Consolidation: Silver Bullet or Red Herring?

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The recently announced merger of PanAmSat into Intelsat, pending regulatory approval, is no doubt stunning news. The first instinct of many was to check that the press release was not a hoax, but as the news settled in and the idea grew familiar, it did not seem all that strange.

Actually, in hindsight, it now appears this type of move in the commercial satellite industry was almost inevitable, and there is certainly a lot of logic behind an Intelsat-PanAmSat link up. After all, how many times have we heard the claims that commercial satellite operators are “ripe for consolidation”?

Reducing the number of capacity providers has been proposed as the solution to most of the commercial satellite industry’s ills for years now, and many simply cannot understand why consolidation has not happened sooner. After all, basic economic principles tell us that consolidation is the normal course of action for dealing with oversupply and excessive price competition.

Yet, the reality is that there are numerous non-economic obstacles to consolidation in the commercial satellite market. First and foremost, political barriers present significant impediments to consolidation of many of the smaller, regional operators, if not blocking their sale outright. This is a particular challenge in the Asian market where Northern Sky Research (NSR) counts nearly 25 active satellite operators and relatively low-capacity utilization rates in many parts of the region.

Second, the apparent price that buyers are willing to pay for smaller operators does not always meet the expectations of the current owners. Valuation of satellite assets and the potential for future revenues is no simple matter and is subject to wide variation depending on a range of assumptions. Further, there are intangible benefits, such as being able to enter new markets, which may be valued more highly by some potential buyers than others. EuropeStar was clearly a non-core asset for Alcatel Space, yet it took the company two years to sell this small satellite operator, and some not unexpectedly are quick to claim that PanAmSat had overpaid for this asset. (It is not my role or my company’s role to judge whether or not PanAmSat made a wise purchase, but this example does illustrate many of the challenges in making consolidation a reality).

Those who do promote the consolidation route often contend that one of the primary benefits will be the efficiencies gained by concentrating demand onto a smaller number of active satellites. Once again, the reality is that securing efficiencies through consolidation is rarely as simple as taking satellites off orbit.

A typical situation may be that a satellite operator holds several long-term contracts for services at a particular orbital location. The contracts may only fill half of the satellite’s capacity, but this is often sufficient to generate a positive return on investment.

As the time comes to replace the satellite asset, few operators elect to decrease the size of the satellite asset to match existing demand levels, because the marginal cost for the extra capacity is very small.

Additionally, an operator does not want to risk losing out on future business because of a full satellite. Even in orbital locations where leased capacity is very low, most satellite operators are highly reluctant to forsake the launch of a replacement satellite and give up an orbital slot. Many licenses for orbital slots were won in competitions, and satellite operators are obliged to have a satellite in the location in order to continue providing services.

Further, if they were to give up a slot, the satellite operator would be fearful that an existing or new competitor would gain rights to the slot and launch a competing satellite, even if it meant that all players were to be hurt by lower average pricing due to excessive competition. An example of this state of affairs came when New Skies effectively used the threat of occupying its 125 degrees west orbital slot before its December regulatory deadline when it was in negotiations to sell the rights to this location to SES Global.

Another argument in favor of commercial satellite market consolidation contends that the market is highly fragmented. From certain points of view, this may be true. Depending on how one counts, there are over 40 satellite operators competing in the market. Yet, Northern Sky Research’s recent “Global Assessment of Satellite Demand, 2nd Edition” study demonstrates that in terms of leased C- and Ku-band transponder capacity, the top five satellite operators (Intelsat, PanAmSat, SES Global, Eutelsat and New Skies) control 63 percent of the market.

When examining market share based on 2004 revenues, the top five satellite operators (SES Global, Intelsat, Eutelsat, PanAmSat and JSAT) generated 65 percent of all revenues in the industry. By adding in the smaller satellite operators in which the top five hold an ownership stake (therefore being able to influence the smaller operator’s business planning), 72 percent of the industry revenues already are concentrated within the largest operators.

A merger of New Skies Satellites or Loral Skynet into one of the top five pushes that figure up to three quarters of all commercial satellite revenues.

If one looks carefully, consolidation appears to be mostly taking place at the top end of the industry, with only a few exceptions. There will probably be a few additional smaller operators swallowed up by the leading players, but as with EuropeStar, these transactions will tend to be strictly financial purchases that are unencumbered by politics.

Moreover, the push for consolidation appears to be more driven by financial gain than by any real attempts to correct the underlying oversupply situation. The top satellite operators were taking steps to reign in their launch of satellites well before private equity entered the game and, the fact is, the commercial satellite industry seems to be spawning new satellite operators faster than it consolidates among existing players.

Quetzsat and Ciel Satellite Communications are two of the latest entrants and perfectly illustrate how national and political policy forces the creation of operators in order to secure orbital slots. Other up-and-coming operators that could well launch services in the next few years include Rascom, Nigersatcom, a still forming Venezuelan initiative to launch a satellite called “Simon Bolivar,” and the venture capital backed ProtoStar.

Consolidation for financial gain is not a bad thing in and of itself. If anything, it shows that when companies like Kohlberg Kravis Roberts & Co. can make a four-fold gain in just over one year, then most us are probably in the wrong business. Yet, here is the case of the first private-equity investor getting out of the industry, and little has really changed in the market fundamentals.

The regions suffering from oversupply and severe price competition remain unchanged and, at least in the case of Latin America and potentially Eastern Europe, the situation may well get worse before it gets better. A few satellite operators are truly trying to rei n in capacity growth, but this does little good if the industry as a whole does not work together.

Overall, a number of outright mergers will be inevitable given the current environment of the commercial satellite market. However, it appears that partnerships and ownership stakes among the players will dominate the efforts to better align the on-orbit capacity to meet the actual demand being generated on the ground.

The recent partnerships between Measat and the Indian Space Research Organisation and the Russian Satellite Communications Co. and ChinaSat are perfect examples of this trend.

No one should expect that consolidation will be the wonder drug that will cure the ills of the satellite industry. Too many factors, business and non-business, come into play. The simple fact is that our industry today is already dominated by a small handful of players. This is true even more so today than just two weeks ago.

Patrick M. French is regional director, Europe and senior analyst at Northern Sky Research, based in Strasbourg, France.