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Sprucing up for a sale

As media suitors woo General Motors for the hand of Hughes Electronics and its DirecTV in merger, executives of the two satellite companies are fighting hard to make their operations seem as lustrous as they were a few weeks ago.

Hughes' Electronics' earnings stock continued its steep slide last week, propelled by word that DirecTV was having a harder time growing its subscriber base than expected. Hughes Electronics' earnings report last week offered the gory details. A $2-per-month basic-rate increase and ever-cheaper installs mean that customer churn is rising from 18% annualized to 20.4%, not huge but not a good sign. Subscriber growth in rural markets is slowing sharply. The company lost 600,000 of rival Primestar's 2.1 million subscribers in that takeover. And competition from newly fattened digital cable systems is stunting DBS growth.

Even though the snags have chopped 30% out of Hughes'stock price in two weeks, cable operators shouldn't cheer too hard. The snags mean that DirecTV's subscriber base will probably grow just 44% this year instead of the more than 50% that had been expected, with many of those subscribers coming out of the hide of MSOs. But they also show that, if DirecTV does get a new owner, it will have plenty of problems to wrestle with in getting the company to generate some meaningful cash flow.

"The market has been fearing that the DBS market has been slowing dramatically," said Merrill Lynch & Co. satellite analyst Marc Nabi. "It's slowed, but it's not that dramatic."

The operational problems shouldn't repel too many suitors. Even bulls believe that DirecTV's subscriber growth will peak this year. But, with DirecTV expected to break 10 million subscribers, the sale of Hughes has attracted primarily entertainment companies enticed by the national reach of the third-largest distributor of multichannel programming. That clout could be useful in fights against cable operators balking at carrying certain cable networks or broadcast stations.

"You've got to be looking at what happened between Disney and Time Warner," said a senior executive at one entertainment giant, citing the MSO's decision in June to drop stations owned by Disney's ABC network in a dispute over carriage of Disney's cable networks. "You might want some distribution of your own to counter that."

That's in part why suitors include Disney, Viacom and Sony. But the ones expressing the greatest interest are News Corp., which already has DBS operations in Europe and Asia, and General Electric Corp., which has a broadcast network and an existing satellite services division that competes with Hughes' other divisions.

Hughes is a "tracking stock" subsidiary of GM: It trades separately but isn't truly independent of the automaker. DirecTV has been such a success that GM and Hughes shareholders are pressuring the car company to fully spin it off or sell it, something GM acknowledges may happen.

Hughes Consumer Sector Senior Vice President Eddy Hartenstein insisted that DirecTV's subscriber growth remains solid, particularly in urban and suburban markets where the company has started to deliver the signals of local broadcasters via satellite. That "local-into-local" plan robbed cable of its biggest advantage over DBS. In some rural markets, growth has slowed, Hartenstein acknowledged, but in New York, Los Angeles and Boston, where local stations came on the bird this year, growth exceeded 50%.

But he does give fuel to one of investors' greatest fears: that digital cable can pinch DirecTV. Hartenstein noted that "we really got hurt" in Portland and Pittsburgh-both AT & T Broadband markets that are heavily pushing digital cable. DirecTV was not able to start delivering local broadcast signals in those markets until late spring. "Pittsburgh and Portland were anemic for us until we actually launched local-into-local there," he said. Analysts took his comment as evidence that local-in-local only offsets damage that digital cable can inflict on DBS sales.

DirecTV is moving ahead on technology to increase revenues and hold subscribers. It has started rolling out a combined receiver and TiVo personal video recorder that will allow DirecTV to try to create a video-on-demand service. The company is introducing boxes enabled for Wink interactive TV programming, improving its DirectPC higher-speed Internet delivery, and offering free installation, a $200 benefit.