By Mark Crossman and Anh Steininger

Panamsat has finally outlined its long-awaited Internet strategy, Net/36, and this will be very positive for the company’s growth prospects going forward. Unfortunately, investors will not see empirical results from the Internet business until at least 2001. Due to the dilution involved with this strategy in the next two years, we have lowered our estimates.

In the near-term, we have lowered our 2000 and 2001 EBITDA estimates from $759 million and $890 million to $728 million and $806 million, respectively. This lowers our 2000 and 2001 EPS estimate to $0.86 and $0.48 from $1.08 and $1.38 respectively. As a result, we have also lowered our target price from $75 per share to $63 per share. Even with the dilution associated with the Internet strategy and the downward revisions to the core business, the company should generate 27 percent revenue growth and 18 percent EBITDA growth in 2000 and a minimum of 10 percent revenue growth and 11 percent EBITDA growth in 2001. As the company demonstrates that it is capable of achieving these numbers in the second quarter and beyond, investors will again focus on the cash flow story. We are maintaining our long-term buy rating.

The Internet announcement is very positive; however, it will be dilutive until 2002. While having an Internet strategy is key to Panamsat’s future growth and multiple expansion, Net/36 will be costly to Panamsat for the next two years. In the first year, 2000, Net/36 should dilute earnings by $0.22. In 2001, Net/36 should dilute earnings by $0.30. Our estimate for 2000 is slightly higher than management’s guidance of $0.20 and in the middle of management’s guidance of $0.25 to $0.35 in the second year. In 2002 and beyond, the company expects the project to be earnings positive. In 2001, Net/36 should generate $28 million of revenue, ramping up to $286 million by 2005. In 2005, Net/36 would account for 18 percent of total revenue. If successful, the project has the potential to account for a greater portion of the mix. On an EBITDA basis, Net/36 should add $28 million of EBITDA in 2000 and $23 million of EBITDA in 2001. In 2005, Net/36 can add $174 million of incremental EBITDA.

Details of Internet Strategy

Panamsat has formed strategic alliances with US West and Realnetworks to deliver video content to the Internet. The product, called Net/36, is a high-speed, bandwidth-intensive network that will be capable of broadcasting IP video, audio and data simultaneously to thousands of DSL providers, cable headends, ISPs and wireless broadband providers worldwide. The company will leverage existing satellites to deliver Net/36. The company anticipates initially allocating 24 transponders (half of a satellite) to the project. In addition, Panamsat will also be investing in a ground network, which is unexpected. This lends further credibility to their Internet strategy and solidifies their commitment to pursuing the Internet market.

The total investment cost in Net/36 will be approximately $350 million over three years. Over the next two years the company will spend $250 million, approximately $70 million for operating expenses and $180 for capital equipment. Given the changes we have made to our 2001 EBITDA forecast (decreased from $890 million to $806 million) we have also lowered our target price. Because of the drastic cuts to our EBITDA forecast, investors will not pay a premium multiple for Panamsat’s future Internet business until it further develops through the additional strategic announcements and deployment of ground equipment.

Panamsat will begin trial transmissions through US West DSL during the second quarter of 2000, and will begin commercial rollout by the third quarter of this year. US West will use Net/36 to deliver IP content to its DSL and Internet subscribers, and Realnetworks, a leader in streaming media delivery on the Internet, will provide its Real System G2 for the delivery of video and audio programming to the masses worldwide. Panamsat’s relationship with US West gives it access to all of US West’s DSL customers. Expect future similar announcements with other DSL providers and cable headend providers. By the end of 2002, Panamsat expects that Net/36 will be able to support 3,500 to 5,000 servers at the edge of the Internet (of which 1,000 are expected to be installed in the United States by the end of 2001), 200-300 content providers (of which the majority are most likely to be Panamsat’s existing customers), and 15 to 17 million broadband users.

Marc Crossman and Anh Steininger are satellite analysts at J.P. Morgan in New York City. These views are those of the authors and do not necessarily reflect the views of the Via Satellite editors or J.P. Morgan.