George Mannes

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FCC Blocks EchoStar-DirecTV Deal

George Mannes

Updated from 1:56 p.m. EDT

The Federal Communications Commission has declined to approve the merger of EchoStar Communications (DISH Quote - Cramer on DISH - Stock Picks) and Hughes Electronics (GMH Quote - Cramer on GMH - Stock Picks).

The decision, released at noon EDT Thursday, appears to kill a $16 billion deal intended to combine the nation's two big direct broadcast satellite services.

The announcement raises questions about whether EchoStar and Hughes will propose a revised deal that might pass muster with the FCC and the Justice Department, the other government body examining the deal. The deal also makes investors focus once again on the companies' prospects if they continue separate operation.

The FCC says a merger of EchoStar's Dish Network and Hughes' DirecTV would likely harm consumers by eliminating a viable competitor in every market, creating the potential for higher prices and lower service quality, and hurting future innovation.

Though the commission declined to release full details of its economic analysis of the proposed deal's effect, an FCC official said at a Thursday press conference that projected "consumer welfare losses" of the deal were "staggering."

Contradicting contentions of EchoStar and Hughes, the FCC says the record doesn't support the conclusion that combining their spectrum resources is necessary for deployment of "viable satellite-delivered broadband services."

The merger would have the effect of replacing facilities-based competition with regulation, a move "which is not consistent with either the Communications Act or with long-standing policy," the FCC says in a statement.

If the deal doesn't get done, EchoStar and Hughes -- traded as a tracking stock of General Motors (GM Quote - Cramer on GM - Stock Picks) -- may encounter turbulence as they go their separate ways. Under the terms of the deal, EchoStar must pay Hughes a $600 termination fee if the merger is blocked by "a permanent injunction or final and nonappealable order prohibiting the merger in an action brought by a United States federal, state or local authority under United States antitrust laws or FCC regulations," or if Hughes calls off the deal because EchoStar can't get approval within a certain time period.

If the deal doesn't go through, EchoStar must also purchase Hughes' stake in PanAmSat (SPOT Quote - Cramer on SPOT - Stock Picks), though observers speculate that EchoStar may argue that material adverse changes in PanAmSat's business may clear it of its obligation to purchase that firm.

In the meantime, both companies have continued to take market share from cable operators, though they have struggled to keep subscriber acquisition costs under control. In a report published last month, Banc of America analyst Doug Shapiro initiated coverage on EchoStar with a strong buy, saying he expected it to start generating free cash flow -- that is, cash flow from operations after interest expense and capital expenditures are deducted -- in 2003. Shapiro initiated coverage on Hughes with a buy, saying he expected the company to start generating free cash flow in 2004. Shapiro's firm has received compensation from both EchoStar and Hughes, or their affiliates, in the past twelve months.

Precisely speaking, what the FCC did Thursday was decline to transfer licenses held by EchoStar and Hughes into a new entity. Rather, the commission referred the companies' license transfer applications to an administrative law judge for a "full evidentiary hearing."

Though the ALJ could theoretically find in favor of the applicants, comments by the commissioners Thursday suggested that the possibility of a decision favorable to them would be remote.

"The combination of EchoStar and DirecTV would have us replace a vibrant competitive market with a regulated monopoly," said FCC Chairman Michael K. Powell in a statement. "This flies in the face of three decades of communications policy that has sought ways to eliminate the need for regulation by fostering greater competition. I decline the invitation to turn our national communications policy back so many years."

In recent days, EchoStar and Hughes had asked the FCC to delay passing judgment on the merger, in order to give the companies time to discuss possible revisions to the deal that would make it acceptable to the Justice Department.

"EchoStar, Hughes and General Motors are disappointed that the Federal Communications Commission has designated the matter for administrative hearing," the companies said in a statement. "We will continue to work aggressively within the context of this FCC process to achieve approval of the merger. We cannot comment further until we have had an opportunity to evaluate the order, which has not yet been released by the FCC."

Hughes shares fell 32 cents to trade at $8.08. EchoStar's fell 5 cents to $16.96.