By Sam Silverstein

In the wake of a burst telecom bubble that threw the satellite communications business off its fast growth track and into a multi-year tailspin, a newly arrived crop of private financial backers has been taking over much of the industry and priming it for improvement. Having sensed a unique opportunity to enter the storied industry as it regroups in the face of a sharply changed business landscape, these investors are taking a back-to-basics approach that emphasizes bottom-line performance over technological advances–and promises to strengthen a market sector that many believe had raised its sights too high.

Indeed, what began as a new phenomenon when Eutelsat started selling itself to private investors following its 2001 privatization, has now come to define the satellite communications industry. A host of prominent satellite communications operators–including New Skies Satellites and Panamsat as well as Eutelsat–now are partially or fully controlled by investment groups that use privately raised money to take stakes in businesses and then actively move to improve their profitability before selling out a few years later.

In addition, another high-profile satellite operator, Loral Space and Communications of New York, is preparing to emerge from bankruptcy and will likely count its creditors among its owners once the company’s reorganization is complete in early 2005. London-based mobile-satellite operator Inmarsat was taken over by private equity owners at the end of 2003. And, after abandoning long-delayed plans to go public, Washington-based Intelsat has been working to close a deal to sell itself to a consortium of private equity firms.

"The cash-flow characteristics of this business are very attractive," says Eliot Merrill, a New York-based principal with the Carlyle Group, a private equity firm that purchased a stake in Panamsat in mid-2004. "There are a number of areas where we can add value. We try to be very proactive in assisting management teams to maximize the market."

It all adds up to a dramatic shift for an industry that not long ago basked in the glow of its coming-of-age on Wall Street as stock market investors gobbled up satellite company shares and analysts dedicated to covering satellite stocks appeared for the first time. Now that the industry’s growth has slowed and satellite operators are grappling with transponder overcapacity in many parts of the world, satellite stocks have become less attractive, paving the way for other kinds of investors to step in, says Tom Watts, satellite analyst with SG Cowen in New York.

One private investor familiar with the satellite industry says: "There will come a time again when satellite companies are growing fast enough for the public markets. But for now, the private equity community is the next best thing. We’re OK with slower growth."

According to sources in the publicity-shy private equity world and across the satellite industry, several key factors have converged to make the satellite industry ripe for an ownership transformation. For starters, satellite companies and their backers, long focused on the growth-hungry public markets, have lately grown increasingly receptive to transactions with private investors. At the same time, low interest rates have fanned the market for the high-yield debt instruments private investors depend on to make acquisitions.

It also helps that satellite companies have the potential to be very profitable and can lock-in customers for long periods of time, says Gilbert Saada, a member of the executive board of Paris-based Eurazeo, which owns a large stake in Eutelsat through an investment vehicle known as BlueBirds. "The banks that can provide financing are very happy when you have visibility and profitability," Saada says.

Moreover, satellite operators by and large have finished the costly process of updating their satellite fleets, meaning the industry’s next large round of heavy capital expenditures on new spacecraft is at least a few years off. "The fact that the industry as a whole is at the end of a cap-ex cycle is a real enabler," says Daniel S. Goldberg, CEO of The Hague, Netherlands-based New Skies, which closed a deal to sell itself to The Blackstone Group of New York in November. "It means cash flows can be used to repay debt, not pay for new satellites."

Watts says private equity firms can be expected to strengthen the satellite industry’s focus on the bottom line and he predicts that operators will cut back on spending during the next several years as the new investors look to build value in preparation for selling the companies for a solid return. He noted that these types of investors typically look to move on within a few years after making an investment, suggesting that they will work rapidly to increase efficiency while reducing costs.

But even as the new investors push satellite companies to make better use of their existing transponder inventories and produce better bottom-line results, they are unlikely to risk the industry’s long-term health, says Peter Jackson, CEO of Hong Kong-based Asiasat. Jackson’s company is partially owned by SES Global of Luxembourg, one of the few satellite operators that have steered clear of private equity investors. "They may be very conservative and look at the industry over the shorter term, but these people are not going to leave it a smoldering mess," Jackson says. "They have to have a terminal product with value."

Nevertheless, people in the private equity community say the satellite industry needs to become more cautious about spending money, especially at a time when many orbiting spacecraft have large numbers of unused transponders and already-low lease rates are under constant pressure. "It is fair to say private equity players scrutinize $250 million capital decisions closely, arguably more closely than the prior owners," says one investor. "These companies need strong financial discipline and focus at the board level and that has historically been lacking" because many key satellite industry shareholders, such as large telecommunications concerns, were distracted by other investments.

"It is not about changing the way the business is run; it is about changing the emphasis," says Patrick K. Brant, president of Bedminster, NJ-based Loral Skynet. Satellite executives have always paid close attention to making money, he added, but with the added scrutiny of investment bankers becoming a more prominent part of the mix, the industry is "putting more emphasis on financial performance and justification for projects… We are creating business solutions using satellite technology rather than using satellites for the sake of the technology."

Making this adjustment means concentrating heavily on making the best use of existing satellites before investing in more spacecraft, given the satellite industry’s continuing transponder overcapacity and corresponding depressed lease rates. "The industry cannot afford to replace $250 million satellites at $100,000 a year per transponder. Prices are at the bottom" and investors will press satellite executives to find ways to improve the situation, one private equity source says.

This source stressed that existing management teams are likely to remain in place despite the entry of a new group of active investors behind the scenes. "Investors will rely on the experts to run the companies, but they will make sure it is done in a disciplined and cost-effective way."

Giuliano Berretta, chairman and CEO of Eutelsat, says the satellite industry did not need a new crop of investors to impress upon executives the need to make changes in the way they run their businesses. He says the decline in new satellite orders in recent years is evidence that satellite operators have been making tough choices in the face of a difficult market. "Believe me, the discipline did not come from the new investors, it came from the overcapacity," he says.

Other satellite company officials also say they recognize the need for improvement and have the bottom line at the top of their agenda. "The industry collectively has overbuilt and all of us have to focus on making more productive use of the assets we already have," says Goldberg. "What we should be seeing over the next couple of years is just that. All of the operators should be focused very hard on the most productive utilization of their satellites."

Joseph R. Wright, president and CEO of Panamsat, says he has pushed for restraint since assuming the top job at the Wilton, CT-based satellite operator in 2001. The company, which had been controlled by the former Hughes Electronics Corp., recently was taken over by a consortium of private investors.

Under Wright’s leadership, Panamsat has resisted entering new markets and opted to replace several satellites with lower-cost spacecraft carrying fewer transponders. "Private equity firms bring financial discipline and I welcome them to our industry," he says. "We have been used to [this kind of discipline] for three years."

Wright added that Panamsat is working to increase its profitability by defining itself as a telecommunications solutions provider, not a satellite company. The company has been working for several years on hammering out joint ventures to expand its capabilities, Wright says, and it intends to tap the financial expertise and connections of its new owners to further the process of branching out.

"Existing management and new private equity shareholders will be able to learn from each other about the satellite business as well as corporate finance, management efficiencies and strategies to improve the bottom line," says Peter Nesgos, a partner with the law firm of Milbank, Tweed, Hadley and McCloy in New York, which has advised a number of players in the satellite industry.

Sources in the investment community say one way private equity investors could change the look of the satellite industry is by encouraging and facilitating consolidation. Given their desire to carve out efficiencies and strengthen profitability, these investors are likely to favorably view opportunities to combine operators as an effective way to improve the companies’ worth and position them for eventual sale to other private or public investors.

"The opportunities for consolidation are enhanced by having companies that are able to execute on these types of opportunities quickly," Nesgos says, referring to the motivation of private equity investors to continuously build value in a company they own in anticipation of eventually selling it at a premium over what they paid.

Goldberg says private equity investors are well-suited to hammering out alliances between satellite operators because they combine a sharp focus on improving financial performance and increasing efficiency with broad expertise in arranging often-complex deals. "They are skilled at arranging financing and that makes it all the easier to do a strategic transaction," he says.

According to Wright, Panamsat is particularly excited to be allied with a team of private equity investors because the company has spent the past several years waiting for its ownership situation to be sorted out.

The company had been preparing to join Echostar Communications Corp., the Littleton, CO-based direct-broadcast satellite company that tried unsuccessfully to take over Panamsat’s parent, Hughes. That deal fell apart because the U.S. government did not want Hughes’ DirecTV satellite television arm under the same roof as Echostar’s Dish Network. Following the dissolution of the Echostar deal, Wright and his team had to stand by as Sydney, Australia-based News Corp, which bought Hughes, decided what to do with Panamsat.

With the ownership issues aside, Panamsat will be free to pursue the kinds of alliances and other transactions that can strengthen the company and help it stretch out further beyond its roots as a supplier of satellite capacity, Wright says. The private equity firms "will give us more opportunities than we have had before," he says. "We have not been able to be as active as we are going to be."

Investors say another way private equity sponsors are likely to change the satellite industry is by moving away from the stock market’s emphasis on earnings before interest, taxes, depreciation and amortization (EBITDA), because this popular measure of a satellite company’s performance does not fully take into account other components of the business, such as the high up-front cost of new satellites. "You should never look at a multiple that strips out [much of] the cost of doing business, but that’s what public owners did with the EBITDA margins," one investor says.

Beyond bringing an active, bottom-line-centered approach to running businesses, private equity shareholders also do not have to deal with the kind of public scrutiny that comes with selling shares on the stock market. That difference could be significant for investors in the satellite industry, which has grown accustomed to the public disclosure of financial and operational data that enables firms to gauge the relative performance of other satellite operators, says Rob Kisilywicz, chief financial officer of SES Americom of Princeton, NJ. The satellite operator is a unit of SES Global. "How much transparency there will be remains to be seen," Kisilywicz says. "This is one of the issues we are concerned about… It is important to be able to benchmark competitors."

But Kisilywicz predicts that the same forces that drive private investors to strive for efficiency and financial improvements when they make an acquisition will push them to avoid too much secrecy. "If they eventually want to relist the companies [on a stock market] they need a fairly high degree of visibility and transparency."

Kisilywicz says SES Americom figures it will enjoy a unique advantage as its brethren in the satellite industry operate under the private equity umbrella and focus on improving their balance sheets even if that means putting growth-oriented activities on hold. "This is a favorable development for us and it will give us a unique window to execute on our strategy," which includes building its presence in new markets, he says. These activities include supporting mobile broadband applications and further developing the company’s Americom2Home venture, a service aimed at direct-to-home firms such as Echostar.

Wright countered by pointing to the vast contact base and dealmaking expertise Panamsat’s new owners bring to the table. "We have got more than just capital support," so the company will be able to move forward with expansion plans even as it strives to produce strong results, he says. "We are very lucky."

Goldberg agrees that satellite companies have plenty to gain from being aligned with private equity firms. "They want the companies they buy to thrive and succeed so their investments will pay off. It’s a nice change to have one shareholder who is very knowledgeable about our business and sector," he says.

The ownership changes occurring across the satellite industry also stand to affect Intelsat, which announced in August 2004 that it would be taken over by a group of private equity investors. But company spokeswoman Jodi Katz, citing the pending deal, says Intelsat officials could not comment before this article went to press.

Sam Silverstein has been covering the commercial satellite industry for 11 years. He is a freelance writer to Via Satellite