Hughes Faces Challenging Transition

by

Hughes Communications Inc., the company that virtually invented the VSAT business linking corporate networks via satellite, is undergoing a delicate transition to become a stand-alone entity moving into the consumer market with a satellite whose regulatory status is still up in the air.

Hughes owner SkyTerra Communications Inc. of New York and Atlanta is spinning the company off to SkyTerra shareholders starting Feb. 21 in a deal that is intended to raise $100 million.

Depending on shareholder reaction, the Hughes that emerges from the deal will be 67- to 81-percent owned by Apollo Management L.P., a private-equity investor. SkyTerra, which is focusing on two mobile satellite services ventures in which it has interests, MSV and Terrestar, will no longer have an ownership stake.

Hughes faces increasing competition in its core corporate data networks market but in 2004 it remained the dominant provider of VSAT — very small aperture terminal — satellite networks for businesses, according to the Comsys 2005 VSAT Report, an annual industry assessment by Communications Systems Ltd. of St. Albans, England.

“They are still the 800-pound gorilla,” said Simon Bull, a senior Comsys consultant and one of the report’s principal authors. “Our report shows Hughes with a nearly 56-percent share of enterprise VSATs.”

Hughes is followed by Gilat of Israel, with a 23.4-percent share; ViaSat Corp. of Carlsbad, Calif., with 10.9 percent; and iDirect Technologies of Herndon, Va., with a 4.2-percent share, according to the Comsys report.

But as it is spun off from its current owner, Hughes is facing a business environment in which, for the first time, it will have to survive on its own. Until 2005, the company was owned by DirecTV Group and its predecessor companies, whose ownership portfolio also included satellite-fleet operator PanAmSat Corp. of Wilton, Conn.

To link its customers and their Hughes-built hardware to satellites, Hughes leases capacity from commercial satellite companies. Hughes Chief Executive Pradman P. Kaul said Feb. 6 that the company leases 85 satellite transponders for its U.S. customers alone. Hughes also has operations in most other regions of the world and leases transponders on satellites covering those regions.

These leases are usually for several years. According to the stock-sale prospectus Hughes submitted Feb. 15 to the U.S. Securities and Exchange Commission (SEC), the company has total lease obligations of $232 million between 2006 and 2009, and an additional $103.1 million in lease contracts after 2009.

Hughes plans to launch its own satellite, Spaceway 3, by early 2007. The company intends to move many of its customers to that large, Ka-band satellite to reduce its leasing costs, but has not been clear on how it will implement this transition.

Mike Cook, Hughes vice president for North America, said Feb. 9 during the Satellite 2006 conference in Washington that the goal is to encourage Hughes’ consumer and small-business broadband customers — Hughes had 275,000 of them as of Dec. 31 — to adopt Spaceway.

But using Spaceway will require customers to purchase new equipment to communicate in the satellite’s Ka-band frequencies. It remains unclear whether, or by how much, Hughes intends to subsidize the purchase by its customers of the new hardware.

Neither Kaul nor Cook would detail Hughes’ plans because of SEC rules on releasing information during a stock introduction.

According to the Hughes prospectus, the Spaceway business poses other challenges beyond the consumer hardware issue.

Despite having spent years preparing for Spaceway, Hughes does not yet have U.S. regulatory approval to launch and operate the satellite in orbit. The company suggests it is searching for orbital slots controlled by other nations, but that these slots are not fully coordinated with existing or planned satellites in nearby locations.

Similarly, Hughes has not secured regulatory approval to sell Spaceway services in the United States, its principal intended market. The company “has not yet applied for or received any such authority,” the prospectus says.

Bull of Comsys said that as his company assembled the 2005 VSAT report, no one at Hughes mentioned that Spaceway remained unlicensed. “I am surprised. I just assumed it had been licensed along with the two other Spaceway satellites now owned by DirecTV,” Bull said Feb. 16. “It’s hard for me to believe that Apollo would let something like this slip through.”

DirecTV, when selling its stake in Hughes to SkyTerra, kept title to two of the three Spaceway satellites and plans to use them for high-definition television broadcasts.

As part of the sales agreement, Hughes agreed that in two months — by April 22 — it must stop using the DirecWay name for its broadband data service. The name belongs to DirecTV. DirecTV has partial rights to compete with Hughes immediately, and full rights when a non-compete agreement expires in 2010.

Hughes must therefore expect to incur heavy sales and marketing charges as it re-brands its service. As of early February, a Hughes sales campaign in the United States was still using the DirecWay name.