by Christopher Mecray

In recent years, the U.S. military has increasingly relied on commercial capacity to carry broadband signals in support of global operations.

For providers swimming in excess capacity, this somewhat nontraditional market has been a welcome sponge of transponder space. Lately, however, we have heard more concerns about the sustainability of this market, particularly given Defense Department plans to add new broadband constellations to the proprietary military network. Are we nearing the end of a bubble of demand, driven by Iraq and Afghanistan operations that will further exacerbate the capacity glut for commercial operators? We think not. On the contrary, we suspect that the military-commercial market overlap will continue to grow, providing a critical layer of demand to fill the gap before commercial broadband services eventually take off.

Usage of commercial capacity by the military has already grown substantially since the early 1990s. Speaking at the recent SATELLITE 2004 conference in Washington, DC, Mike Kern of Lockheed Martin noted that bandwidth usage doubled in each campaign starting with Desert Storm, with a total 800-fold increase by Operation Iraqi Freedom. Essentially, available capacity on military networks was sold out and commercial substitute capacity was leased at record rates.

Though Kern noted a number of inefficiencies that could address some bottlenecks, such as the use of IP routers that could provide 3.5-6.0 times bandwidth multipliers, we find it illuminating to consider that assets in theater operations that use significant bandwidth, such as Globalhawk unmanned aerial vehicles and other surveillance platforms, were actually diminutive in number. (Only a couple of Globalhawks were actually used, but were critical in providing targeted data.) Post-operations analysis indicated a high reliance on real-time surveillance and broadband communication between U.S. Central Command and Doha, Qatar, as well as intratheater communication with new land force technologies. Given this, we would fully expect that bandwidth demand will continue to rise in the future at continued exponential rates in the coming decade.

What are the plans to address this rising demand? The Pentagon has a series of programs in place oriented toward replacing and augmenting broadband communications capacity, including Wideband Gapfiller Satellite (WGS), Advanced EHF Communications Satellite and Transformational Communications Satellite. Though WGS is fairly near-term, the others are set for launch in 2006 and 2011, respectively, and are both subject to potential technical delays that could push dates to the right. Though tough to assess, we suspect all three programs would go a long way in alleviating any current shortfalls, but it will be of limited help if the programs are pushed to the right, and clearly they will not be fully in place for some years even under the best case. Admiral Rand Fisher, who leads the Transformational Communications Study for the Pentagon (along with other National Reconnaissance Office duties), noted real concern regarding the ability to keep the Transformational Communications Architecture on track under current budget scenarios that provide $5 to $7 billion annually for all communications programs.

All this offers real hope for the commercial market. Under a combined scenario of continued demand growth and limited and delayed supply, military usage of commercial systems may grow even beyond current expectations. Meanwhile, some areas of the market are longer-term winners, such as international coverage in regions such as Asia, where 80 percent of current demand is fulfilled by commercial capacity. We also believe that a growing use of this capacity will allow the Pentagon to get comfortable with supplementing internal capacity, making partnerships with industry more structural in nature.

Other dividends to commercial players can be seen in terms of military offering "proof of concept" to some commercial services. As with any early adopter, the military can demonstrate the real benefits of mobile broadband with its use of vehicle-installed communications terminals, hand-held troop devices and other applications. Many of these have direct parallels for commercial markets, including the mobile "holy grail" of commercial automotive applications (think thousands of military vehicles versus millions of annual auto sales).

In summary, we believe it is not unrealistic to think of military-commercial overlap as a major element of the recovery story for satellite services as a whole. Though current projections for balancing supply and demand in the market call for convergence around 2008, a better-than-expected scenario for military markets could pull this forward by a year or so, depending on factors such as the military operations tempo, but possibly also by the realization that the commercial market is here to stay and the Pentagon might as well make the most of it.

Christopher Mecray is a research analyst with Deutsche Bank Securities Inc. The preceding comments should not be considered a recommendation concerning the purchase or sale of any security mentioned herein.