Boring Portfolio

More On Hughes
And its Big Birds

by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (June 2, 1999) -- Continuing with my look at Hughes Electronics (NYSE: GMH), I should note right off the bat that I bring zero specialized knowledge of this industry or company to the table. I'm a generalist investor trying to figure it out totally from scratch. At this stage in the game, I'm not trying to convince myself or anyone else of the intelligence or stupidity of investing in a company like this. I have no clue at this point, so I don't endorse the company or have any idea as to its prospects at the moment. So please let that be a guide to your reading.

Last Friday, I mentioned the acquisition of PRIMESTAR, a direct broadcast satellite (DBS) service with 2.3 million subscribers. The deal, valued at $1.8 billion at the time of the agreement, also brought some high-power satellite spectrum and satellites to Hughes. The plan here, as I understand it, is to convert PRIMESTAR's customers from a 36-inch dish to the various Hughes services, whether DirecTV or DirecDUO, and/or DirecPC, over a two year period. One of the main competitive conditions Hughes will have to deal with here is Dish Network, part of Echostar Communications (Nasdaq: DISH), giving out incentives for these customers to switch over to their network. Not a stupid idea, since at some point they break even on the customers and get a good lock-in on the customer with the equipment and the natural reluctance of people to switch away from something that works well.

Though subscriber acquisition costs aren't broken out on the income statement for Hughes, a competitive response will likely be seen in operating income, whether that comes through the gross margin line or directly in the form of increased operating expenses. Either way, if I were an investor here, I wouldn't expect the direct-to-home broadcast unit to generate profits tomorrow. I would vote for taking the earnings hit now as long as the company can offer a better or at least a competitive array of services, attract and lock in the customers, and make an economic profit on the customers amortizing customer acquisition costs over the life of the subscriber (from a managerial accounting standpoint, not from a financial accounting standpoint). From the viewpoint of economic profits, it doesn't matter how you account for the expenses, whether up front or over the life of the customer, because the larger loss today or a smaller but smoother accounting profit over the life of the customer both discount back to the same net present value.

Being that this is an economies of scale business with high barriers to entry, which normally means that such businesses are high fixed-cost, low variable-cost businesses, you want to get to scale. One of the big factors that plays into that process is legislation in Congress right now, which will have to be hashed out in a conference committee and voted on again (if I remember my government courses correctly). If passed, the law would allow the satellite companies to broadcast local network signals to subscribers in 50 million homes. I believe the gating factor on this is must-carry provisions, under which the satellite broadcaster would have to observe the same programming carriage rules that cable companies must observe. That's a gating factor because of bandwidth available on the satellites. So right now this would be probably the top 20 metropolitan statistical areas (MSAs) in the United States, though Hughes is adding capacity all the time and has rights to higher bands.

I don't know how many people know this, but these satellites aren't exactly drinking straws when it comes to data throughput. Right now, the company's DirecPC consumer edition can deliver 400 kilobits per second downstream and the enterprise edition provides anywhere from more than a T-1 to half a T-3 connection, or 3 to 23 megabits per second two-way connectivity using standard data network protocols. The company's next-generation project, Spaceway, will provide additional connectivity to consumers and enterprises and will act as what I interpret to be pretty much an access service as well as a telecom backbone, only via satellite rather than via terrestrial switches. I think I really should ask if I can stop out at Hughes in Germantown, Maryland (which is in our neighborhood) to learn more about this project. So far, Hughes has committed $1.4 billion to the project and the rumor is that AOL is going to step up on this one, as well.

No updates on the rest of the portfolio. Steady as she goes with Berkshire. Carlisle Companies (NYSE: CSL) announced an acquisition of a custom truck body manufacturer yesterday. Glad to see them committing some capital and adding to a core business.

Questions, comments, flames? Send them my way on the Boring message board. Congrats to the Sabres and good luck in the Stanley Cup finals.

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06/02/99 Close
Stock Change   Bid
APCC  +1 1/4   19.44
BRKb  +5       2316.00
CSL   +  3/8   47.44
GTW   -  5/8   59.19

                  Day     Month   Year  History
        BORING   +0.93%  -0.09%   4.43%  40.22%
        S&P:     +0.04%  -0.54%   5.65% 115.64%
        NASDAQ:  +0.85%  -1.54%  10.93% 133.67%

    Rec'd   #  Security     In At       Now    Change
  8/13/96  200 Carlisle C    26.32     47.44    80.20%
  4/20/99  460 American P    14.48     19.44    34.27%
 12/31/98   12 Berkshire   2276.17   2316.00     1.75%
   2/9/99  100 Gateway 20    72.38     59.19   -18.22%

    Rec'd   #  Security     In At     Value    Change
  8/13/96  200 Carlisle C  5264.99   9487.50  $4222.51
  4/20/99  460 American P  6659.25   8941.25  $2282.00
 12/31/98   12 Berkshire  27314.00  27792.00   $478.00
   2/9/99  100 Gateway 20  7237.50   5918.75 -$1318.75

                             CASH  $17972.40
                            TOTAL  $70111.90