Summary
- SATS is the biggest internet satellite provider in the US and a global player in GEO satellite services.
- Although the company is profitable and financially strong, it has not grown, constrained by capacity.
- SATS is going to launch more capacity into space in 1H23, but that may not bring profitability.
- On top of that, the looming threat of LEO satellites (Starlink above all), puts the whole business model at risk. SATS is rethinking its strategy and is accumulating capital for M&A.
- Under that context, current prices, albeit historically cheap, do not provide a sufficient discount and margin of safety.
EchoStar ( SATS ) is the holding company of HughesNet, the largest satellite internet company in the US, with operations in Europe, South America and India.
In a previous article, I considered SATS overpriced given that it had capability limits to its growth and severe competition from substitutes. Although the company is expected to bring new capacity online starting in 1H23, that new capacity will not necessarily bring growth easily enough to justify current prices.
In this article I revisit the company, to find out that its capacity limits are still in place, although the company is holding relatively well against inflation. It seems the market is fearful that Starlink can steal a significant portion of the company's market, which added to stagnant revenue have pushed the company's price downwards.
I still believe SATS is not a buy at these prices, but with so much sentiment in the market it could become cheaper just when getting closer to bringing more capacity online. It is a stock to follow closely.
Note: Unless otherwise stated, all information has been obtained from SATS' filings with the SEC.
Company overview
SATS is the holding company of HughesNet, the largest satellite internet provider in the US. The company is called EchoStar because it used to also own a satellite TV division that was spun off as DISH Network ( DISH ).
For a detailed review of the company, please visit my initiation coverage article.
As a summary, SATS operates in a competitive market characterized by enormous fixed investments, that is being attacked by substitutes.
Starting with competition, providing satellite internet requires satellites, earth stations, antennas and qualified employees. All of this infrastructure is extremely expensive and has to be online relatively independently of how much the service is used. This generates a barrier to entry that forbids some competition but at the same time generates an incentive for competitors to increase volumes at the expense of margins.
In terms of substitutes, satellite internet is used in circumstances where cheaper alternatives are unavailable, which in general means areas that are so sparsely populated that wireless or fixed connections are not economical. This means that the areas where satellite is applicable are constantly shrinking and more and cheaper infrastructure is built by traditional carriers.
Finally, an additional substitute is emerging from a different form of satellite. Traditional satellite internet is provided by geostationary satellites. These are huge throughput satellites fixed in a point in heaven and with beams covering specifics portions of the earth. Their disadvantage is latency and the fact that they are fixed in the sky, meaning that traditional antennas on earth have to be fixed too (there are some alternatives but are very expensive, like the ones used in planes). A new form of satellite internet is emerging from low earth orbit ((LEO)) satellites. These are swarms of smaller satellite networks that are not fixed in the sky and can therefore provide lower latency and service moving targets without requiring expensive antennas. The main competitor in this field is Starlink.
Specifically on SATS, the company is currently suffering from lack of capacity. Its satellites serving the US can either increase the amount of customers they serve or maintain quality, but not both. This means that until the company can bring more capacity online, it will not be able to grow.
Capacity is on its way, because SATS has been manufacturing Jupiter 3, a GEO satellite that will double the company's capacity in the US and portions of North and Latin America. This satellite has been in production since 2017, and its launch is planned to the first half of 2023. The company has recently commented that it will require at least two additional years to be at full capacity.
But capacity may not provide growth, because SATS' main competitor Viasat ( VSAT ) is planning to bring even more capacity to the market at the same time. This probably means that competition among the companies will pass the benefits of most technological improvements to customers, instead of increasing profitability.
What this means is that SATS is a company with a market under attack, currently constrained by capacity, and that may not be able to grow substantially even after increasing capacity.
In my initiation article, I considered that the company would be able to generate approximately $100 to $120 million in net earnings in its current state. With a valuation then close to $1.6 billion, it seemed expensive.
Finally, SATS has an enviable financial position. The company has $1.5 million in fixed rate debts (paying between 5% and 7%) maturing in 2026, but it also has $1.5 million in cash and securities reserves. If the company used even a portion of that cash to repurchase shares, it could justify its current prices by increasing earnings per share.
A strategy is rolled out
The company's new CEO commented on the 2Q22 earnings call on the strategy landscape they are evaluating for the next few years. It is divided in three stages, called horizons.
Horizon one is the next year and a half, during which SATS will be constrained by capacity. The company will try to shift capacity from retail customers towards more valuable corporate customers.
In fact, the company seems to be following a specific customer churn rate of exactly 60 thousand customers per quarter (over 1.3 million as of 3Q22). This (I believe active) loss of customers has not affected revenues in nominal levels, although it has definitely affected them at real levels when inflation is considered. With operational leverage, even small falls in revenue can be really felt at the bottom line.
Horizon two implies Jupiter 3 online, will begin in the first half of the next year and will last at least five years. This period should begin with lower CAPEX from the satellite, offset by higher CAPEX from the equipment required to use the satellite (like stations, small antennas for consumers, etc.), followed by a cash cow period during which CAPEX is low and the satellite is bringing profits. How profitable that period is depends on competition forces. As I commented, with VSAT bringing more capacity online at the same time, and Starlink competing with LEO satellites, Jupiter 3 may not be able to extract a lot of extra profitability.
The mother of all battles is LEO
Finally horizon three is new technologies like the LEO market. In this stage, SATS is considering acquisitions or organic expansion into technologies that may pose a threat to GEO satellite internet.
In my opinion horizon three is getting closer by the hour because of Starlink. You do not want to be on the other side of competition with Elon Musk, famous for disrupting every industry he has set foot on. Starlink has only been in operations for one year and SATS's management already recognizes it (on its 2Q22 earnings call) as the most important challenger to its supremacy.
Currently, GEO and LEO markets are somehow separated as tiers. GEO is cheaper but with lower throughput and higher latency. LEO is faster but more expensive. The problem is that technology improves and can have steep experience curves. LEO may become cheaper and competitive against GEO soon. I believe part of SATS's current valuation, which management and analysts consider extremely cheap, is affected by this fear of Starlink becoming the standard of satellite internet in a matter of years.
How is SATS preparing for that scenario? SATS has a small stake in OneWeb, one of Starlink's competitors in the LEO market. The company is concentrating its operations in Europe. But this may prove slow against Starlink, and is not a sizable bet for a company of SATS' size.
Management has changed attitudes, and is now more lenient towards being more aggressive and acquiring its way into the LEO market. Part of Jupiter 3's cash flows will be directed to this use or accumulated to wait for an opportunity. In fact, SATS has slowed down its stock repurchase program and management commented specifically that they are being more conservative with cash (despite having $1.6 billion of cash and securities) because they think it may be useful to make a strategic shift. In the 3Q22 earnings call they mentioned the M&A possibility directly, saying they are 'working on significant additional M&A' for horizon three.
Going forward
For a growth stock, and growth investors that would have considered SATS, the company is crazy cheap. It currently trades at a market cap of less than $1.6 billion, and has a cash vault of $1.6 billion (of course offset by an equivalent debt schedule concentrated in 2026). The company has been punished by markets for years now.
When non-recurring financial results are removed, the company is generating net income in the order of $120 million (considering an effective tax rate of 30%). When financial results are added, the company is easily reaching $170 million in net income this year, because it has fixed rate liabilities and variable rate financial assets (3% of 1.6 billion is $50 million). On top of that we have to add Jupiter 3 coming online at some point of 2023, which could (hopefully, not necessarily) reopen the path to growth.
Why is then SATS being valued so cheaply compared to current earnings and medium-term future prospects? My take is that Starlink is making the market fearful. This is obviously not good for SATS' investors for several reasons. First, an anxious market can lead to extremes, particularly on the negative. A news piece announcing some threatening move by Starlink could lead to SATS' price being punished. Second, and most importantly, market anxiety can translate into management anxiety. This could push management into acquiring anything in order to be considered a LEO player.
For those reasons, in my opinion it is better to wait by the fences. If the market panics and puts a higher discount on SATS, then it may become a purchase opportunity. If not, then readers can keep evaluating the company, particularly evaluate any acquisitions and how new business models are incorporated into the company.
For further details see:
EchoStar Is Not An Opportunity Yet, Too Much Risk Ahead