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Down in Flames

What's good for General Motors is not good for the country.

That's the harsh assessment FCC Chairman Michael Powell delivered in rejecting Charlie Ergen's $30 billion bid to take over DirecTV parent Hughes Electronics, which is controlled by General Motors.

In voting 4-0 to shoot down the deal, the commission dismissed the central arguments that the EchoStar Communications chairman has spun in the 11 months and 11 days since the deal was first cut: that a single, strengthened DBS provider would compete more vigorously with cable operators and provide more services to customers than EchoStar and DirecTV could separately.

Instead, FCC officials—and probably anti-trust staffers at the Department of Justice—have riveted on how the multichannel video business would go from three players in most markets—one local cable system, DirecTV and EchoStar—down to two. In rural areas not served by cable, the number of players would go from two to one.

Now Ergen is furiously scrambling to keep the deal together, planning to file within 30 days a revised application for the FCC to transfer DirecTV's licenses. He's already making proposals to the DOJ, which DirecTV and EchoStar executives believe is also planning to turn down the deal.

Before the FCC's official rejection Thursday, Ergen acknowledged that he was proposing "structural changes" that would "mean new entrants in the marketplace." He wouldn't offer details, but analysts and industry executives believe that his checklist includes handing licenses for a satellite at 61.5 degrees west longitude to Cablevision Systems, which controls other frequencies in that slot. Another option would be to create "open-access" EchoStar and DirecTV's transponders, letting an outside company run a competitive DBS business on their birds. The most drastic option would be to cede EchoStar's satellite hovering at 119 degrees west.

FCC officials specifically objected to putting all three DBS "full CONUS" slots—those capable of delivering TV to the entire continental United States—in the hands of one company. In addition to 119 degrees west, a merged EchoStar-DirecTV would also have had full CONUS slots at 101 degrees west and 110 degrees west.

Despite considerable skepticism among satellite experts, Europe-based satcaster SES Americom says it plans to launch in late 2004 a DBS satellite at 105.5 degrees west, between existing birds owned by EchoStar and DirecTV. But, for SES to move forward, EchoStar must reposition somewhat its existing satellite and allow SES to piggyback on EchoStar spot beams used for local broadcast channels.

But Ergen is clearly floundering. "There's no easy or quick fix here. They have a very steep hill to climb," said FCC Media Bureau Chief Ken Ferree. "We're looking at years out before there would be real competition provided by these services." FCC officials also noted that Ergen has had a year to make changes if he wanted.

The exploding deal is a huge embarrassment for General Motors, which pulled all the strings on the sale of Hughes, a "tracking-stock" subsidiary. GM is selling because it needs cash to meet obligations in its car-manufacturing operation. In accepting EchoStar's $30 billion bid (which valued Hughes at $22 a share), GM, which owns 30% of the stock, rejected a competing offer from News Corp.'s satellite-hungry Rupert Murdoch, who started pursuing DirecTV in February 2000 (when Hughes was trading at $32 a share and GM was seeking $45).

But Hughes is trading at just $9 a share. And selling it again (probably for around $15 billion) could take a year to complete.

"Not only will GM probably get less," said one media investment banker, "but they have to wait for any money."

If the EchoStar deal craters, Murdoch will still be standing there, no doubt chuckling over his lobbying efforts against the deal. He dismissed as a "myth" well-documented assertions that he was lobbying against the merger. Though acknowledging continuing interest in DirecTV, he said he would have to wait to see whether he would pursue it again.

"A long time has gone since we last looked at that company," Murdoch said. "It had a lot of problems them. We have to see whether they're better or worse."

Murdoch would be no shoo-in. News Corp. was stretching to come up with its last offer and had to secure backing from Liberty Media's John Malone and Microsoft's Bill Gates to make it work. Liberty acknowledges its interest. His old $23 million bid included $5 billion worth of stock in interactive-program-guide developer Gemstar-TV Guide International, then trading at $30 a share. Gemstar shares now trade at $3 each.

A breakup is widely expected to spark a fight between GM and EchoStar. Ergen can appeal the FCC's rejection a couple of ways. If regulatory approval isn't secured by Jan. 21, though, the deal calls for EchoStar to pay Hughes a $600 breakup fee. Ergen would also have go forward with a planned $2.7 billion acquisition of Hughes's 81% stake in ailing international satellite operation PanAmSat. But there are ways out, and Wall Street executives widely expect Ergen to balk at paying the fees.

While, early in the week, EchoStar and DirecTV begged the FCC for more time to revise the deal, Ergen knew the turndown was coming. At a poker game in a Hughes-rented room at the Waldorf Astoria Hotel Tuesday night, a relaxed Ergen hinted to other players (losers for the most part, a witness said) that he expected an adverse decision by the end of the week.

Adverse it was. Powell blasted the DirecTV deal, dismissing Ergen's proposal for rules to guide EchoStar's pricing in rural areas with weak or no cable competition, where DBS has a huge capacity edge. "The combination of EchoStar and DirecTV would have us replace a vibrant, competitive marketplace with a regulated monopoly," Powell said. "This flies in the face of three decades of communications policy."

Powell rejected EchoStar's assertions that the DBS providers don't compete with each other and must combine channel capacity in order to offer local broadcast channels in every market.

The ability to match local cable systems' delivery of local TV stations is considered to be key in competing with MSOs. "The record shows that each company standing alone will be capable of offering local broadcast stations to 80% to 85% of American homes in a very short time."

Although antitrust experts predicted the deal would go down in smoke almost as soon as Ergen's offer was announced, FCC officials say they were baffled by Ergen's inability to read the tea leaves. Beyond his initial offer to submit to a national pricing plan, no hint of additional concessions was revealed until last Monday.

Yet it's hard to blame Ergen solely for the communications breakdown. No commissioners other than Powell had more than cursory discussions about the deal. In the meantime, Powell and Media Bureau staff obsessively guarded any hint of their thinking in order to stem what they apparently view as the most terrible outcome of all: that their plans would be leaked to the press before set in stone.

Only two weeks ago did a shocked Ergen realize that the FCC was going to knock down his deal rather than take the customary route of waiting until separate negotiations, possibly leading to EchoStar concessions, with the Justice Department concluded. Equally shocked were commissioners when they found out Ergen was willing to deal. "We were taken aback that they waited so long to say there were all these things they were willing to do," said one commissioner's aide.

Technically, the FCC cannot reject the merger outright. Instead, the decision is slated for a review by an FCC administrative law judge. The start of the administrative law process could take up to three months, and the proceeding itself conceivably could drag on for years.

Although administrative hearings for station license renewals were once quite common, examples of hearings for major mergers are scant. The last one occurred in 1966, when the Justice Department pressured the FCC to rethink its approval of the ITT-ABC merger. In that case, Justice fought a second FCC approval in court. On New Year's Day 1968, a little more than two years after the deal was announced, ITT dropped its bid rather than continue fighting the feds.

Despite Ergen's refusal to let the deal die, FCC officials and several Washington sources say he faces an almost insurmountable hurdle now. The biggest obstacle will be convincing either Justice or the FCC that new competitors would have a "significant market impact" within two years, a basic tenet of any condition imposed to offset a merger's harmful effects.