Hughes Moves to Shore Up Key Weakness With Deal

Hughes Electronics Corp. announced plans Thursday to buy a Cupertino, Calif., company that provides high-speed Internet access--a move designed to shore up a critical weakness in Hughes’ lineup of satellite TV and data services.

Hughes, based in El Segundo, would pay about $180 million in cash for Telocity, which provides digital subscriber line service through conventional phone lines.

The point of the proposed acquisition, Hughes executives said, is to offer virtually any customer the same combination of video and high-speed Internet services that cable operators are starting to provide.

Another motive for the deal is to open the door to interactive video services that can only be done through an always-on, high-speed connection to the Internet. That’s a long-term goal, however, and company officials had no specific plans in the works.

Hughes already has a satellite-based Internet service, DirecPC, but the cable operators’ cable-modem services have proven to be much more attractive to consumers. One reason is that DirecPC has been a one-way service--users could download data rapidly via satellite, but they needed to connect through a phone line to send commands.

On Thursday, Hughes announced that a two-way version of DirecPC would be available early next year. But the satellites don’t have the capacity needed to support millions of customers, which is another reason for Hughes to acquire a DSL provider.

The deal calls for Hughes to offer $2.15 for each of the 84 million shares of Telocity, which is a 54% premium over the company’s starting stock price Thursday on Nasdaq of $1.40. By the trading day’s end, Telocity’s stock had climbed 63 cents to close at $2.03.

The tracking stock for Hughes, a subsidiary of General Motors, fell 60 cents, or 2.7%, to close at $21.60.

Whether the deal proves to be a bargain for Hughes depends on how many DirecTV customers flock to Telocity’s service. Based on Telocity’s meager subscriber base today, Hughes’ offer amounts to more than $7,000 per subscriber--a surprisingly high cost, analyst Dylan Brooks of Jupiter Research said.

Eddy W. Hartenstein, senior executive vice president of Hughes, argued that DirecTV’s customers tend to be heavy Internet users, making them prime candidates for a discounted package of video and Web services. “We think that our kind of customer is going to naturally want high-speed service,” Hartenstein said.

Hartenstein predicted that Hughes would attract 100,000 to 150,000 DSL customers in 2001, and 3 million to 4 million within five years. With Telocity targeted at city dwellers and the new version of DirecPC at rural areas, Hughes will be able to offer virtually every consumer in the country high-speed Internet service.

Most of its competitors, on the other hand, can’t make the same claim. Cable operators don’t cover entire states, let alone the whole country, and DSL services don’t reach many homes in small towns, suburbs and rural areas.

Hughes’ main rival in the satellite TV market, EchoStar Communications Corp., also has a two-way satellite Internet service with a nationwide reach. The service has just started to roll out, however, and is available only through a limited number of retailers.

Brooks still called Hughes’ estimates overly aggressive.

“I think they’re being hopelessly optimistic about the kind of market share they’re going to get,” he said.

For Telocity, the deal provides the cash the company needed to survive beyond 2001. The company expected to lose $100 million to $125 million in each of the next two years, before factoring in depreciation and taxes.

Telocity charges $40 to $50 per month for its service, which enables people to download Web pages and other data at 10 times to 30 times the speed of the fastest dial-up modem. The company’s service is available in 140 metropolitan areas in the U.S., reaching about 40% of all homes, but it had little more than 23,000 customers at the end of September.

What makes Telocity unique is its modems, or “gateways.” In addition to enabling a number of extra services, such as computer security and voice mail, the gateways are designed to be installed without the help of a company technician.