When rural customers can't get DSL or cable modem service, they often look to high-speed Internet via satellite
(Editor's note: this is the second in a series of articles on the lack of broadband access in the U.S.)
When Debra and Lee Sherbeyn first moved to rural Virginia 14 years ago, they didn't own a computer, much less fret over access to the Web. It wasn't long before they had a machine and were logging onto the Internet using a dial-up modem. The arrangement suited them fine until family members started sending pictures by e-mail. It became downright untenable in 2004 when Lee entered the real estate business in their home in Bealeton, Va., about 58 miles southwest of Washington. "You can't wait all day for a picture of a house to download," Debra says.
Nor can you get a Digital Subscriber Line or cable modem service in their part of Bealeton. So the Sherbeyns settled on a satellite broadband connection from Hughes Communications (HUGH). At $69 a month, it costs more than comparable services from phone and cable providers, but the Sherbeyns don't mind. "It's been totally worth it," Debra says.
While most urban and suburban U.S. households have access to cable modem service from a cable TV company or DSL from a phone carrier—or both—the majority of residents of rural areas have neither. According to a July study by the Pew Internet & American Life Project, only 38% of rural American households have access to high-speed Internet connections, compared with 60% for suburban dwellers (BusinessWeek.com, 9/18/08).
Cable and telephone companies usually build their networks in areas where the population is dense enough that they can expect a profit on their investment. Those like the Sherbeyns, who live outside cable or phone service areas and eschew dial-up service, often look to satellite. More often than not, they buy it from Hughes, the biggest provider of satellite broadband services, a small but surprisingly healthy sliver of the broadband business.
Hughes traces its roots to 1971, when it was created in a Gaithersburg (Md.) garage as Digital Communication Corp. and specialized in satellite modems. The company has gone through an array of incarnations under owners as varied as General Motors (GM), News Corp. (NWS), and—early on—the Hughes defense and aerospace giant built by the late billionaire Howard Hughes. Today it delivers Internet access by way of a satellite orbiting the Earth at an altitude of 20,000 miles.
And satellite isn't just for people living in the middle of nowhere. "We have more subscribers in suburban areas of Virginia and Maryland, where people commute to Washington, D.C., and Baltimore, than we do in places like Montana and South Dakota," says Hughes CEO Pradman Kaul. "Our customers often tend to live right on the outskirts of rural areas where the suburbs meet the country."
Room for Growth
In all, Hughes serves some 420,00 households in 50 states. Most of its subscribers are concentrated east of the Mississippi River, usually within commuting distance of major population centers. Geographically, some 44% of Hughes' customers live in counties that account for about 70% of the U.S. population.
Since the service tends to cost more than cable or DSL, Kaul doesn't even try to compete with the likes of Verizon Communications (VZ) or Comcast (CMCSA), but instead markets the company's main product, HughesNet, to places where customers have no other option. Kaul estimates there are some 10 million to 15 million households that crave broadband but aren't within reach of cable or DSL service. Hughes shares that market with WildBlue Communications, a private satellite broadband concern backed by Liberty Media (LCAPA), satellite consortium Intelsat Corp., and Silicon Valley venture-capital firm Kleiner Perkins. "There's a lot of room for growth that will allow us both to do well," Kaul says. WildBlue boasts about 360,000 subscriptions.
Why do satellite broadband providers have such a tiny slice of so vast a market? First, there's the higher price of monthly service. Then there's the cost of installing equipment. Until recently, a Hughes installation cost $500. But in September, Hughes began offering the gear for a rental fee of $10 a month for customers who sign a two-year contract. Subscriber growth has accelerated since the rental option was announced, but not by much.
Competition from WiMAX
In the coming years, Hughes and WildBlue may face new rivals. Clearwire (CLWR), backed by companies like Sprint (S), Intel (INTC), and Google (GOOG), relies on WiMAX, which provides wireless Web access over large areas.
Clearwire has launched service in 50 U.S. markets, though it's mainly focused on population centers. "If you look at their rollout plans, they're clearly focused on the same areas the cable and DSL guys are," Kaul says. "They need the same kind of density, and so I don't think we're going to be competing with them." A San Diego-based satellite provider called ViaSat (VSAT) recently announced plans to enter the residential broadband business, saying it will launch a satellite in 2011. "That's outside my worry window for now," says Kaul, who adds that he hopes to have 1 million subscribers by that point.
To get there, Hughes will need to step up growth. The company is adding subscribers at an annual pace of about 15%. At that rate it can expect to have a customer base of between 500,000 and 600,000 by the end of 2011. Last year Hughes posted a $44 million profit on sales of $971 million, and analysts expect it to break the $1 billion revenue mark this year. Amid the same economic concerns dragging down the rest of the market, however, shares of Hughes tumbled 10.2%, to 15.96, on Nov. 12, leaving them well off their December peak of 61. Hedge funds also are selling Hughes stocks, analysts say. Hughes is 58% owned by Apollo Management Group, which declined to comment for this story.
Residential Service Taking Off
In August 2007, Hughes launched a new satellite called Spaceway 3 that analysts say may help the company cut costs while improving service. The new satellite operates in a higher frequency band than other communications satellites, meaning that more data can be packed into the stream. The new satellite could reduce service delivery costs by 70% on a per-bit basis, says Raymond James (RJF) analyst Chris Quilty.
Additional savings will come as Hughes relies more on Spaceway 3 and less on capacity from other providers such as Intelsat Ltd. and Eutelsat. Once Spaceway 3 is operating at full capacity, Hughes might save as much as $150 million a year, says Barclays Capital analyst James Ratcliffe. Two or three years of savings like that would be enough to pay for another $400 million satellite, Ratcliffe says.
Hughes also caters to companies including gas station owners Exxon (XOM) and Chevron (CVX), fast-food companies Taco Bell (YUM) and McDonald's (MCD), and retailers such as Best Buy (BBY) and Wal-Mart (WMT). The enterprise side accounts for less than half of sales and is growing at a more modest 5% to 7% a year, according to Quilty.
But the place to watch for growth, Quilty says, is on the residential side, which accounts for about 55% of sales. "They've been plugging away at this business since 2001 and it's starting to take off," he says. For that, Hughes has customers like the Sherbeyns to thank. "When we first moved out here we didn't care a thing about computers or the Internet," Debra says. "Now we can't live without 'em."