish Network must stop sending signals from local TV stations to an estimated 800,000 of its subscribers in small towns that don't have their own local stations. The so-called violation of the federal government's so-called "distant network signal" could cost Echostar as much as $50 million a year, figures Jimmy Schaeffler, chairman of digital media consultants The Carmel Group, but more importantly could send as many as 20% of Dish's "distant network" subscribers over to DirecTV. "That's another $100 million or more a year and those subscribers won't come back," says Schaeffler. Ergen has been trying to negotiate a settlement with the broadcasters for months.


  Could the spate of legal disasters force the notoriously independent Ergen into a deal? If so, the most likely merger partner would be non-other than DirecTV, which is controlled by his one-time nemesis Murdoch's News Corp. (NWS) Stranger things have happened, especially in the bizarre world of satellite TV, where deals are seemingly made and un-made at a moment's notice. Murdoch won DirecTV in 2003 only after Ergen had initially agreed to buy it and was rejected by the federal government. Ergen refuses to comment on the prospect of a merger. Murdoch, playing it far more coy, recently said on PBS's Charlie Rose Show that he believes such a deal between the two largest satellite operators "would be much harder for the government to turn down today."

When it comes to DVR service, Ergen is at a distinct disadvantage. Murdoch's DirecTV has started to use a completely different DVR technology, based on technology it's developed through NDS Group (NNDS), another Murdoch-controlled company. DirecTV also has a new three-year deal with TiVo that allows TiVo to continue to provide service to DirecTV customers who used Tivo-equipped boxes prior to its NDS rollout.

Even before the TiVo ruling, there were talks that the two satellite operations were contemplating a merger, which neither has commented on so far. The satellite business, after years of hefty growth at the expense of cable operators, has started to slow as cable companies have fought back with better customer service and added features such as Internet access and phone service, which satellite can't duplicate because of its one-way signal from the sky. In its most recent quarter, EchoStar announced it had added 195,000 new subscribers, down by 13% from a year earlier and its lowest quarterly figure since 1998. DirecTV also noted slowing new subscribers earlier in the week.


  The two companies already have begun working more closely together. In June, they signed a joint five-year agreement with Denver-based Wildblue Communications to begin offering broadband access over a satellite connection to customers in small cities and rural areas. And this week, the two companies linked forces in an unsuccessful effort to win wireless spectrum for a cell phone or data service through the still-under-way auction by the Federal Communications Commission.

What could stop a potential merger between the two companies? Just about anything. For starters, as Murdoch told Charlie Rose, there would be the issue of who would run the joint operations. Ergen wanted to run a combined company a decade earlier, when the two moguls first contemplated a joint venture. That blew up into a nasty lawsuit, although Murdoch now considers Ergen "my friend." And there would be price issues, always a sticky point with the tight-fisted Ergen. Then again, despite Murdoch's confidence, no one knows whether the feds would really approve a merger between two giant satellite operators.


  Telephone companies, eager to offer video, are still years away from making their recent TV startups work. "Nothing the telecoms have done or said changes the equation in rural America one iota," says Bernstein analyst Moffett, noting that satellite still is the only way to get TV signals in most of the heartland. "It's hard to see why the [regulatory] result would be any different this time around."

Still, the economic logic for a merger, already persuasive to analysts like Moffett, became a lot stronger this week in a Texas courtroom. And the costs of doing business for Charlie Ergen just got a lot higher at a time when the competition from cable operators is already blistering. For Ergen, who once made a living by playing professional poker, could it be time to ask for a new deal?

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