AOL, Hughes Link Up to Challenge Cable

Challenging the cable TV industry’s hopes to dominate the market for high-speed Internet connections to the home, America Online on Monday said it would make a record $1.5-billion investment in Hughes Electronics and jointly introduce new consumer offerings with Hughes’ DirecTV satellite service.

The deal will widen the choices available in the potentially huge consumer market for high-speed Internet service and interactive television. Cable companies are leading the development of such services but have made them available to only a few hundred thousand customers. Local telephone companies are rolling out their own packages even more slowly.

Companies ranging from AT&T; to Microsoft have been making multibillion-dollar investments in cable TV operators on the expectation that cable lines will eventually become the leading distribution channel for entertainment-on-demand, electronic commerce, and even local and long-distance telephone services. Cable’s primacy, however, is the subject of considerable political, regulatory and legal wrangling.

The agreement between AOL and DirecTV is designed to strengthen each company’s role in this fast-evolving landscape. It will allow them to capitalize on Dulles, Va.-based AOL’s existing 16 million customers and El Segundo-based DirecTV’s 7 million TV subscribers to jointly market new services. These include AOL-Plus, which will provide high-speed connections over satellite, and AOL TV for such television-based functions as interactive shopping, Web surfing, e-mail and electronic chat, more commonly performed over the Internet.

“With this agreement, we are accelerating the pace of Hughes’ transformation into a media and entertainment and information services growth company,” said Michael Smith, chairman and chief executive of Hughes Electronics, which already derives more than 70% of its market value from selling satellite television services through DirecTV.

For all that, many analysts are skeptical that even AOL’s name recognition and marketing muscle can overcome the shortcomings of Internet delivery via satellite that include its relatively high price. DirecTV customers would also need to purchase new equipment to receive AOL TV and AOL-Plus.

“In areas where cable modems are available, it makes more economic sense than [satellite transmission], at least for now,” said Yankee Group analyst Bruce Leichtman.

Even the new partners agreed that they might have the most marketing success in regions that receive no other high-speed, or broadband, service.

“This is most important for the broadband have-nots,” said Steve Case, chairman and chief executive of AOL. In four years, Case said, about one-third of the nation’s households will still have no high-speed option because they are in areas where the returns do not justify the cost of upgrading cable or telephone lines to carry the transmissions.

The partners said the bulk of AOL’s cash infusion is earmarked for marketing and promotion, including equipment subsidies that will make these products cheaper and easier for consumers to purchase.

The deal underscores the extent to which satellite services such as DirecTV and Internet access providers such as AOL--not to mention other entertainment and telecommunications companies--are racing against the cable industry to roll out lucrative services.

Although phone companies and satellite services also possess technologies that can bring high-speed Web connections to homeowners, the cable industry has signed up the largest number of subscribers. About 500,000 homeowners have high-speed Internet connections via Excite@Home, a consortium controlled by AT&T;’s cable TV arm, and RoadRunner, which is jointly owned by Time Warner Cable and MediaOne Group, which has agreed to be purchased by AT&T.;

Thus far, however, cable networks have been closed to AOL because federal regulators have decided that cable operators have the exclusive right to market data services to their own subscribers.

Although AOL has signed up with two regional phone carriers--Bell Atlantic and SBC Communications--to offer its online service over high-speed digital subscriber lines, or DSL, it lacks a national high-speed pathway to compete with the more ubiquitous cable industry.

DirecTV is the world leader in providing satellite television. But its DirecPC service, which offers high-speed Internet connections over satellite links, is a distant also-ran in the home Internet market. Available since 1997, the service has signed up only 40,000 customers in the U.S., in part because of its high price and technical inadequacies of this largely one-way medium.

While cable companies sell their high-speed services for about $40 a month, including equipment, DirecPC requires users to buy a special dish for about $199 and charges about $35 a month for slightly over 100 hours of use. By contrast, Excite@Home and RoadRunner cost roughly $40 a month for unlimited use.

According to Monday’s announcement, $500 million of AOL’s $1.5-billion investment will be directed at the marketing for AOL-Plus via DirecPC. Another $500 million will be used for marketing and subsidies for new set-top boxes for AOL TV that will be available next year.

The box, which the partners are developing jointly, will allow TV viewers to chat with friends, check their e-mail and engage in on-the-spot commerce. DirecTV President Eddy Hartenstein said the retail price for AOL TV has yet to be worked out.

For its cash infusion, AOL will receive preferred securities in Hughes that will be converted to common stock, worth about 5% of Hughes’ equity, within three years.

As a result of AOL’s investment, Hughes said it would not proceed with a planned public sale of $500 million in stock or receive a previously announced $500-million infusion from parent General Motors.

Although Hughes also announced Monday that it will take a charge of as much as $85 million against second-quarter earnings because of delays in satellite production, the AOL’s $1.5-billion commitment overshadowed the bad news.

Shares of GM Class H stock, which track the performance of its Hughes subsidiary, rose $3.19 to $56.63 on the New York Stock Exchange. AOL shares increased $3.38, to $115.38.