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Satellite data service sounds like something that might have a lot of potential. However, a bet on Intelsat (NYSE:I) is really just a bet on satellite internet and traditional TV. These are both questionable bets given the competition today. But the thing that Intelsat’s situation dire is their massive debt load. Intelsat’s price rise is in stark contrast to this reality and I believe the stock is nothing more than a bubble.
The following tables summarize Intelsats business since 2010.
Source: I SEC Filings – Intelsat SA
1. Network services really just mean satellite internet. A greater number of mobile broadband (4g) and fiber connections and increased availability of fiber explain plainly why Intelsats revenue has dropped by 12%/year for this customer set. On top of that, there is also increased competition within the satellite space.
One place where satellite internet doesn’t face competition is during air travel. This is a rapidly growing market. This is the only compelling case I could think of to turn around the satellite internet business and deserves a closer look.
Two customers of Intelsat, GoGo (NASDAQ:GOGO) and Global Eagle (NASDAQ:ENT), each lost more than $100m in 2017 providing in-flight internet service. Despite beating earnings expectations this month GoGos share price sharply fell 40%. The drop was simply a correction after the market realized how bad the business looks. Global Eagles results have been so bad that in March they accepted a deal with a hedge fund that was unfavorable to shareholders, resulting in a 30% stock price decline.
Viasat (NASDAQ:VSAT) provides in-flight internet service with their own satellite network and is a direct competitor to Intelsat. Their profit margins have been thin in the past and have now recently turned into losses. Interestingly, the stock trades at the same price as one year ago when they were actually profitable. Either the price was too cheap back then or it is too expensive now. The market’s reaction of GoGo’s recent earnings is evidence for the latter case.
By researching a potential risk factor in shorting Intelsat I actually discovered another few short possibilities.
2. Media really means satellite TV. Traditional media has steadily lost market share to alternatives such as YouTube and Netflix. While revenue has kept up with inflation it is hard to envision a hard turnaround that Intelsat really needs. Far more likely would be an eventual decline in subscriptions, similar to cable.
Source: Infographic: Netflix Surpasses Major Cable Providers in the U.S.
I wanted to get an idea for the market’s outlook of TV broadcasting companies. So I searched google and added the first 5 that came up to a portfolio to see how it compared to the rest of the market in recent years. Clearly, the market is not optimistic about the future of the traditional TV broadcasting business as you can see in the portfolio below. Why is the suddenly so bullish about Intelsat then when it is the largest part of their business?
Source: Portfolio Visualizer
3. The government set is hard to quantify. The annual report states that the drop in revenue is caused by declining market prices of their services, suggesting competition from other satellite data providers:
Source: I SEC Filings – Intelsat SA
Government represents just 16% of Intelsat’s revenue though and has been declining more rapidly than the other two customer sets. From a bigger picture perspective it is hard to tell why the government would demand Intelsat’s services at an increased rate than the general population.
If anyone in the comments has an idea of how the government customer set will dramatically increase demand and/or pay higher prices I am definitely interested in hearing that argument. I’ve studied this one quite a few hours now and couldn’t come up with a single credible idea that would turn this declining revenue trend around.
4. The barrier to entry for satellite operators has dropped significantly. This is because a launch with SpaceXs Falcon 9 rocket costs just $60m compared to $180m for the old popular option, the Ariane 5. Satellite launches are projected to increase significantly from here. You can see in the table below that the number of launches will make a serious jump in 2018.
Source: Space launch market competition – Wikipedia
Newcomers to the satellite data business will be able to charge significantly cheaper prices as a result of these cheaper launches and Intelsat will be forced to follow suit.
If you disagree with this idea run a quick thought experiment. Hypothetically, if all satellite launches were free tomorrow would this be good or bad for Intelsat? The answer is that the cost of future satellite services would be dramatically lower because launch costs wont have to be passed onto the end user anymore. Meanwhile the money that Intelsat spent on old rocket launches would still be built into their debt as a sunk cost. The much cheaper Falcon 9 rocket did this only to a lesser degree.
5. Intelsat has $14.1 billion of long term debt that carried an interest expense of $1b in 2017. Technically they have fixed rate loans and a partial hedge for rising interest rates. However, their income statement tells a different story as interest expense increased 12% in 2 years. A review of the table below shows what is going on. Fixed rate loans are being refinanced regularly at a much higher interest rate. And while a third of their debt is hedged to a maximum rate of 2% that hedge expires in 3 years. This really puts Intelsat on the clock for a turnaround.
Source: I SEC Filings – Intelsat SA
This is a massively underwater business. They have both a declining customer base and service price. Most importantly, they are facing steadily rising interest rates. The fundamentals are clear that this company is likely going to zero barring something like a bailout. In fact, I would actually challenge someone in the comments to point me to unhealthier balance sheet for a company that isnt trading at bankruptcy prices.
One risk factor against the short case is that c band sharing can turn things around for this company. I do not believe this argument has much merit. It relies on an awful lot of ifs. 1. If c band sharing were actually allowed. Maybe, fair enough. 2. If the service was actually superior to 4g. This seems questionable given higher latency which is constrained by the speed of light. Doesnt everyone think 4g is already great – I can’t even tell a difference anymore between this and my fiber line at home it has become so high quality. 3. If a company like Google doesn’t come in compete with low margins. They already tried to do this with fiber in order to get more users. Even if that threat doesn’t come to fruition what is the economic moat for a regular internet service provider from jumping in?
The main risk in shorting Intelsat is that the price has not remotely followed a rational path since it became hyped up. It is impossible to tell when the share price will match the reality of the situation. The best way to combat this is conservative position sizing and patience. A specific risk is that you can expect the position to strongly move against you if c band sharing is allowed – regardless of if it can actually save the company or not.
The other main reason not to short is that there is no obvious short term catalyst that would cause the price to drop. I dont pretend to have one. When the company recently missed its earnings expectation the company price shot up instead of making a rational drop. That was actually when I decided to enter the short because that was the moment it became clear to me that the market is using this stock as a blackjack table rather than an investment vehicle. Thus, youre really just betting against a pure bubble here and take on the risks that entails.
Disclosure: I am/we are short I, ENT, GOGO, VSAT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am no longer short ENT after the recent earnings announcement but plan to be again in the future.