Description

            EchoStar Corporation (SATS) is the recent spin-off from EchoStar Communications Corp (DISH).  This business is comprised of a very advanced set-top box (STB) business, seven satellites, SlingMedia, 50% ownership of an encryption technology provider, a Chinese satellite venture, investment in TerreStar, and $1.05B in net cash.  Charlie Ergen owns 50% of the economics of the business and will remain chairman of both companies.

            SATS has 90mm shares outstanding and the stock price is $32, so its market capitalization is $2.9B and enterprise value is $1.85B.  Also, of note is that EchoStar just paid $380mm for SlingMedia in November, so that is a reasonable value to put on the business.  Ergen was an early investor in Sling and a pioneer of the digital video recorder (DVR), so he has intimate knowledge of the business.  Thus, for $1.45B, you get the STB business that earns $135mm pre-tax with very little invested capital, seven satellites with a book value of over $1.0B, 50% ownership in Nagrastar (an encryption technology provider), a Chinese mobile satellite venture, a strategic investment in TerresStar bonds worth $100mm, an exponential growth opportunity, and Charlie Ergen running it.  The book value of SATS is $36, so you are buying it below stated tangible book value and, most importantly, none of the book value is in the operation that generates $135mm pre-tax.  SATS is a steal and the reason nobody is aware of the value of the business is that Echostar has no investor relations and will not talk to anyone.  Accordingly, Ergen authorized a $1B buyback so as to take advantage of a low stock price after the spin-off.  It is also noteworthy that he spun this off effective January 1^st, 2008 when all of Wall Street is off.

            In order to understand the value of SATS, it is important to look at why the company was spun-off.  EchoStar has always had superior STB technology but used it solely for the benefit of Dish Network.  Now that Dish is maturing, Charlie wanted the ability to sell off Dish and maintain his technology assets; he has always been most interested in the technology component of the business.  One reason that Dish could not have been realistically acquired previously is that Ergen’s valuation of SATS was likely much higher than any strategic buyer would give him credit for.  He has spent a great deal of time working on international deals and investing in technology.  To give you a sense of the STB business, it has 700 engineers and its technology is definitely more advanced than Scientific Atlanta, which was acquired for over $5B (net after cash) by Cisco a couple of years ago.  He pioneered the multi-room DVR, the high-definition DVR, PocketDish, etc.  That said, as the STB business has always been inside Dish, it was difficult to attract external cable and satellite customers.  They have an agreement with a Canadian company but nothing else substantial.  Ergen’s hope in making this business independent is to take advantage of the FCC’s cable-card mandate (which makes STB sales through retail viable), the analog-digital television conversion (he is basically giving away converters to get into 10-20mm homes), and give himself a growth vehicle should he decide to sell Dish.  His purchase of SlingMedia was also related to the spin-off, as Sling was already working with DirecTV and various cable operators and its devices are in many stores internationally.  This gives him a seat at the table with every operator and electronics retailer in the developed world.

            Right now, 85% of SATS’ revenues are from Dish, which is both a potential risk and opportunity.  SATS signed a two-year contract to sell boxes to Dish at cost-plus 13-14%.  If Ergen continues to run both businesses, there is obviously zero risk of him not using SATS.  If he sells Dish, you could argue some of the STB business is at risk.  However, I believe that the reason he only signed a two-year contract when he could have signed a contract of any length is because if he sold Dish, he would move the STB margins to levels comparable with Scientific Atlanta and Motorola’s business-25+%.  If he were willing to keep the margins at 13% for AT&T or whomever, SATS would not have any risk because the competitors would have to spend money engineering boxes for Dish and undercut SATS prices which would be uneconomical.  I would also bet Motorola and Scientific Atlanta have most favored nation clauses with the large cable operators so they would have to extend the same discounted prices across their book.  I don’t think there is any risk to the current STB earnings, and I think there is enormous upside to moving up the rates charged to Dish,  selling to consumers, and incorporating Sling technology in all their boxes for free and using it to get into other cable/telco competitors both locally and internationally.  It will be somewhat difficult at first to sign agreements with cable and DirecTV, but international should not be an issue.  Also, if they under price competitors, which they are known to do, cable companies would likely be open to lowering their continuously rising capital expenditures.  If/when Dish is sold, there would be no reason that all operators would not consider using SATS.  Importantly, I think the purchase of Sling was to head down this path.  Cable operators ignored DVRs at first, and satellite killed them by giving out DVRs.  Cable realizes that they do not want to get behind on Sling technology and be competitively disadvantaged again.  There are many other pieces to this puzzle including the analog to digital television adapter they are selling at below cost to get into potentially 20mm homes.  The reason they are doing this is they can put hard drives in them and the ability to plug into the internet, thus enabling SATS to sell programming to these homes that currently do not subscribe to any pay-television service.  He ultimately might try to create a product similar to FreeView in the United Kingdom.  Ergen is a very clever guy with incredible engineers and a lot of intellectual property, so his options are very broad.  As an aside, he just bought $100mm of bonds from TerreStar today, and the agreement included a right for TerreStar to buy spectrum from SATS that I was valuing at zero for 30mm TerreStar shares (or roughly $170mm).

The other main piece of the business is the seven satellites they own for the fixed satellite service (FSS) business.  Currently, they have Dish and a couple of small customers but most of the satellite capacity is not being used.  The business is doing $150mm in EBITDA.  They recently hired Dean Olmstead to be new CEO of the business, so Ergen is trying to make this a real venture.  Olmstead used to be head of SES North America and helped grow SES dramatically during his tenure.  I am not certain that they are worth book value, but I find it hard to believe Ergen would have committed to them if he did not see a large opportunity.  He will be able to get additional revenues to them, as he can under price all competition since the satellites have already been paid for and aren’t being used.  In other words, although I would bet Ergen will get a good ROIC on them as he always has in all his other businesses, it is not necessary for there to be material upside here.  The FSS business is a fixed cost business so all incremental revenues go to the bottom line, and there is a lot of demand for FSS capacity right now.  The demand is from cable companies, telcos, the government, and corporations as the satellites can be used to send data and other applications beyond video.  Additionally, companies always add incremental providers as backup.  SATS has commitments for two other satellites that, if Ergen decided he does not want, he could easily sell.   Satellites take a long time to construct and launch so they are not a commodity; I am sure competitors would gladly take them so he did not have the incremental capacity to compete.  Realistically, he is not going to sell them; he purchased the satellites and hired Olmstead because he understands satellite technology better than any of his competitors and is hopeful to grow the FSS business as well as offer a one-stop shop service to video providers that neither Intelsat nor SES (his two main FSS competitors) can match.  He can provide both the satellite capacity and the set-top boxes in a turn-key solution for video providers.

            The company is substantially undervalued on a sum of the parts basis.  I would value the satellites at 80% of book conservatively or around $900mm (or 6x current FSS EBITDA), SlingMedia at cost-$380mm, and the net cash is $1.05B.  STB businesses have historically been valued at 2-3x revenues.  Scientific Atlanta was sold for over $5B with $1.7B in revenues vs. the $2+B SATS already has in STB revenues before additional opportunities to sell their technology to other vendors.  At a bare minimum, a technology STB business with no hard assets or capital requirements could be easily sold for 14x pre-tax earnings or $1.9B (this is 19x FCF).  So, I think a reasonable valuation of the STB business is somewhere in between $1.9B and $5B, conservatively we can call it $3.0B.  I think many people including Apple, Microsoft, Motorola, Cisco, Alcatel, and others would love to own this business.  The other assets of SATS are worth around $400mm. 

The sum of the parts value today is $5.7B or $63 a share.  That said, as Ergen right now can buy in over 33% of the stock with the current buy-back.  If he did this at today’s price, SATS would be left with only $50mm net cash and 59mm shares outstanding.  Under this scenario, the sum of the parts value would be $4.7B or $80 a share, and Ergen would then own 78% of the stock outstanding.  You have to believe this was his plan all along.  SATS is his chance again to start from the ground-up and grow a business, and this is where he put all his growth and international assets.  His ultimate goal is to be a leading STB and technology provider and replicate his Dish Networks satellite service on an international basis.  He is not one to take advantage of shareholders as he has never taken Dish private when he could have, and he puts all applicable information in his filings.  That said, he is also insanely focused on returns and taking advantages of opportunities.

 

Sum of the Parts:

Net Cash:  $1.05B

Satellites:  $900mm

Sling:  $380mm

STB Business:  $3B

Nagrastar,Terrestar, etc:  $400mm

Total:  $5.7B or $63 per share (assuming Buyback goes to $80 per share)

 

            This stock is an absolute steal and the best deal on a spin-off I have seen in years.  The downside is nothing as there is $12 a share in cash alone and $135mm pre-tax in profitable STB operations.  The upside, however, is over $80 a share, and you have perhaps the smartest media executive of all time running the company with the authorization to buy in the stock very cheaply.

Catalyst

Once all the sell-side analysts have a chance to initiate coverage, the company will be better understood. Also, once Dish shareholders are done dumping their spin-off shares and Ergen starts buying in the stock, the share price will stabilize. Operationally, as SATS starts announcing FSS contracts, advances to the Sling technology, and future ventures both internationally and domestically, investors will start placing a significant value on the growth potential of the company.