Boring Portfolio

<THE BORING PORTFOLIO>
Bore Looks Skyward
Flying High Again

by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (May 28, 1999) The Boring Port once again looks skyward in search of an outstanding company at an attractive price. With this report, I'm kicking off our research on Hughes Electronics (NYSE: GMH), a subsidiary of General Motors Corp. (NYSE: GM). What I'm most interested in here is the array of satellite services operations at Hughes. With the acquisition of United States Satellite Broadcasting Company (USSB) and PRIMESTAR's 2.3 million customers, the company serves over seven million direct broadcast satellite subscribers around the world. At last count, DirectTV had 4.8 million subscribers and PRIMESTAR had 2.3 million subs. Over 90% of USSB's customers are also DirectTV customers, so the consolidated count includes USSB's 2.19 million customers.

The company is larger than just these businesses, however. With a huge variety of satellites of varying power and bandwidth capacities and a number of manufacturing and service operations, pulling apart the company to get at the heart of its value isn't going to be an easy project. First let's just parse out the various divisions of Hughes. The annual report does this just fine, by the way, but for the purposes of getting this straight in my mind and allowing people to bypass the annual report if they wish, I'll summarize and comment on the company below.

Hughes Space & Communications

"Hughes Space and Communications Company (HSC) designs and builds satellite systems for commercial customers worldwide and for the Department of Defense, NASA (National Aeronautics and Space Administration), and other U. S. government agencies. It also arranges for the launch and delivery of satellites in orbit... HSC enjoys a mix of government and commercial business, with approximately 75 percent of revenues coming from commercial customers. At year- end, HSC had orders for 38 spacecraft valued at $4.4 billion from companies and government agencies in eight countries. To ensure future access to space for its customers at competitive prices, HSC in recent years has bought more launches than the U. S. government, contracting for nearly 50 launches from six of the world's top launch companies."

In 1998, this division recorded revenues of $2.82 billion, up 13.6%, and operating earnings of $246.3 million.

"Hughes Network Systems (HNS) builds, installs, and services satellite and wireless networks for businesses and governments in more than 85 countries. The world leader in satellite-based VSAT (very small aperture terminals) networks, HNS also manufactures DIRECTV receivers, as well as subscriber equipment for its own high-speed Internet access service, DirecPC. HNS supports its networks worldwide with a variety of services, including shared hub service companies in the United States, Europe, India, Mexico and Turkey."

This division also manufactures DirecDuo equipment, which combines direct broadcast satellite capabilities with downstream Internet access of up to 400 kilobits per second.

1998 revenues were $1.08 billion, up 6.5%, and operating income was $10.9 million.

PanAmSat

This is the "world's leading commercial provider of satellite-based communications services." A majority-owned subsidiary of Hughes, PanAmSat trades on Nasdaq under the symbol "SPOT."

"The company serves hundreds of cable programmers and television broadcasters, as well as six current or planned direct-to-home TV services. Together, these direct-to-home services distribute more than 500 channels of programming to viewers in Latin America and the Caribbean, Southern Africa, and India. PanAmSat's spacecraft also provide global telecommunications services and Internet access to numerous businesses and telecommunications providers, including HNS. Over 99 percent of the world's population is within the coverage area of PanAmSat's 19-satellite fleet."

1998 revenues were $767.3 million, up 21.8%, and operating income was $321.6 million.

DirecTV

"DIRECTV has permanently changed the television landscape on three continents by offering a superior entertainment experience... DIRECTV leads the competition because it delivers exclusive and differentiated programming, with unparalleled quality and customer service. In the United States, DIRECTV is the largest direct-to-home television service provider. America's subscribers receive up to 185 channels of television shows, premium movies, sports, and pay-per-view events and 31 audio channels. Revenue per subscriber has increased each year, with U.S. subscribers spending an average of $46 a month in 1998...

"In Latin America and the Caribbean, with over 100 million TV households, the DIRECTV service is provided by Galaxy Latin America, LLC (GLA), a partnership that is now 70 percent owned by Hughes and includes major communications and media firms in Venezuela and Brazil. Broadcasting both in Portuguese and Spanish, GLA delivers 197 television channels and 35 audio channels. At year-end, GLA's DIRECTV subscribers were spending an average of $42 each month. The DIRECTV Japan partnership includes Hughes and nine Japanese firms. The service offers up to 153 television channels and 35 audio channels. Dozens of its programs have been created specifically for the Japanese market, including Asia's first interactive TV services. By year-end, DIRECTV Japan's subscribers were spending an average of $40 a month."

Not that I want to get into relative valuations, but if you want to value the company only on direct broadcast satellite subscribers, the entire company is priced at $3,399 per sub at the moment. That's with an annualized growth rate (annualizing off sequential growth) in paying subs of 36% for USSB last quarter. DirecTV subs grew at an annualized rate (same method as above) of 30.2%.

Now, what happens when you overcome a major objection potential subscribers have to signing up for these services? Provided legislation gets through Congress, which looks favorable but is in no way certain right now, subscribers will be able to receive the Big Four networks. This is currently a big hangup for a good deal of potential subscribers. I'm not looking for some sort of deathmatch competition here -- the game is not to stomp local broadcasters and cable operators. It appears to me that Hughes is trying to work with broadcasters, who naturally want to retain the value of their local franchises. Apparently, Hughes is rolling out the capabilities to allow local broadcasters to keep their local franchise while allowing consumers the choice of broadcast signal distributors. Seems pretty fair to me.

I'll learn more about these specifics as we go along.

DirectTV last year reported revenues of $1.82 billion, up 42.2%, and reported an operating loss of $228.1 million. Broadcast segment revenues increased 43.5% in the first quarter, to $556.6 million and operating losses for the quarter fell to $23.4 million, down from $31.6 million.

There's also the Spaceway element to the company, which I'll get to next week. I'm attaching a very preliminary spreadsheet today, which is nowhere near being ready as a base for assessing the value of the company. There are significant additions to be made to it. Getting everything together factually and conceptually so that I can project financials going forward is going to be a large task.

A note on these data. Right now, the company is not meeting its cost of capital and some might wonder why a value investor is even interested in this sort of company. I've commented on this sort of thing before, but to reiterate, we don't necessarily invest in companies that are easy to understand (I'm not a technophobe), we don't restrict ourselves to companies that are currently generating boatloads of cash, and we don't necessarily restrict ourselves to companies that are not capital intensive.

The beauty of satellite communications is incremental profitability. Once you cover your fixed costs, a significant amount of additional revenues drop into operating earnings. We prefer to invest in companies that exhibit high returns on capital or the potential to generate high returns on capital. Weighing those possibilities where the cash flow currently is unattractive is the trick. You can see the operating margin at PanAmSat. Even given a low capital turnover rate, margins like that can provide excellent overall returns on capital.

So this is a very raw project here. I welcome your input, suggestions, or flames on the Boring message board. And so as to not mess up their mojo, I will keep wishing the Buffalo Sabres good luck throughout the playoffs. Great job last night.

Have a good weekend.

Make a Living Foolin' Around.

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05/28/99 Close
Stock Change   Bid
APCC  +  9/16  38.94
BRKb  -1       2318.00
CSL   +  3/8   46.75
GTW   +  5/16  60.81

                  Day     Month   Year  History
        BORING   +0.32%  -0.36%   4.53%  40.35%
        S&P:     +1.59%  -2.50%   6.23% 116.78%
        NASDAQ:  +2.12%  -2.84%  12.67% 137.33%

    Rec'd   #  Security     In At       Now    Change
  8/13/96  200 Carlisle C    26.32     46.75    77.59%
  4/20/99  230 American P    28.95     38.94    34.48%
 12/31/98   12 Berkshire   2276.17   2318.00     1.84%
   2/9/99  100 Gateway 20    72.38     60.81   -15.98%


    Rec'd   #  Security     In At     Value    Change
  8/13/96  200 Carlisle C  5264.99   9350.00  $4085.01
  4/20/99  230 American P  6659.25   8955.63  $2296.38
 12/31/98   12 Berkshire  27314.00  27816.00   $502.00
   2/9/99  100 Gateway 20  7237.50   6081.25 -$1156.25


                             CASH  $17972.40
                            TOTAL  $70175.27

</THE BORING PORTFOLIO>