|Shares Out. (in M):||50||P/E||0||0|
|Market Cap (in $M):||3,902||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
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We think SATS is a long because it’s a newly separated public company, primarily comprised of the Hughes broadband business, that trades at a discount (5.5-6x EBIDTA*) to its secularly challenged peers (7-8x EBITDA), but is a solid growth business. In the satellite business growing comps (with more growth than us) can trade for 12-13x EBITDA, so perhaps it should be somewhere in between the two.
Until a few months ago this business was lumped with a true secular decliner (a satellite servicing company now sold to Dish), so this stock has yet to get credit for the growing, duopolistic, and high incremental return business of residential satellite broadband. Risks (or the lack thereof) of cellular overbuild are already visibly not impacting the company’s growth, and 5G isn’t a rural technology, so not likely a significant incremental risk either.
Catalysts include the mere passage of time for the market to understand a new stock, very likely step-function increases in profitability for a scheduled future satellite launch, cleaning up an inefficient balance sheet (sizable cash = debt) and there’s a long shot chance that they could merge with ViaSat’s corresponding business which would have very sizable synergies.
Risk includes the fact that this is a controlled company by Charlie Ergen, who may use these asset on a larger chessboard. In addition, the rockets that launch satellites can blow up, which will delay the business plan. Please note also, that the company will be investing much of its would be FCF into new satellites, so current free cash flow will be thin until 2021, so there may not be FCF support in a weaker market.
Not a slam dunk, but we like the risk reward – our assumptions imply a target price of ~$60 by the end of 2020, or ~45% upside from here.
* - We dislike EBITDA based valuations because they don’t account for capital intensity, and will always cross check them to a FCF based method, but I hold my nose and will discuss them, with this caveat, when it’s the metric the market uses.
Business Overview & Corporate History
EchoStar (SATS) is a collection of businesses/assets in the satellite services industry. Like Dish, EchoStar is 51% owned by Charlie Ergen. Now that EchoStar has spun off its declining business that served Dish, the main EchoStar asset is Hughes Networks: Today, EchoStar owns a collection of satellites and other assets that serve the following business segments:
· Within Hughes, 75% of revenue (and likely ~85%+ of EBITDA) comes from the HughesNet residential broadband business, where 1.4M subscribers mostly in DSL-only areas uneconomic for cable/fiber receive faster internet via HughesNet satellites.
· The other 25% of revenue (and smaller portion of EBITDA) comes from Enterprise contracts, where HughesNet provides connectivity services to lottery machines, fast food chains, and gas stations in the US, Europe, and emerging markets.
· From 2013-2018, Hughes grew revenue/EBITDA at 7%/13% CAGRs.
In addition to Hughes, EchoStar also owns
· S-Band spectrum rights in Europe that could be used to make a pan-European auxiliary data network (with many potential uses)
· 49% of Dish Mexico
· A minority stake in a satellite JV in EMEA
In May 2019, Dish & EchoStar announced that Dish would acquire EchoStar’s BSS business (declining satellite capacity provider for Dish) in exchange for a meaningful portion of DISH stock. Prior to the transaction, SATS equity had a meaningful trading connection to DISH stock, as the market seemed to treat the two stocks as inevitably intertwined. The transaction closed in September, and the underlying business of SATS now has a substantially different growth profile.
Residential Broadband Basics
HughesNet and competitor Viasat offer satellite broadband to residential customers. The customer value proposition is as follows:
· Many Americans live in areas where their only wireline internet option is slow DSL. Those customers would like faster internet, and are willing to pay ~$60-80 for satellite broadband (vs. DSL @ ~$40-80/month) to get download speeds of about 19Mbps that compare favorably to the other DSL offerings
· In 2021, Hughes will launch the Jupiter 3 satellite, which will enable them to offer speeds of 50-100Mbps (vs. the 25mbps offered in their highest plan currently) and increase their customer base by 30-80% (depending on desired speeds of new & old customers…the new satellite would enable them to add 35% to their customer base and double everyone’s speeds in the US).
As a result of marketing this proposition to the US, satellite broadband penetration has grown significantly in the 2010s. Between Hughes and Viasat, residential broadband subs have grown at a 10% CAGR over the last 6 years (the time period over which we have data for both companies), and Hughes’s subs have grown at a 13% CAGR.
As the two companies launch additional satellites with greater capacity, they are able to offer faster internet speeds, which
· Expand the satellite companies’ penetration into their TAM, as more customer cohorts are interested in the satellite service
· Enable higher-priced service plans with faster speeds and greater data caps, boosting ARPU growth
· Lower churn – while monthly customer churn at Hughes was 2.8% several years ago, we believe churn has fallen to the low 2%s today, because the company can offer higher data usage caps so that there are fewer customer overage charges (which customers dislike).
Hughes’s financial results have been impressive – Pre-Corporate EBITDA has grown at a 12% CAGR over the last 7 years, with the business generating ~53% incremental EBITDA margins over that time period (which we expect to continue going forward):
In terms of specific path forward, we expect that Hughes will grow its revenue ~MSD% in 2020, before launching Jupiter 3 in 2021, after which we expect a meaningful acceleration.
· Hughes is capacity-constrained in North America, so we expect L-MSD% North America growth and high growth in Latin America to continue to drive the overall number higher.
· After Jupiter 3 is launched in 2021, we expect another strong step-up in revenue/EBITDA (~30-35% over 2-3 years or so).
Given the business layout above, the key question is the valuation of the Hughes business + the valuation of the non-Hughes SATS assets + the modest net cash generated. We assume
· No explicit EBITDA from Jupiter 3 in our 2021 EBITDA estimates, but instead $330M of value for the new satellite (60% of the construction value)
· ~$250M in value for the 49% stake in Dish Mexico, a ~50% valuation discount to the rumored valuation of DirecTV Mexico
· $50M of S Band spectrum value (the price paid for it; some experts believe this could be worth much, much more)
· $60M of value for the EMEA JV
· Little net cash generated through the end of 2020
With those pieces out of the way, the key variable is the valuation methodology for Hughes.
We believe that the broader market will use TEV/EBITDA as a shortcut, because it tends to use that methodology for satellite companies that are constantly spending large amounts of growth capex. But we sense-check that methodology vs. other methods discussed below). Hughes’s 3 real satellite peers are Eutelsat, Inmarsat, and Viasat. Eutelsat and Inmarsat have historically traded at 7-8x TEV/EBITDA, and have generally been expected to generate flattish to slowly growing EBITDA. Viasat, growing EBITDA very very quickly, trades at 12-13x TEV/EBITDA. Meanwhile, the SATS stub trades at 6x TEV/EBITDA on a headline basis and 5.3x if you back out the value of the non-Hughes assets described above. We think a re-rating to 7-7.5x over the next 18 months seems reasonable.
Given the capital intensiveness of residential broadband (due to consumer equipment), we sense-check the TEV/EBITDA methodology above by looking at TEV/(EBITDA – maintenance capex), where maintenance capex is defined as the capex needed to keep the customer base flat (customer equipment capex to replace churn + an allocation for a replacement satellite). On that basis, Hughes trades at 10.8x TEV/(EBITDA – maintenance capex) on a headline basis and 9.3x if you back out the value of the non-Hughes assets described above. Hughes’s slow/no-growth peers Eutelsat and Inmarsat have historically traded (10-15x) on this basis. Our 7x TEV/EBITDA referenced above implies 12x TEV/(EBITDA – Maintenance Capex) on 2021 #s .
Potentially Bullish Trading by Charlie Ergen
Charlie Ergen doesn’t engage in open-market buying of SATS stock, but he does occasionally exercise non-expiring options as a way to increasing his holdings, and he did so on May 21, after the deal was announced. Ergen has a good track record in these exercises:
· After the 2012 exercise, SATS went on to generate 30 points of alpha in the following 12 months and 45 points of alpha over 18 months.
· After the 2015 exercise, SATS went on to generate 25 points of alpha in the following 12 months and 35 points of alpha over 18 months.
· Government-subsidized rural DSL: Congress could allocate funds to subsidize buildout of DSL in Hughes customer areas where it is non-economic for the DSL providers to build, threatening Hughes’s competitive position.
o Our view: (a) This is a constant dynamic of the Hughes business in the last decade, and Hughes has thrived despite it (b) when Jupiter 3 launches, Hughes speeds will be so much faster that it will be hard for subsidized DSL to compete. While some have noted that the population of homes with <10mbps internet has been shrinking, the continued launch of Hughes satellites is raising the bar for what counts as the under-served TAM…in a few years when Jupiter 3 has made 50mbps the standard, the “under-served” TAM may be households with internet <30mbps, a much larger group, keeping the Hughes TAM fairly constant.
· 5G buildout: It’s possible the buildout of 5G by AT&T/Verizon/T-Mobile/Dish could introduce 5G as a competing technology to satellite broadband.
o Our view: 5G rollout is largely concentrated in cities where Hughes has does not have subscribers. 5G buildout is designed to help the need for data capacity in population-dense areas, whereas satellite broadband serves areas with low population density that makes cable/fiber/5G buildout non-economic.
· LEO (low-earth-orbit) satellites: other satellite companies such as OneWeb and SpaceX plan on launching a large quantity of small, low-orbiting satellites to provide connectivity to areas around the globe, and some fear the LEO satellites could threaten Hughes in residential broadband
o Our view #1: Because LEO satellites are not stationary, they require rotating antennae that track the satellites as they orbit Earth, and those antennae will not be economic for consumer applications for 5-20 years. This is why those satellites are focusing first on B2B/government applications, particularly those in emerging markets. To the extent they are targeting consumers, those consumers are high-use gamers that prefer the low latency of the LEO satellites, but those users don’t use Hughes now because of the Hughes latency and data caps.
o Our view #2: The LEO satellite companies would have to establish a customer service & distribution network that is expensive and time-consuming to replicate…OneWeb has partnered with Hughes for ground equipment and market access, and the two companies view each other as partners addressing different end-markets rather than competitors.
· Jupiter 3 launch errors: It’s always possible that there could be an issue launching the Jupiter 3 satellite.
o Our view: There was an issue with the Viasat 2 launch that caused Viasat to lose 20% of its capacity, but Hughes has never made this sort of error, which speaks to their technical expertise vis-à-vis Viasat.
Continued time as a public company; additional satellite launches
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