2023-07-27 01:49:42 ET
Summary
- Iridium Communications' shares have performed well over the last five years due to the market expecting significantly lower Capex throughout 2029.
- The company is facing a positive decade ahead, and focusing on the IoT market can improve the growth profile of the top line. However, the recent earnings miss shows that valuation maybe stretched.
- Iridium is an extremely attractive and strategic asset, however, given the comparison with similar transactions, we estimate a margin of safety to buy the shares below $40 per share.
Iridium Communications ( IRDM ) shares have experienced superb performance over the last 5 years. We believe this is because the company entered a new prolonged phase of strong cash generation that led to a re-rate of IRDM valuation. The company is now extremely well positioned to take maximum advantage of its highly strategic assets - a constellation of 66 satellites.
We will lay out how the company spent massive Capex over the last decade and is now ready to “cash out” throughout at least 2029 for the benefit of shareholders. However the last earnings confirmed that valuation may be too stretched, and the market is now taking into account higher capex in its valuation, causing the stock to drop more than 15% in one day. We are cautious and start coverage with an HOLD rating and waiting for multiples to come down and allow a better entry to buy this high-quality asset.
Spent a decade building, now is the time to reap the benefits
To truly understand the massive changes that IRDM went through in the last 5 years, we have to look at Capex. The massive cut in capital expenditures is the result of the end of the expansion of their constellation, which now comprises 66 operational satellites. This is also the reason why the stock has been performing so well since 2019 - more free cash flow available for shareholders.
Capex over time (Seeking Alpha)
We can immediately see that the cash burn on Capex slowed down dramatically from more than $400 million per year to an average below $100 million. But the most important detail comes from the company’s guidance on future Capex:
We now expect our capital expenditures to average approximately $50.0 million to $60.0 million per year until 2029.
These figures were actually guided higher from a previous estimate of just $40 million. This is because of inflationary forces and other “business development opportunities”. This caused the stock to drop more than 15% in one day as the company released this guidance at the last earnings release on July 25. The market was clearly disappointed by this higher-than-expected long-term capex, and probably also concerned about their ability to pass on inflationary pressures. This is what revenues in the last years looked like.
Revenue over time (Seeking Alpha)
We can see that the company was able to attract way more business and that growth even accelerated in the last 2 years. This is significant for a company that operates under long-term contracts with customers like the US government and adds growth on top of cash flow visibility. This is why we are also very positive to start a BUY rating in the case valuation comes down, because Iridium is a high-quality asset that may perform very well.
Iridium side-hustle can soon become core: the IoT opportunity
The Company ended the quarter with 2,140,000 total billable subscribers, which compares to 1,875,000 for the year-ago period and is up from 2,051,000 for the quarter ended March 31, 2023. Total billable subscribers grew 14% year-over-year, driven by growth in commercial IoT
This is a quote directly from the latest earnings release . Iridium has been focusing on IoT for some years now, being able to integrate this offering to its larger portfolio of services. However, we started to see a stronger and stronger focus by the company (like mentions of “IoT” in the filings, which went up 20-25% since last year). We think that this may be a sign that management is seeing strong demand in a segment that is still non-core, but may soon become the main focus to attract growth.
Right now IoT revenue is around 23% of total revenue, up slightly from 22% of last year. However it is clear from a very quick analysis that the IoT market is the place to capture growth:
With an expected CAGR of more than 20%, this market is expected to reach more than $500 billion in aggregate value by 2027. Compared to Iridium’s revenue of just $700 million, this represents a huge TAM. But with so much competition coming from all fronts, why are we expecting Iridium to be better and being able to capture more growth? It’s very simple: infrastructure.
Iridium may be able to integrate devices, suites, functions, and services more easily given they are the owners of the satellite infrastructure that can be used to support IoT. Indeed, if no ground networks can be employed, no IoT device can work. And this is where Iridium’s satellites can be used to allow the adoption of this technology even in very rural and underserved areas.
Risks: what can go wrong
We do not forget, however, that this is a capital-intensive company that is exposed to a lot of operational risk and execution risks. The company also brought on a considerable amount of debt to finance the recent years' Capex, and there is now $1.7 billion of net debt on the balance sheet. This creates an additional layer of risk for one main reason: it limits the ability of the company to excessively remunerate shareholders and creates the need to re-finance such debt at maturity. And as we noticed in 2022 and 2023, re-financing can become a very painful thing if in the meantime rates go up 5 folds. Luckily, the company already has some variable debt and the maturity is beyond 2025.
The bottom line: fair value and targets
For the valuation, we would like to use a comparables analysis. In particular, we want to bring in the case that in our opinion better represents the value that can be assigned to a “fleet” of satellites. This is the acquisition of Maxar Technologies by a private equity firm in a deal valued at around $6.4 billion.
Considering that Maxar at the time of closing had something around $2.2 billion of net debt, it means that the transaction assigned more than $4.2 billion of equity value with just $260 million of EBITDA. For an overall multiple of 16. We want to use this transaction as the main barometer for two main reasons: (1) it shows how much value in terms of a premium can be put on the satellites and the infrastructure of a highly-strategic company; (2) it took place in a normal (probably even restrictive) market environment and the multiple is thus not inflated.
The interest of private equity (and not a competitor or related industry player), shows that there are different parties looking at strategic infrastructures. And while Iridium operates a very different business model, we highlight that after a decade spent building their satellites, it may not be a surprise that someone now tries to take them over for a premium like Maxar. The issue is, of course, that right now the valuation appears even more generous that this comparable transaction. Iridium trades, in fact, at around 17 times forward EBITDA (expected around $460 million). This is why we believe that a bargaining opportunity in IRDM stock starts below a 15 multiple, which corresponds to a share price of $40.
Conclusion
Iridium Communications is an extremely strategic, high-quality asset that is now entering a new phase of prosperity in terms of cash generation. The company also faces a very interesting opportunity in pursuing strong growth in the IoT space, where it could eventually build a MOAT. The issue is that, however, the stock is very expensive and even when compared with similar companies and transactions (Maxar takeover), we note that we need more margin of safety at around $40 per share. We thus start coverage with a HOLD rating that could become a BUY below $40.
For further details see:
Iridium Communications: High-Quality And Strategic Asset But Still Too Expensive