Pegasus: Contract Bars Post-Merger Competition

Pegasus Communications Corp. is claiming that contract terms protect it from future satellite competition if EchoStar Communications Corp. and Hughes Electronics Corp. — parent of DirecTV Inc. — close their proposed merger.

EchoStar chairman and CEO Charlie Ergen has publicly said he disagrees that the merged company would be barred from competing against Pegasus.

Although the companies are far apart on the scope of the contract obligations, Pegasus believes the dispute would ultimately be resolved out of court.

"[Ergen] will do a deal. He'll buy us," said Pegasus executive vice president Howard Verlin.

Pegasus, a publicly traded company based in Bala Cynwyd, Pa., resells DirecTV's service to about 1.5 million subscribers in 41 states. It has the exclusive rights to distribute to rural subscribers DirecTV's programming beamed from 27 transponders on a satellite positioned at 101 degrees West longitude.

The programming Pegasus distributes is a robust package of the most popular cable networks.

Currently, EchoStar uses satellites at other orbital locations to compete in Pegasus territories. EchoStar, Ergen said, serves about as many subscribers as Pegasus.

If the EchoStar-DirecTV merger closes, Pegasus claims that the merged company would be required to honor the exclusivity provisions agreed to by DirecTV.

"It would click in the day the merger is consummated," Verlin said. "They can only serve customers in our territory through 101."

According to Verlin, EchoStar has several options, but a purchase of Pegasus makes the most financial sense. He said the value of EchoStar subscribers inside territories served by Pegasus is about $3 billion, based on the per-subscriber price of the EchoStar-DirecTV merger.


Pegasus's market capitalization stands at about $300 million.

"He could buy us at $20 a share [valuing Pegasus at about $700 million]. It would still be cheaper than giving us 1 million subs," Verlin said. Of late, Pegasus's stock has closed trading at between $5 and $6 a share.

Pegasus is a member of the National Rural Telecommunications Cooperative. A decade ago, the NRTC invested between $100 million and $120 million in DirecTV in exchange for exclusive distribution rights in rural areas. Verlin said Pegasus has a contract with the NRTC that closely tracks its contract with DirecTV.

An NRTC spokesman last week said he agreed with Pegasus that in a post-merger world, the exclusivity provision would remain in force.

In November, Ergen told reporters that the contract required the merged company to permit Pegasus to continue distributing DirecTV programming from the 101 satellite, but it did not require EchoStar to abandon Dish Network subscribers attained in head-to-head competition with Pegasus.

EchoStar spokesman Marc Lumpkin last week said the company's position was the same one Ergen articulated last fall.

Verlin said Pegasus and EchoStar might meet in court after the merger to litigate the exclusivity provisions. But he said EchoStar could face a big financial hit if Ergen lost the case.

"[Ergen] might think he could get a better result by litigating it for a while. But here's something I feel strongly about: He might allow it to go initially to court, but he would never let it go to jury trial. Why risk losing $3 billion in value?" Verlin said.

Any deal with EchoStar would occur during the period when the Justice Department and the Federal Communications Commission appeared ready to approve the merger and when EchoStar and DirecTV actually sit down to sign the closing papers, Verlin said.

"As soon as [Ergen] has that path, he'll want to do a deal with us. Once it becomes apparent [that] he is committed to getting a deal done, our leverage goes up," Verlin said. "That's what makes business fun."

Two weeks ago, Pegasus filed comments at the FCC in opposition to the EchoStar-DirecTV merger, asserting that the deal would create a DBS monopoly for millions of American consumers.

"The merger doesn't have any serious likelihood of happening," Verlin claimed.

EchoStar has pledged to address the elimination of competition in rural markets by adhering to a national pricing plan in which DBS prices in competitive markets would prevail in monopoly DBS markets.

EchoStar has also committed to providing local TV service in 100 markets (up from about 40 today), rolling out one dozen high-definition TV channels, and creating a national high-speed Internet access service.

Enforcement of the exclusivity provisions against EchoStar-DirecTV would eliminate DBS competition to Pegasus.

"We become a monopoly," Verlin acknowledged.

But Verlin said people who oppose the EchoStar-DirecTV merger because it would create a monopoly could not make the same argument in opposing a possible post-merger deal between Pegasus and EchoStar-DirecTV.

The EchoStar-DirecTV deal, he said, would reduce the market from two DBS carriers to one carrier, but a post-merger deal with Pegasus — based on the assumption that EchoStar-DirecTV would have to honor the exclusivity provision — would substitute one monopoly for another and would not be a reduction in competition.

"Whether or not they buy us, the [EchoStar-DirecTV] merger will create a rural monopoly because we don't compete," Verlin said.