ViaSat Inc. VSAT S
March 05, 2011 - 2:39am EST by
jdr907
2011 2012
Price: 41.00 EPS $1.39 $1.17
Shares Out. (in M): 43 P/E 29.5x 35.0x
Market Cap (in $M): 1,751 P/FCF 12.5x 10.6x
Net Debt (in $M): 269 EBIT 0 0
TEV ($): 2,020 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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Description

ViaSat Short Investment Thesis

ViaSat (VSAT) presents a short opportunity where street expectations and current valuation assume little risk inherent in the company's business model and flawless execution of its relatively new consumer strategy.  VSAT is both a consumer broadband satellite service provider as well as a corporate and government contractor of VSAT systems.  The company was transformed in late 2009 when it acquired Wild Blue - a provider of rural satellite broadband services, a fundamentally different business than VSAT's legacy business.  The street has completely ignored the lackluster performance & outlook for the defense-focused business, as well as the margin-less corporate business.  Instead, the stock is being solely valued on the prospects of a new high capacity Ka-band satellite, Viasat-1, which is expected to be launched in July and will provide faster speeds than current satellites to rural US consumers lacking a wired alternative.  Expectations have focused on an overly aggressive estimate of subscriber growth; leading to a massive EBITDA ramp expected in FY 2013 (FY ends Mar 31).  The stock currently trades at 12.5x FY 2011 EBITDA, 10.6x FY 2012 EBITDA, 7.1x FY 2013 EBITDA and 30x, 35x and 24x FY 2011/2012/2013 EPS respectively. 

The risk profile of the ViaSat has been increased due to a few recent events, which should both continue to reduce consensus estimates, as well as shrink the trading multiple as a greater risk premium should be assumed on the forecasted subscriber ramp.  On January 13, the company announced that its launch expected in spring 2011, was being pushed into the July time frame because of damage caused to the satellite during a testing procedure, requiring additional time for repair and testing.  However, while Loral will for to fix the satellite, certain fixed cost leases that were contracted and signed around the original launch date will begin to kick in around the March time frame, without any corresponding revenue.  More importantly, VSAT's only true North American rural broadband competitor, Hughes, announced on February 14th that it was being acquired by EchoStar (SATS) for $60.70 / share in cash or $2.1 billion including debt.  This represents 6.8x 2011 EBTIDA, 8.7x trailing EBITDA and a 31% premium to its January 19th price, when rumors had begun swirling about a sale.  Not only is the valuation a large discount to the current trading multiple of VSAT; more importantly DISH (sister company of SATS both controlled by Charlie Ergen), is the largest wholesale distributor for Viasat's consumer broadband product.  When the DISH/VSAT distribution agreement ends in June 2011, it will likely not be renewed by DISH.  And while this does not impair the long term prospects of the Viasat-1 project, it likely impairs the aggressive subscriber ramp that is embedded in estimates. 

Description & Competitive Landscape

ViaSat operates in 3 segments:  Government Systems, Commercial Networks & Satellite Services.

  • The Government Systems segment is currently the largest business unit, and is the legacy operations of the company. This segment produces network-centric IP based secure communications systems. The hardware systems sold primarily collect and disseminate secure real-time digital information between command centers, air defense and other communication outposts for the US and foreign governments. The primary products in Government Systems are:
    • Tactical Data Links(30% of gov't revs) - key products are the Multifunctional Information Distribution System (MIDS) terminals for fighter aircraft, portable small tactical terminals, weapons data links, surveillance & reconnaissance applications etc.
    • Information Assurance - (30% of gov't revs) Products that provide high speed IP based encryption solutions for secure communication and data storage
    • Government Satellite Communication Systems (40% of gov't revs) - Products include a range of portable and fixed broadband modems, terminals, network access control systems and antenna systems.
    • The Gov't segment, while the largest driver of revenues, sports low double digit operating margins (8.4% in FY Q3, historically 13%). The most recent quarter revenues grew close to 10%, due to stronger than expected government networking orders. However, other programs including the MIDS continue to experience delays. In general - growth in government segment is not driving the stock price - but may see pressure in the coming years, as the US military budget gets cut. I offer little insight into the outlook in this segment, and focus this short thesis on what I believe the street is focused on - the satellite broadband business
  • Commercial Networks
    • This segment produces satellite communications equipment and ground networking equipment that address the consumer, enterprise, in-flight, maritime and ground mobile applications. This segment has been suffering as of late due to two main factors - the loss of retail sales to Wild Blue (they were a customer prior to being acquired), and stagnant growth at Wild Blue as the current capacity on the satellites (more below) are fully utilized.
    • Operating Margins in this segment have ranged from -10% in FY Q3 2011, to a high of 6% in FQ 4Q 2010.
    • Upside in the future from this segment may come from a few different areas. Several Ka band satellites have or will be launched globally to address the need for rural broadband. ViaSat has partnerships in several of these projects to sell CPE equipment to wholesale partners, so as these initiatives are successful, ViaSat will benefit in this low margin segment. Eutelsat recently launched KASat and VSAT signed and then seem to have lost a contract with Yahsat in the middle east. IN addition, ViaSat has a contract with JetBlue to provide in-flight Wi-Fi services to Jet Blue over the ViaSat-1 satellite. While this opportunity could generate revenue, margin upside remains relatively limited. Additionally, Aircell, has locked up almost all domestic airlines, so it is unlikely there will be other commercial airline wins
  • Satellite Services
    • ViaSat bought WildBlue in December 2009 for $575 million, or 6.7x LTM EBITDA. WildBlue has roughly 400,000 subscribers in unserved or underserved areas within the rural US and has 2 satellites, both of which are essentially fully utilized. Since acquiring the company, they have not actively marketed the product, and have in fact lost subscribers to focus on a higher quality sub base, and because there was no capacity for additional customers.
    • Distribution has historically been 45% retail / 55% wholesale - with DISH making up roughly 50% of the wholesale side, followed by DTV and the NRTC.
    • The chief competitor in this market is HughesNet, which ended 2010 with 578k subscribers, about 393k of which are on its owned satellite Spaceway-3. Hughes has distributed its products historically through retail and direct marketing channels, not utilizing a wholesale model, and thus has a higher ARPU than ViaSat, despite similarly priced retail offerings.
    • Hughes recently announced its full year 2010 numbers and reported Gross Adds of 213,000, net adds of 74,000 and full year churn of 2.1%; 74k equates to about 6k / mo
    • ViaSat has stopped giving any subscriber level guidance on WildBlue since its acquisition - including ARPU, Churn, gross adds etc.
  • Next Gen Satellites
    • In 2008 (prior to acquiring WildBlue), ViaSat announced they would be launching a high capacity Ka band satellite to service the rural markets in North America. Current generation satellites offer speeds of 500 kbps-2 mbps, with capabilities up to 5 mbps. ViaSat-1 has promised capacity 10x that of WildBlue, and speeds up to 20 mbps.
    • ViaSat-1 is scheduled to be launched in July 2011, delayed from Spring 2011 and should be fully operational and adding subscribers roughly 3-4 months after launch The satellite has total capacity of 100 gbps, and can handle roughly 1-2 mm subscribers
    • In addition, ViaSat has already begun discussing building and launching ViaSat-2, which it will articulate its strategy closer to the launch of ViaSat-1 this summer
    • Hughes current satellite, Spaceway-3, which offers speeds of between 1-2 mbps, still has capacity for an additional 200k subs, and it has been growing net subs between 15-30k / quarter, inclusive of 2-2.4% monthly churn
    • Hughes has also announced a next generation satellite launch - Jupiter, which will be launched in 1H 2012, roughly 9 months behind ViaSat. Speeds are expected to be slightly faster than ViaSat-1 with similar capacity
  • The rural unserved broadband market is estimated by Morgan Stanley to have between 4-5 mm potential customers, while the 'underserved' market may be up to 20 mm. There is clearly a market for these services, albeit shrinking as telcos and cablecos continue to build out broadband deeper into their territories, and as 3G and 4G wireless networks are expanded / built.
Risk 1:  Putting aside Hughes/SATS and the distribution question, consensus estimates are aggressive and only leave room for downside
As a baseline - in the peak of subscriber growth for WildBlue after first offering rural satellite broadband services when it was launched in Q3 2005, the company was adding upwards of 25k net adds / month or 300k / year.  As noted before, Hughes, who is the market leader recently added 74k for the full CY 2010, or roughly 6k / month.  In addition, Hughes offered long term guidance on its Q3 call, and said it expected roughly 75k net adds annually through 2015 on both Spaceway-3 and Jupiter, when its launched, a big disconnect from where ViaSat expectations are.
 
Below, find what sell side coverage has forecasted for ViaSat's broadband subscriber growth - this includes growth on ViaSat-1 and churn of roughly 35k / year on WildBlue's older satellites. Note, because the satellite will not be operational until FYQ3 2011 (CYQ4), FY 2013 will be the first full year with growth from ViaSat-1. 
 
ViaSat Satellite Broadband Net Adds    
FY 3/31   2012 2013 2014
Wedbush                  145,000          383,000          358,250
Morgan Stanley                  182,000          182,000          145,600
Merrill Lynch                  119,433          269,455          269,478
Credit Suisse                     72,000          327,000          245,000
Opco                  205,837          192,708          196,938
Average                  144,854          270,833          243,053
Net Adds / Month                    24,142            22,569            20,254
         
Y/E Customers         415,000                559,854         830,687      1,073,740

Clearly the capabilities of ViaSat-1 are superior to those of Hughes current generation satellite, the company has indicated that price points will remain similar to current levels, or about $60-$80 at retail.  The rural population has a lower per capital income than the balance of the US, and those that are not currently purchasing satellite broadband, may be not because they are holding out for a better product, but because they are income strapped, especially in an environment with 9% unemployment.  Price elasticity won't be in effect, as pricing will remain stable.  Despite this, the street is estimating that customers are going to come running to this product at a rate 4x faster (on a net basis) than Hughes is acquiring customers and anticipates adding customers for the next 4 years.   The comparison to WildBlue's initial ramp is flawed for multiple reasons, but most importantly broadband penetration in the US has expanded rapidly from initial Wildblue launch until ViaSat-1 launch, and other alternatives in the marketplace exist.

Broadband penetration in Q3 2005:60%

Broadband penetration in Q1 2011: 96%

To be fair, I would expect Hughes to see increased churn in the 1 year period between launch of ViaSat-1 and Jupiter, increasing the pool of potential customers for ViaSat.  Assuming a 1% increase in churn from about 2% currently, an additional 70k subscribers would be available in year 1 for ViaSat.   Churn should still remain relatively low at Hughes, as customers have signed 2 year contracts.  In addition - new RUS funding (part of the federal stimulus plan) gave Hughes 60% of available rural broadband financing - about $60 mm. This will allow Hughes to offer a product at subsidized rates - roughly $550 / customer - to lower the cost to the customer of $40 / month from $70 / month, and lock customers in for 1 year contracts.  This program began at the beginning of the year - and arguably could fill some of the rural demand at the lower income level

Lastly, and importantly - While Jupiter is being launched in the middle of FY 2013 for VSAT, nobody has taken into consideration that a comparable product will be in the market, and net adds will most likely be more evenly split than if ViaSat-1 was the only high capacity satellite in the sky.  It is interesting to note that there is barely any overlap in the sell side analyst coverage of HUGH and VSAT -as HUGH was not widely covered due to its high PE ownership, and low liquidity, and VSAT has a large portion of coverage out of the Aerospace & Defense groups. 

Incremental EBITDA margins as the company is loading ViaSat-1 are around 70-80%, with fixed operating costs roughly 80% of cash costs/user, a small amount of variable CCU and in the direct channel SAC which is wholly variable.  To the extent that subscriber growth is not as robust out of the gate as the street expects, EBITDA will be hit disproportionately to Revenue.  Below shows a sensitivity if net adds/month are lower by 10-30% of current estimates and the Revenue & EBITDA impact on the company, and the corresponding share price implications.

Subscriber Growth Sensitivity    
  2012 2013 2014
Net Adds / Month                24,142            22,569          20,254
Implied ARPU $47.19 $45.09 $42.75
Sub Growth Lower by x% / Month:
10.0%                   2,414               4,671            6,697
20.0%                   4,828               9,342          13,393
30.0%                   7,243            14,014          20,090
       
Revenue Impact (in $mm)
10.0%  $                 16.4  $             30.3  $          41.2
1.8% 2.6% 2.9%
20.0%  $                 32.8  $             60.7  $          82.4
  3.5% 5.3% 5.8%
30.0%  $                 49.2  $             91.0  $        123.7
5.3% 7.9% 8.7%
EBITDA Impact assuming 70% EBITDA Flow Through  
10.0%  $                 11.5  $             21.2  $          28.9
7.1% 11.2% 10.2%
20.0%  $                 23.0  $             42.5  $          57.7
14.2% 22.3% 20.4%
30.0%  $                 34.5  $             63.7  $          86.6
21.3% 33.5% 30.6%
Stock Price Impact
10.0%  $                 2.97  $             3.70  $          3.53
  7% 9% 9%
20.0%  $                 5.95  $             7.40  $          7.06
15% 18% 17%
30.0%  $                 8.92  $          11.09  $        10.59
  22% 27% 26%
 

 

A significant deviance from analyst expectations in terms of monthly net adds, has a material effect on EBITDA and the share price assuming constant multiples to where the stock is trading currently. In the 30% case (NOTE - THIS STILL ASSUMES 200,000 NET ADDS / YEAR) total company EBITDA falls by almost 30% in 2013/2014, impacting the stock price accordingly. 

 

Risk 2:  The above analysis does not factor in any impact from SATS acquisition of Hughes.  In fact - there may be significant disruption to VSAT's wholesale distribution, as DISH represents almost 50% of current VSAT wholesale distribution. 

The distribution agreement between SATS/VSAT comes up for renewal in June 2011. I would anticipate that this will not be renewed. If the SATS/HUGH deal has not closed yet, it's possible a temporary agreement could be signed. When asked on the Q4 SATS earnings call if he expected a distribution deal between DISH and Hughes, Ergen commented that Hughes has been trying to get a deal with DISH for quite some time. He goes on to say "I know the guy over at DISH, he would probably see who gives him the best deal [b/w Hughes/SATS & VSAT]. Given Ergen's other comments on the call about this almost being a land grab for high capacity satellite customers, and acknowledging VSAT's time to market advantage, I would have trouble believing that he would seed the ViaSat-1 with new subscribers, which would end up hurting him on the SATS side.

  • I think in fact there is a greater risk, that while Hughes management team has been happy with 75k net adds / year, and growing the business at a moderate pace, Ergen may be more aggressive in bundling packages with DISH, and trying to take as much share of the market as possible.
  • In order to derisk the VIaSat-1 project, VSAT management has discussed shifting distribution from the current 45/55% retail/wholesale mix to 30/70% over time, and deemphasizing the retail channel
  • The wholesale channel offers higher margins, lower Revenue & EBITDA dollars, less upfront cost to acquire a subscriber.
  • Based on the assumption that DISH does not resign a distribution agreement with ViaSat for wholesale distribution, VSAT will be forced to shift more of its business to retail than they had previously guided to and hoped for.
  • EBITDA margins in the near term will be lower if the model shifts slower to wholesale, as subscriber acquisition cost of roughly $200 will compress near term margins
  • While the IRR in the long run of a retail strategy is higher, it will be more difficult in the short run to meet expectations
  • In addition, incremental investments in the retail channel will need to be made, as the company noted on a BofA conference call, they would have to move to a more integrated vertical strategy - stores, marketing etc, also lowering margins in the near term
  • Lastly - commercial revenues will also be affected. In the wholesale model, the company generates $275-$300 of revenue / CPE sold to its wholesale provider, this will be impacted negatively, as the company eats the cost of customer acquisition

Assuming a loss of 50% of wholesale subscribers is not made up immediately, the effects again on the potential subscriber ramp as well as EBITDA for VSAT are significant

Impact of Losing DISH Distribution assuming 50% of Wholesale    
FY Ended 3/31   2012 2013 2014  
% Wholesale of Total 55.0% 65.0% 70.0%  
Wholesale subs foregone                   39,835            88,021            85,069  
           
Wholesale ARPU / Sub (in $mm)       Cumulative
 $                    25.00    $                   12.0  $             12.0  $             12.0  $               35.9
                      26.4                 26.4                   52.8
                               -                        -                   25.5                   25.5
Total Revenue Impact                       12.0                 38.4                 63.9                 114.2
% of Revenues   1.3% 3.3% 4.5%  
% of Service Revenues 4.5% 10.8% 14.5%  
           
Incremental EBITDA Margin of Wholesale Subscriber @ 70%    
     $                     8.4  $             26.8  $             44.7  
% of Total EBITDA 4.4% 9.5% 11.1%  
           
Foregone commercial Revenues @ $275 Wholesale ASP    
Revenue Impact    $                   11.0  $             24.2  $             23.4  
% of Revenues   1.2% 2.1% 1.6%  
EBITDA Impact - 10% Margin  $                     1.1  $               2.4  $               2.3  
% of Total EBITDA   0.6% 0.9% 0.6%  
           
Total Impact on Wholesale Loss Assuming no Direct Gains    
Revenue Impact    $                 22.91  $          62.56  $          87.27  
    2.5% 5.4% 6.2%  
EBITDA Impact    $                   9.46  $          29.27  $          47.05  
    5.0% 10.3% 11.7%  
Current EBIDTA Multiple 10.6x 7.1x 5.0x  
     $              100.41  $        209.01  $        235.94  
Stock Price Impact   $2.35 $4.89 $5.52  
           
           

 

Risk #3:  Competition in Commercial Business

  • Aside from the commercial part of the business that will go away as a result of the company shifting to a more retail-focused company, Hughes yesterday won a contract, that had already been signed by ViaSat to provide consumer broadband terminals in addition to satellite gateway earth stations to Yahsat, in a contract initially valued at $27 million, but that should increase in value over time
  • ViaSat had previously announced in 2009 that it won the contract worth $46 million for consumer broadband terminals to Yahsat. They issued a statement stating that the contract had 'been restructured', and that the backlog would be adjusted. The statement goes on to say that the contract will now focus on Viasat's Yonder mobile offering- which offers a VSAT service offering for commercial and business aviation, and maritime and government operations -a segment with significantly less upside potential
  • More can be found here on the recent loss - http://www.spacenews.com/satellite_telecom/110304-hughes-wrests-contract-viasat.html
  • This goes to show that Hughes, the world leader in VSAT systems is becoming increasingly aggressive on the consumer side of the business, an area VSAT has staked its future on
Risk #4:  Valuation
 
ViaSat Valuation & Capitalization        
Recent Price $41.00   Free Float             36.580
Shares Out         42.717   Short Interest             2.800
Market Cap  $    1,751.4   SI / Float   7.7%
Debt           319.3   Days to Cover 14
Minority Interest                3.9   ADV           200,000
Cash              53.8   Largest Shareholder  
Enterprise Value  $    2,020.8   Baupost Group 23.4%
           
           
Valuation Multiples for FY 3/31  2011 2012 2013    
           
Revenue  $       800.8  $     933.9  $   1,152.8    
EBITDA  $       161.4  $     190.4  $       283.0    
EPS $1.39 $1.17 $1.68    
           
EV / EBITDA 12.5x 10.6x 7.1x    
P/Adjusted EPS 29.5x 35.0x 24.4x    
           
 
  • Aside from the change in the competitive landscape, which likely will bring down forecasts for 2013, and may continue to be elevated, the stock trades at a material premium to what its best comp just got acquired for
  • Hughes was acquired at a multiple of CY 2011 EBITDA of 6.8x. Being valued on CY 2011 numbers gives the company 0 credit for the launch and eventual ramp of the Jupiter satellite, which the market has so kindly afforded VSAT
  • ViaSat acquired WildBlue for $568 million, obviously an even better comp to its own business for 6.7x current year EBITDA in 2009
  • Investor euphoria about the potential EBITDA ramp has caused valuation to levels where the inherent risks are not being accounted for. The current valuation is clearly below what a rational buyer (SATS or VSAT itself) would be willing to pay for these assets , since Hughes was a full auction process
  • And although not the basis for this short thesis, the defense contractor comps for the other piece of the business, all trade at multiples that are a discount to the satellite service universe, based on lower ROIC, lower margins and a slower growth profile
  • Trading at north of 10x FY 2012 EBITDA and 7x FY 2013 on consensus numbers, which I believe could be upwards of 30% to high, presents the opportunity for material downside to the stock. My base case scenario has EBITDA for FY 2013 of $235 million (vs consensus of $283). Assuming a multiple of 6.5x FY 2013 EBITDA, the stock would be at $30, or almost 30% below current trading levels. It is hard to assume any one number for net adds because of the total lack of visibility, but I actually give them some benefit of the doubt, and assume a significant ramp of more than 200k subs / year in 2013. Further downside could exist if subscribers ramp at a slower pace, if VSAT cannot fill the DISH distribution void, or if Hughes has additional commercial wins.

Catalyst

End of wholesale distribution agreement b/w DISH/ViaSat
Clarity around distribution strategy for HughesNet once owned by SATS
Continued downgrades to subscriber expectations as we get closer to launch of ViaSat-1 in July
Commercial wins by Hughes - Yahsat deal being removed from guidance/expectations for ViaSat
Continued strong performance by Hughes in acquiring subs 
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