GILT - A Glimpse Into Gilat's Shaky Ground In The Satellite Space

2023-10-23 14:06:13 ET

Summary

• Gilat, an Israeli company specializing in satellite services, has shown a flat revenue trend and historically volatile margins.
• The company's business model revolves around communication technologies between the earth and satellites, with a focus on in-flight connectivity and mobile back hauling.
• While the defense sector may become a significant customer in the future, Gilat's financials have been erratic, with unpredictable revenues and operational profitability.

Gilat ( GILT ) is an Israeli company specializing in services for the satellite industry. The company has been around for 35 years and, in theory, should have greatly benefited from the current dynamism of the satellite industry. To add some context, Mordor Intelligence estimates the satellite communication market is growing at a 12.12% CAGR.

In recent years, dozens of companies have emerged focusing on satellite constellations: some design the satellites and constellations, others handle space launches, and still others focus on selling data or services related to these constellations. Despite this, Gilat shows a flat revenue trend and historically volatile margins. After a thorough analysis of this company, I believe it deserves a SELL rating.

My investment thesis is based on a mix of factors related to the company's financials, which display an overly uncertain and unpredictable trend for a company that has been operating for over three decades in a rapidly growing sector, and on the future prospects of Gilat.

Gilat Satellite Networks: Business Model

Gilat's business model revolves around technologies for communication between the Earth and satellites. They offer a blend of hardware and software products that are not sold individually, but as part of two major offerings: the well-established SkyEdge II-C and the newer SkyEdge IV. Both essentially serve the same purposes: backhauling for mobile networks, internet connectivity on ships and planes, data transmission for military operations, and optimization of satellite network resource usage. SkyEdge IV is more advanced, being able to offer backhauling for 5G networks and VoIP services for governments and military applications; SkyEdge II-C, on the other hand, targets the market for backhauling for 3G/4G networks and residential broadband.

The range is vast, but the bulk of revenue comes from in-flight connectivity services and backhauling for mobile networks. The in-flight connectivity niche is the one showing the highest growth rate, accounting for nearly all the YTD revenue increase compared to 2022 data. In the mobile backhauling domain, SkyEdge already has a global market share of 40% and a 70%+ market share for 4G or higher networks, leaving little room for further growth.

Currently, the defense sector is not a significant customer but might become one in the future. Gilat announced in Q1 2023 that it would acquire DataPath , expecting to add $50 million in annual revenue from this new acquisition. The transaction was expected to close by Q3 2023, but as of now, there has been no news.

A Look at the Financials

Below, I present the main figures from the income statement over recent years, along with the unlevered FCF, which I always consider essential for evaluating a company like Gilat. (figures in $ millions, source: Seeking Alpha).

As can be seen, revenues have been very erratic. In the latest earnings call, a revenue projection of $265-285M for FY 2023 was provided, which is higher than the previous year but consistent with the 2016-2018 figures. This is during a period when the industry has seen companies like Rocket Lab, SpaceX, Viasat, and Planet Labs grow at record rates. Moreover, operational profitability has been even more volatile than revenues, as has the ability to generate cash flow.

Things look better when we turn to the balance sheet. The figures provided are from the latest quarterly report:

Valuation

If we glance at the multiples, Gilat's valuation seems appealing. Especially in terms of the price/FCF, it's intriguing to consider investing in a company that can repay our entire investment in 11 years solely with the cash flows it generates.

The issue is that, as we have seen, the financial figures are highly volatile, and the company doesn't demonstrate a steady growth rate. The same multiples could change drastically in just a few quarters, considering that the company largely operates from contract to contract and that its margins are very erratic.

Even though the valuation appears considerably lower compared to the average sector multiples, I'm hesitant to label Gilat a "value stock". The potential for deteriorating relations with one of the two main clients, the lack of assurance on growth, and the inability to capture a slice of the industry's strong growth in recent years rightly imply a high risk premium.

Why I'm bearish on Gilat

There are essentially three reasons why I believe it's better to sell Gilat shares at this moment:

1. Significant increase in competition placing Gilat in a weak competitive position in terms of future growth;
2. Risk of losing one of the two major clients;
3. Inability to significantly expand the client base.

I will analyze each of these factors in detail below.

1. Weak Competitive Position

The satellite design and construction business, which was once very important for Gilat, has now almost completely halted. The company announced on September 13th a significant contract related to the launch of new satellites by an Ethiopian telecommunications company, but it has been a long time since orders of this nature were received. The reason is simple: nowadays, small satellites are easy to build, and companies like SpaceX, Terran Orbital, and Rocket Lab have initiated the trend of mass production. Small designers and manufacturers that provide tailor-made services are increasingly being overshadowed by firms handling the entire design, manufacturing, and orbit insertion processes.

This leaves Gilat increasingly competing for alternative services, namely ground-to-satellite communication software and equipment. Major satellite communication giants like ViaSat and young companies with disruptive technologies like AST SpaceMobile are the most imminent threats, but potentially Rocket Lab, Terran Orbital, and SpaceX could choose to vertically integrate their offerings over time. With an R&D expenditure of $30-40 million annually, for a small entity like Gilat, it will be hard to keep up with the giants.

2. Risk of Losing a Major Client

A significant portion of Gilat's revenue comes from two clients: Intelsat in the in-flight connectivity field and ST Engineering in the cellular backhaul and enterprise solutions domain. Intelsat indirectly became a Gilat client when it acquired Gogo in 2020 and is now evaluating proposals for the development of its satellite network.

The latest earnings call offered no guarantees about the progression of the business relationship.

Chris Quilty: "Got you. And so they've got four software-defined satellites on order. Do you feel good about your position on there? Are they still making a decision about what they're doing with the new satellites?"

Adi Sfadia: "[...] I feel comfortable that in the next satellite, they were -- Gilat is a very strong candidate. Nothing is guaranteed, but I feel very comfortable with our relationship and the solutions that we are providing for Intelsat. The fact that they have our solution deployed globally. It's -- in a way, show a high stickiness to Intelsat."

3. Challenges in Attracting New Clients

Beyond the announcement linked to the Ethiopian communications company, the other significant news in recent months was a "tens of millions of dollars" contract for the development of electronically steered antennas, again related to in-flight connectivity. The order has been received, but it will only materialize as revenue in 2025. While the company continues to secure deals, keeping it within its historical revenue range, the industry is progressing much faster. And the orders are increasingly geared towards in-flight connectivity; if a single major competitor decides to enter this vertical forcefully, the risk of Gilat facing serious difficulties is very high.

Conclusions and Final Thoughts

In conclusion, I believe that currently, Gilat is not in a good competitive position, and its near-zero growth rate in a rapidly expanding market will make it less competitive globally. As the industry moves towards offering standardized solutions, satellites-as-a-service, and larger entities that can handle end-to-end all services related to satellite constellations, Gilat struggles to stay afloat in just two verticals - backhauling and in-flight connectivity - and has not yet provided shareholders with clear details about the DataPath acquisition.

Given all this, I believe there are better stocks to invest in the satellite world. For those interested in a small cap with promising potential, I recommend reading my analysis of Terran Orbital . I will nonetheless update my analysis of Gilat should any interesting developments arise.

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