US-based satellite operator EchoStar has entered into a strategic transaction with its sister company Dish Network that will see it take ownership of 5 of the latter’s satellites. Under the agreement, Dish will transfer ownership of EchoStar-1,…
US-based satellite operator EchoStar has entered into a strategic transaction with its sister company Dish Network that will see it take ownership of 5 of the latter’s satellites.
Under the agreement, Dish will transfer ownership of EchoStar-1, EchoStar-7, EchoStar-10, EchoStar-11 and EchoStar-14 to EchoStar along with approximately US$11.4m in cash.
In return, EchoStar will provide Dish with two issues of preferred tracking stock, which will track the residential retail satellite broadband business of EchoStar subsidiary Hughes Network Systems.
The private preferred tracking stock represents 80% of the economic value of Hughes’ retail business, while EchoStar will retain the remaining 20%.
EchoStar will continue to own all assets associated with the delivery of its satellite broadband service including Spaceway-3 and Jupiter-1 (EchoStar-17). It will also retain all economic interest in the wholesale satellite broadband business.
Hughes will continue to manage and conduct the day-to-day operations of the retail business. As of 31 December 2013, Hughes had approximately 635,000 retail satellite broadband subscribers in the United States.
The transaction is due to take place on 1 March and is expected to be tax free. Deutsche Bank acted as sole financial adviser to EchoStar on the deal with White & Case providing legal advice.
EchoStar’s enlarged fleet
The satellites that EchoStar will take ownership of have an estimated weighted average remaining useful life of nine years and will increase the size of the company’s owned and leased fleet to a total of 17 satellites.
As part of the agreement, EchoStar and Dish have entered into a long-term operating lease agreement for transponder services on the spacecraft. The satellite operator also expects to generate around US$145m of incremental revenue from the new satellites in 2014.
However, EchoStar will now be liable for the in-orbit incentive payments, estimated at approximately US$58.9m, to the manufacturers of those satellites.
The rationale behind the transaction
EchoStar’s announcement came as something of a shock to the industry, with some analysts questioning the logic of the deal.
In a research note, Chris Quilty of Raymond James wondered why EchoStar would agree to effectively sell an 80% stake in its ‘crown jewel business’ while further increasing its exposure to Dish, which is by far and away its largest customer.
In its Q4 2013 results conference call, EchoStar’s chief executive officer Michael Dugan sought to explain the rationale.
“We did valuations, obviously, on both sides of the transaction. We used discounted cash flow projections on both the broadband business as well as on the satellites. And that’s how we got both to the 80% and the US$11m of cash. We put all the factors in there in terms of what we believe was going to happen with the broadband business going forward as well as the satellites.
“You need to view the broadband business as a wholesale arrangement. We will be retaining the wholesale fees that we will be charging to the Hughes retail business.”
Emphasising the importance of retaining the wholesale business, EchoStar’s CFO David Rayner added: “You need to look at the real growth of the retail business since we launched Gen4 (Hughes’ high-speed broadband service). While our total subscribers have grown by 265,000 in total, the majority of that growth has been coming from the wholesale business.
“So when you look at the incremental growth coming off of pure retail, it’s not as much. In addition, the growth on the wholesale business is unaffected by this transaction.”
Clearing the way for more M&A
It became apparent in the analyst call that one of the outcomes of the transaction is that it will provide EchoStar with further scope for acquisitions.
Having agreed to purchase Solaris at the end of 2013, the company’s management admitted it is looking at other potential deals.
Rayner said: “Management and the board went through significant analysis on this. We do not believe it is a bad deal by any stretch of the imagination. We believe it is a positive deal and fuels our ability to pursue other strategic objectives.
“There is no specific acquisition that we’re willing to discuss. I mean, we’re always looking at alternatives. Ken Carroll (EVP of corporate and business development) and his group are very active in looking at opportunities, but there is nothing specific that we’re ready to announce or discuss other than we are interested in growth through M&A.”
Dugan concurred, “As we’ve told you a number of times, we’re very anxious to expand our business profile. This was a way to get us into a position where we really are financially in a better position to look at investments.”
Terrestar-2 to be used as EchoStar’s Solaris satellite
EchoStar also revealed in its 2013 results that as a result of its acquisition of the European S-band joint venture Solaris, the company entered into an agreement with Dish to provide for the ability to purchase the TerreStar-2 satellite.
Under the amended T2 development agreement, EchoStar has a US$55m payment option to take over the purchase right of TerreStar-2. Though it has yet to exercise this, it plans to do so in order to offer advanced mobile services throughout the European Union.
TerreStar-2 was designed to provide mobile services using S-band frequencies and is being constructed by Space Systems Loral. EchoStar revealed in a previous results call last year that it had been paying Dish to continue to its payments to SSL under its authorisation to proceed contract.
