Value Investors Club / GIlat Satellite Networks, LTD (GILT)

Description

Intro

At $2.30 per share, Mr. Market is offering GILT at a fraction of NAV and giving you a growth business - nearly bought in August for $11.50 per share - for free. Gilat (1) trades below working capital, (2) has a negative EV, (3) cash and short term investments of $141mm that exceed the market cap, (4) contractual obligations that are modest, and (5) minimal competition in the industry. Most importantly, the balance sheet overwhelms the current valuation.

Industry

Second to Hughes Communications, Gilat is a leading provider of very small aperture terminals (VSATs) – small cost-effective satellite devices for internet, broadband access, and telephony. The revenue breakdown is approximately 50% terminal sales, where they make most of their money, and 50% services, which are highly recurring but with lower margins (due to outsourcing of satellites).

Gilat operates in three segments: Global Network Solutions (GNS), Spacenet, and Spacenet Rural. GNS works mostly with telecom operators worldwide and the focus is primarily on equipment sales. GNS is a lumpy business with sales cycles that can be as long as 18 months. Recently, GNS revenues have declined while Spacenet sales, which are mostly focused on services, have increased. The longer sales cycles in GNS have hit the bottom line and the market is punishing Gilat for the lumpy revenues.

Why it’s down

Columbia Contract

Other than being punished for lumpy revenues in the GNS segment, Gilat is losing $3.75mm a quarter on a contract they signed with the Columbian government. If they walk away, which they will most likely do if an amended contract isn’t signed fairly soon (govt. agencies in Columbia agreed to amendments but still haven’t signed) they will forgo $24mm in potential revenue that sits in a trust and potentially take up to a $27mm hit for walking away. The market has overreacted to this potential loss. If you hit them with the $27mm by taking it out of cash, they still trade below working capital and could still meet the next two year’s contractual obligations with cash alone.

Failed Acquisition

Gilat was approached by a private equity consortium who offered the company $11.50 a share in March. The deal never closed and the $47mm termination fee that Gilat is entitled to is now in litigation. In my view, the company has a contingent asset.

Forced selling

Gilat received an offer of $11.50 per share in March of 2008 from a private equity consortium. When the buyers failed to close the deal in September, the stock collapsed and then came the broader market selloff in October and November. The market cap declined and with it the pool of potential investors. Gilat hit $5.00 and the negative feedback loop continued; as the market cap shrank, the pool of potential investors shrank.

Why the company deserves a higher valuation

Columbia contract will most-likely be terminated. This eliminates a $3.75mm per quarter drain on cash flow. Regardless, Gilat is nearly cash flow positive even with the $3.75mm per quarter drain, so eliminate the Columbia contract and they could have a 10% or greater FCF yield overnight.

Huge growth potential, especially in emerging markets. It’s too expensive to lay down full-terrestrial networks in emerging markets. VSAT technology is the low-cost alternative. As a result, many governments either require telecommunications operators to provide communications access through Universal Service Organizations (USOs) to these communities or provide funding via Universal Service Funds (USFs) to subsidize the provision of these services. At this time, availableworldwide USF funding is estimated to be $4.4 billion in approximately 15 countries. Gilat currently has 25% market share.

$47mm termination fee. In litigation and could take 2-3 years, but appears they will eventually receive the fee.

Immaterial Capex. Unlike competitors Hughes Communications and ViaSat, Gilat doesn’t operate their own satellites in orbit, so capex is minimal. Also, business expenses are modest and can be cut further in a more difficult environment.

Valuation

We value it based on NAV and a conservative estimate of NAV. We reach our conservative estimate of NAV by assuming the company eats the entire $27mm potential loss for walking away from the Columbia contract, and we write-down inventories, other assets, and all ST and LT receivables by 50%, and write-down PP&E by 20%. As you can see from the table below, even under these very conservative assumptions, Gilat would have to increase by over 40% to reach our conservative estimate of NAV (and over 125% to reach NAV based on book value). These estimates are based on the current stock price of $2.29. And, of course, this does not account for future earnings potential.

	ASSETS	BV (mm)	% of BV	Realizable Value	LIABILITIES
	Cash and cash equivalents	$112.29	100%	$ 112.29	Current Labilities	$112.59
	Short term investments	29.60	100%	29.60	Long-term Liabilities	66.49
	Short term restricted cash	8.55	100%	8.55	Total Liabilities	179.08
Current Assets	Restricted cash held by trustees	7.50	100%	7.50
	Trade receivables	55.19	50%	27.59
	Inventories	23.99	50%	12.00
	Other current assets	21.31	50%	10.66


	Long-term restricted cash	5.29	100%	5.29
LT Investments	Long-term restricted cash held by trustees	16.70	100%	16.70
& Receivables	Severance pay fund	13.35	100%	13.35
	Long-term trade receivables, & other receivables	9.93	50%	4.97
	Columbia Contract	(27.00)	100%	(27.00)

	Property and equipment, net	107.78	80%	86.22

	Total Assets	$384.48		$307.72
	- Liabilities	179.08		179.08
	= NAV	205.40		128.64

	NAV	$205.40		$ 128.64
	Market Cap	90.11		90.11
	Residual NAV	115.29		38.53

	NAV/share	$ 5.13		$ 3.21
	Appreciation to NAV	127.95%		42.75%

Catalyst

1. Columbia contract gets fixed or cancelled
2. Revenues stay roughly within current projections and the business does not fall off a cliff

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			2008	2009
Price:	2.20	EPS
Shares Out. (in M):	0	P/E
Market Cap (in $M):	90	P/FCF
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT