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Long road ahead for EchoStar merger

The proposed $25.8 billion deal between Hughes Electronics and EchoStar Communications is already fanning the flames of consumer discontent.

Patrick French, a research analyst with Frost and Sullivan, says the Echostar-DirecTV merger will spawn a satellite giant. (4:10)

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The proposed $25.8 billion deal between DirecTV parent Hughes Electronics and EchoStar Communications, which would create a satellite TV company bigger than any cable TV rival, is already fanning the flames of consumer discontent.

Announced Monday, after a final weekend of brinkmanship negotiating between General Motors-owned Hughes, EchoStar and Rupert Murdoch's News Corp., the deal would create a satellite television behemoth finally able to wield the kind of market power that has been commonplace in the cable industry for decades.

That, critics say, is exactly the problem. Satellite TV has been hailed as a force for competition in a business where cable companies otherwise have local monopolies over subscribers. The satellite industry has grown quickly, capturing close to 20 percent market share offering lower prices and more stations than cable companies.

Allowing the two biggest satellite providers to merge would halve that competition at a time when the cable industry itself is in the midst of consolidation, and new businesses such as broadband Internet and phone services are just beginning to reach consumers, critics say.

Analysts say it will provide one of the first real tests of the Bush administration's more open market policies and a more merger-friendly Federal Communications Commission.

"If the current administration was not in office, I don't think the merger would have a snowball's chance in hell," said principal analyst Michael Harris of Kinetic Strategies, who believes the deal is unlikely to pass regulatory muster.

The combination is the first big consolidation in the satellite market, which has remained on the sidelines over the past few years as cable TV and telecommunications markets have been reshaped by a litany of mergers worth tens of billions of dollars. Federal antitrust officials have given most of these a conditional green light, blocking only the proposed merger between WorldCom and Sprint, which would have linked the No. 2 and No. 3 long-distance companies. Comparisons to that merger, according to EchoStar's Chief Executive Charles Ergen, are "apples to oranges."

The deal comes after months of on-again, off-again negotiation. General Motors was fairly open about its desire to sell its Hughes Electronics subsidiary, an unpopular division with the company's shareholders.

The market's odds-on favorite for a buy was Murdoch's News Corp. Murdoch had been circling the division for its DirecTV and DirecPC satellite assets for more than a year, but EchoStar's bid ultimately proved more attractive to GM's management.

Big but not that big?
The logic of the deal lies largely in the $25.6 billion in cash and stock Ergen offered. But executives also touted the advantages of finally having an entity in the satellite business that could rival the big cable companies.

"We've always had a vision at EchoStar about trying to compete with cable and, for the first time, I think we've really put together a company that can do that on all levels," Ergen said in a conference call announcing the deal.

The two companies, which would be led after the merger by Ergen, now have the task of persuading regulators that even together they are in fact a tiny competitor in the face of cable TV's might, and that their link poses no threat to competition.

Ergen and GM Chief Executive Rick Wagoner noted that cable TV companies control 80 percent of the non-broadcast TV market. Their combined operations make barely a dent and should not warrant antitrust concerns, they said.

Analysts tell a different story. In each market, cable companies essentially have a monopoly. Satellite products have come in to loosen that dominance, and with both companies competing most urban centers now have three competitors offering similar services. Allowing the two companies to consolidate would drop that to two.

EchoStar's Dish Network has about 6.9 million subscribers, while Hughes' DirecTV system numbers more than 10 million customers. By contrast, AT&T Broadband, the largest traditional cable operator, serves about 16 million households. The rumors that AT&T Broadband is now up for grabs were not lost on the architects of the satellite merger.

"We know we're going to have to see consolidation in the cable monopoly and they're only going to get stronger. We have to be proactive to go after and compete against that," Ergen said.

But David Kaut, an analyst at Legg Mason, notes that there is very little precedent in past government merger reviews that permits a market from shrinking from three players to just two.

"Generally, most market economists don't think that two competitors is the best way to run a market," said Kaut. The merger "faces a pretty high bar."

Consumer groups will also watch the pending union with a close eye. Satellite TV providers obviously have a monopoly where cable companies cannot reach, so moving from two providers to one creates a potential hazard.

"There's competition without competitors," said Mark Cooper, the director of research at the Consumer Federation of America. "You just can't hide the fact that these markets are becoming more consolidated and the jargon of competition does not match the reality that's in the marketplace."

Cooper says the combined company may have to kowtow to the government in some areas and agree not to discriminate against rural subscribers who cannot get cable service.

Now comes the hard part
The industry's growth rate alone also could raise warning bells. Industry research group The Carmel Group estimates that the cable industry as a whole will add about 400,000 new subscribers this year, a very slow pace compared to EchoStar and DirecTV which added a total of 785,000 in the third quarter alone.

Also in the mix is the satellite industry's ability to offer broadband Internet service, a small market now but expected to grow larger as each company launches a new generation of technology over the next few years.

Many analysts downplay this effect. Satellite feeds are important for rural areas, where the costs of laying DSL or cable modem infrastructure are prohibitive. But the overall effect on the market is likely to be slim for years, and thus not a large part of a competitive review, some analysts say.

Satellite access "is too limited and too expensive to deploy so I think it will be a niche market," said senior analyst Ken Twist of RHK.

Ergen too downplayed this market, saying, "We really don't have an industry there today."

However, the threat of a more powerful satellite company could force cable companies to lower prices, bundle Net access with TV or otherwise improve their own Net service, indirectly helping to boost broadband access, Carmel Group analyst Jim Stroud said.

Whatever the result, the next few months are likely to be marked by an uphill lobbying effort, with no guarantee of success in Washington, D.C.

"If Charlie Ergen thought buying DirecTV was an arduous process, wait until he sees the regulatory process," said senior analyst Michael Goodman of The Yankee Group.'s Ben Heskett contributed to this report.