AT&T: Beware Reaching Too High for EchoStar

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Shares in EchoStar shot into higher orbit earlier this week on rumors that AT&T might try to acquire the satellite video distribution company.

Part of the recent speculation in investment analysts’ reports focuses on two factors: the need of AT&T to supplement its Internet and video offerings, and the likely end of a merger-tolerant Justice Department if the Democrats capture the White House next year. Instead, the real focus should be on the future of satellite television distribution and the two principal companies, EchoStar and DirecTV, owned by News Corp.

As satellite services, EchoStar and DirecTV offer distributed video services, but they cannot effectively offer two-way services such as telephone or Internet access. Until a few years ago, a standalone video service was quite competitive, as Americans tended to acquire telephone, video, Internet, wireless, and other services separately.

For most of the past 10 years, EchoStar has grown at double-digit rates. No more.

EchoStar has 13.7 million subscribers, and subscribers grew at an annualized rate of 3.2% in the third quarter. Double-digit growth is not likely to resume. The reasons are simple.

Beginning a few years ago, most local telephone companies began competing intensively for video service customers by offering packages of land-based telephone, video, and data services to match similar packages offered by cable companies. Price wars for packages of services were a boon for consumers but a bad omen for satellite providers.

An additional challenge looms for satellite video services. Increasingly, customers are acquiring video services directly over the Internet from broadband-based Web sites. Over the next several years, consumers will likely bypass packagers such as satellite operators to obtain video content directly from content owners.

In 2002, EchoStar attempted to purchase DirecTV from General Motors, one of the few mergers blocked by the Bush administration. More recently, both EchoStar and DirecTV have been the topic of endless rumors as takeover targets. These rumors all have a theme of synergies between acquiring and satellite companies. Indeed, some part of EchoStar’s and DirecTV’s value has been the option of being acquired by a third party.

Historically, most satellite subscribers also subscribed to local telephone companies. Because cable operators provide video services, it would make little sense for a household to subscribe to both cable and satellite services. Thus, a telephone company is perhaps the most likely acquiring party for EchoStar. The two largest are AT&T and Verizon.

Verizon is understandably less interested in satellite television than AT&T. Verizon has invested substantially in a fiber technology, called FiOS, to deliver advanced video services to homes. AT&T has invested in a less costly and less capable technology, known as U-verse, for the same purpose. In the near term, AT&T could use EchoStar’s customer base and video service offerings to compete with cable. In addition, EchoStar’s spectrum holdings have substantial value.

But AT&T, or any other buyer, should be careful not to pay too much for EchoStar. First, EchoStar is likely near its peak subscribership as a stand-alone company. Approximately half of American households subscribe to one form of bundled services today, and a large portion of the remaining households are considering bundles. That is bad news for standalone services such as EchoStar. Subscribership may grow as part of an AT&T bundle, but AT&T must take pains not to cannibalize its fledgling U-verse service.

Second, U-verse or another terrestrial-based high-speed data system, not satellite, should be AT&T’s long-term service offering for both data and cable. EchoStar fills a temporary, not a permanent, hole in AT&T’s service offering.

Finally, if AT&T does not buy EchoStar, it is not obvious who will take it instead. Indeed, AT&T always has the option to approach News Corp regarding DirecTV or simply continue to pursue a fiber strategy for video. In negotiations with EchoStar, AT&T should have substantial bargaining power.

EchoStar’s equity price has been on a roller coaster for years. The share price of EchoStar peaked above $75 in 2000, then fell to $15 in mid-2002, bounced around $30 until the end of 2005, and slowly climbed to around $50 10 days ago before being rocked by poor third quarter financials. This week’s acquisition speculation has restored much of the recently lost ground.

Once every couple of years, AT&T is rumored to be buying either EchoStar or DirecTV. This year, the rumors may come true.

A former FCC commissioner, Mr. Furchtgott-Roth is president of Furchtgott-Roth Economic Enterprises. He is organizing a seminar series at the Hudson Institute. He can be reached at hfr@furchtgott-roth.com.


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