By Owen D. Kurtin

2004 may just go down in history as the year the satellite business started to rationalize itself, turned the economic corner and positioned itself to take on both terrestrial competition and the challenge of new service offerings. The year began with President Bush’s call in January for a U.S. return to the moon and a manned expedition to Mars; it winds down with the success of SpaceshipOne, the first privately financed manned spacecraft, developed, built and launched for $20 million. These events speak volumes about where the space business has been, and where it should be going.

In the satellite world, the year’s most dramatic news was the unprecedented entry of private equity firms into the space sector through leveraged acquisitions of several leading operators, including Intelsat, Panamsat, New Skies Satellites, Inmarsat and Globalstar. In the last two columns, we discussed the good and bad implications of private equity on satellite business ownership mentality, culture, strategy and finance. However, it is the ugly that poses the greatest danger: relentless focus on maximizing short-term profitability in order to boost valuations for an anticipated exit event, featuring abandonment of technical and service innovation and further hammering of manufacturers and launch service providers. If private equity investors can manage to avoid that kind of myopic death spiral, their participation in the space business will probably be a net plus.

The U.S. Open-Market Reorganization for the Betterment of International Telecommunications (ORBIT) Act’s mandate that former intergovernmental organizations (IGOs) Intelsat and Inmarsat follow their privatizations by floatation on the public markets has been effectively trumped by the leveraged acquisitions, and a good thing, too: the mandated IPOs at the very time of the stock market’s collapse would have decimated the operators’ valuations and probably imperiled their existence. The U.S. Congress is now wrestling with whether to enforce the ORBIT Act’s mandate. In the absence of legislative meddling, market forces, rather than legal mandates, will now dictate when the former IGOs are offered to the public.

The emerging services market has continued to show great vitality, and, most importantly for the satellite industry’s future, has skewed the arguments of some industry players that satellite service cannot compete with terrestrial service. Direct Broadcast Satellite (DBS) pickup of subscribers in areas well served by terrestrial cable and Digital Audio Radio Service (DARS) pickup of subscribers for home and office, in addition to in-vehicle use show what is wrong and right in the industry. Clearly, when the service offerings are superior, the price is competitive and the platform and technology are transparent and consumer-friendly, satellite service competes effectively with terrestrial service.

Not only should DARS and DBS restore the satellite industry’s confidence in its ability to take on terrestrial service, a confidence lost in the wake of the MSS debacle of several years ago, they also demonstrate that the future of satellite service lies in innovative service offerings, and should restore industry and market confidence in investing in those offerings’ development and roll-out.

What 2004 has brought then, is a substantial rationalization of the operator sector. The current operator paradigm should continue for the next three to five years, when the next major cycle of capital expenditure for satellite procurement and the average private equity exit horizon should coincide. That will be the time to assess the development of public market sophistication in valuing satellite assets and operator business models.

What is ahead? Perhaps, finally, some rationalization of the manufacturing sector. The manufacturing and launch services sectors stand to benefit from operator growth and vitality, but are not likely to be private equity targets themselves, since they lack the operators’ stable cash flows and customer bases and require enormous infrastructure investment and development. The manufacturers have resisted consolidation and launch service options have actually increased, aided in some cases by "national champion" support from governments and by status as structurally integrated parts of larger corporate entities. Specialization may provide an answer for some of these players, with de facto divisions between civil and government/defense work, large fixed and small mobile service satellites and other specialties acknowledged and becoming the effective preserve of different companies.

Then, too, operators, manufacturers and launch services providers may finally develop the will to attack the root causes of industry-wide overcapacity. They may choose to emphasize standardization and reliability and reduce production cycles in manufacturing. They may reduce costs to increase access to space and create a new generation of customers for themselves; and they may take stakes in each others’ ventures to develop new financing models. The year 2005 can be a memorable year in space; our guess is that the companies bold enough to embark on these steps are the ones that will want to remember it.

Michael Flynn co-wrote this article. Kurtin and Flynn are partners in the New York office of law firm Sonnenschein Nath and Rosenthal LLP. They may be reached at 212/768-6700 or by e-mail at [email protected] and [email protected], respectively.