Shortly after EchoStar (NASDAQ:DISH) bought Sling Media in September the story mills starting grinding out reports that no sooner than Sling was absorbed, they’d be spun off into a new company with EchoStar splitting itself in half. That buzz gained ferocity a few days later on rumors that AT&T (NYSE:T) was circling to acquire one half. The stock surged and one analyst at Oppenheimer even upgraded his rating from Neutral to Buy.
From late September forward, the writing was on the wall that EchoStar was in some way putting itself in play. Their Chairman and CEO Charlie Ergen confirmed they were exploring it. Now, courtesy of an information statement filed with the SEC, details of the proposed spin-off are starting to emerge. A buyer could still step in to pick up one side before this all plays out, but one way or another, it’s looking pretty certain the company will split. In fact, it seems it’s not so much a matter of if as when.
Per the deal described in the preliminary review documents, it looks to be a stock distribution to existing investors. The current company would divide into two halves and trade as two separate companies on Nasdaq. Half one, which retains the EchoStar Communications Corporation name, would be renamed Dish Network Corporation. It would become home to the Dish Network satellite television service. Their 13.7m subscribers would remain with them.
The other half of the company would be called EchoStar Holding Corporation (“EHC”), with the possibility of a name change later. EHC would house the company’s wholesale infrastructure and hardware groups including their digital set top box business, the newly acquired Sling Media products and their Satellite Services business lines.
The basis of the separation is the thought that the infrastructure/hardware business has a far different value proposition than the subscription service and combined, the current vertical integration is actually a disadvantage. An independent EHC could sell to 3rd party services and vendors who otherwise would have been competitors. That includes both the sale of digital set top boxes to cable vendors, and the licensing of excess satellite capacity. The consumer subscription business (Dish Network), in turn, can more acutely focus on the customer experience and competition with rivals like DirecTV (DTV) and Time Warner (NYSE:TWC). Also, an independent Dish Network might be a better financial performer without the costs associated with hardware and manufacturing industries weighing on their books.
If the deal goes ahead, the characterization is that both companies will operate independently from each other. That’s potentially semantics. Proposed terms include management agreements that allow a handful of Sr. executives, including the General Counsel, CFO and CEO, to hold the same title and job at both companies. That may be part of a transitional process, and it’s possible, it could change. It’s also possible; however, that Charlie Ergen will remain Chairman and CEO of both. As the controlling shareholder of EchoStar he may be unlikely to let go.
The two companies would also be very much involved with each other in customer relationships. Notably, Dish Network accounts for more than 80% of the set top boxes that the hardware business sells and Dish Network also relies on the satellite services for distributing their programming.
Absent from much of the deal speculation is Sling Media. At this time, with the Sling Media deal not yet finalized (it’s due to close this quarter), the role of Sling’s executives in the new ECH spin-off are not defined in what’s been disclosed. How and where Sling fits with ECH, or how prominent it will be, is also unclear.
There are some grounds for speculation that Sling’s CEO Blake Krikorian could take a substantial management role. On the other hand, Sling represents a small part of the business today. Their near $30m in revenue is a tiny share compared to the plus $1b the rest of the combined hardware group earned in 2006.
The satellite and infrastructure business is also highly specialized and complex, both from regulatory and managerial levels. Those two facts insures a high probability that ECH will be run by an executive from with EchoStar’s ranks.
As likely as the spin-off is, on transactional and ongoing levels, deal faces a number of risks and questions. A few more that could be on any top ten list:
Pre Deal Issues
•Tax: No shareholder approval is needed, and the board of EchoStar seems behind it, but for a spinoff to happen, it’s certain that the IRS will need to assure the company that the divestiture will be classified with tax free status, that is, shareholders receiving shares in the two companies won’t have tax liabilities as a result. EchoStar reportedly requested a review of this in September.
•Regulatory: SEC and FCC clearances are likely formalities, but they’ll need to be assured before this deal happens.
Post Transaction Questions
•Will the separation of the two companies be enough for competitors to view them as truly independent? They share management and more than 80% of ECH revenue will come from Dish Network. Given the basis of the deal is partly to remove the shackles of competitive conflicts of interest, to allow the hardware to be sold to cable companies and others, if they aren’t viewed as independent, it’s trouble.
•Will the technology driven ECH be able to transition into a 3rd party sales model? Traditionally, as their heavy dependence on one customer suggests, they haven’t focused on selling their products to other companies. So, given the competitive nature of the set top box industry, can they make that transition and sell their products effectively against competition from Cisco (owner of Scientific Atlanta) or Motorola?
•Unused satellite bandwidth is something like a product sitting in inventory. If the company struggle to sell this, or has too much unused air space in a given quarter, will ECH have to take regular, and potential heavy accounting impairment charges to write that off?
•Streamlined to better focus on customer acquisition, and without hardware related costs on their books, will Dish Network be able to better compete with DirecTV and cable companies? That’s certainly the hope. But will it work? The companies’ gross subscriber numbers are relatively close but DirecTV viewers tend to be of higher income levels demographically according to reports. That opens the door to potential customer losses when economic conditions are poor. For example, in EchoStar’s current 3rd quarter earnings which were announced last week, Dish Network had a churn rate (or the rate at which they lost subscribers) increased from 1.94% from 1.76% for the same period last year. Some of that has been attributed as an indirect consequence of sub prime real estate problems and consumers being more cautious with their spending. Rival DirecTV in contrast saw its 3rd quarter churn decrease to 1.61% from 1.81%. As as an independent company, will Dish Network be able to acquire customers more effectively? reverse the churn patterns? reduce customer acquisition costs? Lots of questions, no certain answers.
•Can the hardware group that will form ECH actually make a substantial profit given their cost structure? Historically, they haven’t. For Fiscal 2006, the combined entities forming the spin-off had revenue o $1.52b but lost $34.1m. Sling, as something of a startup, isn’t poised to change that in the near future either.
•How will Sling Media fare in the new setup? EchoStar bought Sling for $380m in September and all indications are they want to make the TV Place-Shifting technology a significant part of their technology offering. Now, the SEC documents show Sling’s past financials for the first time. In 2006, the company has revenue of $29m and net loses of $20.9m. The company had about $10m in cash at the end of this past June and seems on track to show a 50 to 100% increase in revenue for 2007 (the holiday season is their biggest earning period and somewhat difficult to predict.) The growth numbers are positive, but how big can Sling be and when will they break even?
There are a host of other issues facing the deal. These are just the tip of the iceberg.