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Pegasus falters on downgrade

Pegasus Communications had its wings clipped by a couple of downgrades Friday and plummeted 22 percent. Analysts said the direct broadcast satellite company's first quarter was weak, and management's plans were confusing.

Shares in the direct broadcast satellite operator and distributor of DirecTV were off $5.54 to $20.54.

The company's first quarter included a few disappointments. Revenue was $214 million; though that was more than twice last year's $104 million, it less than the $221 million most analysts had been expecting.

The company reported a loss of $1.61 a share. First Call had expected it to report a loss of $1.50 a share. Subscriber additions were also lower--36,000, a 28 percent decrease from last year's first quarter and below analysts' expectation of around 40,000.

Furthermore, management warned that direct broadcast satellite revenue for 2001 would be $875 million, less than the $890 million to $990 million originally expected.

Morgan Stanley analyst Vijay Jayant downgraded the company to "outperform" from "strong buy," but said that while shares are likely to be weak in the near term, an anticipated consolidation in the direct broadcast satellite industry could bring good news for the company.

Bear Stearns analyst Robert Peck also downgraded the stock to "attractive" from "buy" and dropped his price target to $29 from $39.

Merrill Lynch analyst Marc Nabi maintained his "accumulate/long-term buy" rating on the stock, but lowered his price target to $34 from $49 as a result of the company's forecast changes.

Subscriber growth vs. profitability
But it wasn't just the company's disappointing quarter that troubled analysts. Management also said it was changing its long-term strategy to focus on profitability rather than subscriber growth. It has seen a sharp increase in subscriber acquisition costs, which were up $150 to $200, bringing the average cost to around $500 per subscriber in recent quarters.

In its drive to profitability, Pagon said he plans to reduce Pegasus' customer acquisition costs, a move that will impact new subscriber additions. On the conference call, management said that its current business model simply isn't beneficial to shareholders. It attributed this to higher subscriber acquisition costs and higher turnover rates, especially from more recent customers. These two factors have been denting the amount Pegasus gets in revenue from each subscriber.

Credit Suisse First Boston analyst Ty Carmichael called management's comments "puzzling," and adopted a more conservative growth forecast for the company based on increasing competition from EchoStar Communications (Nasdaq: DISH).

"While we have great respect for Pegasus CEO Mark Pagon, we do question his negative comments on the overall economic health of the industry as well as the rational used to justify the downward revision in the company's subscriber growth outlook," Carmichael said.

Bear Stearns' Peck said he will "talk with management over the next several days in order to get a clear understanding of the company's new strategy."

Though most analysts were critical of the move, C.E. Unterberg Towbin's William Kidd said the "bold action may confuse, but ultimately (it will) create value."

"At first blush, management's move may have caught some by surprise and is likely to be misinterpreted. We wouldn't be surprised if the market misinterprets the move as an ominous sign that the industry has suddenly dipped for the worse," Kidd wrote. But the final results should be positive, he said.