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There has been a lot of confusion about Intelsat’s debt and operating performance. We believe an analysis of a few publicly available numbers will clear-up much of this confusion and thereby advance industry discussion.
I. INTELSAT’S OPERATING PERFORMANCE IS STABLE
|Income for Ops (ex. asset impairments)||1,045||1,023||1,169||1,186|
|Amortization of Intangible Assets||(146)||(130)||(106)||(92)|
|General and Administrative Expenses||(260)||(220)||(208)||(204)|
|Intelsat S.A. EBITDA (adjusted)|| ||1,973||1,989||2,017||2,016|
As the chart above indicates, Intelsat’s revenue has been nearly flat over the past four years, increasing $97M, from 2,513M to 2,610M, an annual rate of 0.95%.
Income from Operations (excluding a $499M and $110M asset impairment charge in 2009 and 2010 respectively) increased $141M between 2009 and 2012, from $1,045 to 1,186M, or 3.22% annually. However, over $54M of this increase (more than 1/3) was driven by the tapering-off of amortization of backlog and customer relations from the 2008 acquisition. This non-cash item declined from $146M in 2009 to $92M in 2012 and will continue to decline independent of the company’s actual performance. Additionally, decreases in General and Administrative expenses, which declined $56M annually from $260M to $204M between 2009 and 2012, provided an additional $56M of the increase in Income from Operations. These two items together accounted for all but $31M of Intelsat’s increased Income from Operations over the past four years. Without these items, Income from Operations would have increased at an annual rate of 0.74%, closely in line with the revenue increase.
Intelsat’s annual EBITDA increased $41M, from $1,973M to 2,016M, or an annual rate of 0.54% over the past four years. But without the reductions in General and Administrative expenses mentioned above, Intelsat’s 2012 EBITDA would have been about $7M LOWER in 2012 than in 2009. Interestingly, Intelsat’s EBITDA was $700K lower in 2012 than 2011 Typically a company planning an IPO works very hard to ensure that its most recent financials show some improvement, even if it is small.
Our Take-Aways: Intelsat’s revenue is growing slower than inflation. As a result, inflationary growth in some expense items is starting to put downward pressure on operating results. Cost cutting to maintain margins, in our opinion, is likely to be unsustainable in the long-run.
II. CASH FLOW FROM OPERATIONS ARE A MIXED BAG
|Cash from Operating Activities|| ||874||1,018||916||833|
|Δ Customer Pre-payments|| ||64||172||296||124|
|Cash From Ops Excluding Customer Prepayments||810||846||620||708|
|Sub Interest Paid in-Kind|| ||(298)||(245)||(27)||(5)|
|Cash from Ops (Exc. Pre Payments and PIK)||512||601||592||703|
|Depreciation (Exc. Intangible Amort)||(658)||(669)||(664)||(673)|
Intelsat’s reported Cash Flow from Operations (includes interest payments) have been declining for the last three years and are now lower than in 2008. This is in large part because Intelsat has restructured a significant portion of its non-cash pay debt (discount or paid in-kind) so that it is now cash-pay. As a result, although its interest expense has declined almost $100M (due to lower rates), its cash payments have risen significantly. Since all the interest needs to be paid eventually, theoretically it does not make an economic difference in the long run. However, larger required cash payments do reduce the company’s flexibility in the short-run.
Rising customer prepayments have materially supported Intelsat’s Cash Flow from Operations. Essentially, Intelsat has been collecting money from its customers years in advance of providing service (presumably at a discount to normal rates) and then recording it as revenue as it provides the service over time. In our view, it is effectively a form of borrowing. The customer prepayments increases Cash Flow from Operations in the year the money is collected, but decreases customer payments in later years when the service is provided.
As all interest will need to be paid eventually and since increasing customer borrowing is not sustainable, we have attempted to adjust the Cash Flow from Operations to reflect an elimination of non-cash pay interest and customer prepayments. The result of these adjustments is there is a clear trend of increasing underlying Cash Flow from Operations. Cash Flow from Operations has increased approximately $200M since 2009. Approximately half of this increase ($96M) is due to the lower interest expenses and another $56M is due to lower General and Administrative Expenses. We do not believe significant additional reductions in either of these expenses are likely in the future. This limits future increases in Cash Flow from Operations absent increased revenue.
Finally, we note that Cash Flows tend to be more “lumpy” than accrual results. So we would tend to read less into the lower 2011 and the higher 2012 Cash Flow numbers. Since the EBITDA numbers are similar in both years, we suspect much of this swing is due to timing issues. For example bills paid Dec 31th vs Jan 1st..
Our Take-Aways: Intelsat seems able to generate approximately $600M to $700M in sustainable operating cash flow per year, about equal its normalized depreciation. This means that if everything goes just right, Intelsat has enough cash flow to replace the fleet as it currently is, but little left over for debt repayment or other contingencies.
III. DEBT HAS INCREASED MORE THAN MANY EXPECT
|LT Deferred Revenue||161||255||407||724||834||673|
|Net Debt + Deferred Revenue||14,564||15,098||15,631||16,338||16,550||1,986|
Intelsat’s debt is increasing more than is initially obvious. In addition to the increase of the face value of its debt by $1.03B, from $14.833B at the end of 2008 to $15.903B at the end of 2012, the company’s cash has also declined $283M during this period, from $470M to $187M. As a result, its net debt at the end of 2012 is actually $1.313B higher than it was at the end of 2008.
The customer prepayments discussed earlier effectively increase Intelsat’s debt, in our view. But they are not as obvious as traditional borrowing. If one does not take deferred revenue into consideration, one will, in our opinion, not understand the company’s true debt levels. Intelsat’s long-term deferred revenue balance (excludes balances to be settled within a year) grew from $161M at the end of 2008 to $834M at the end 2012. At the end of 2012 Intelsat had $84.1M of deferred revenue for which it expected to provide services in 2013. It will not receive additional cash for this. Unless Intelsat is able to continue to borrow from customers at similar levels, this practice will lower cash flows in future years.
When both the decline in cash and the increases in long-term deferred revenue are considered, Intelsat’s “true debt” (our term) has increased $1.986B since the end of 2008, significantly more than the $1.030B “headline” number. We should note that after the end of 2012, Intelsat 27 suffered a launch failure. The $400M+ in expected insurance proceeds should increase Intelsat’s cash balance and somewhat reduce Intelsat’s net debt.
So what did Intelsat get for this additional $1.986B in debt? Primarily, it received an extra $1B in net satellite fleet assets net of depreciation. If Intelsat limited its Capx to its operating cash flow, it would have been stretched to keep-up with existing fleet depreciation. Intelsat also took almost $500M in losses on early exchange of debt to lower its long-term interest costs. Unfortunately, it did not get much more revenue or EBITDA or Cash Flow from customers.
Our Take-Aways: Intelsat has added almost $2 billion in debt over the past four years, but has little to show for it in terms of improved operating performance. Intelsat has barely enough internal cash flow to maintain its fleet at current investment levels, leaving almost none to pay-down its debt or deal with contingencies, setbacks that may arise, or an industry downturn. Absent a method for converting its debt to equity (perhaps through an IPO or a restructuring) its onerous debt load appears to be effectively permanent.
Intelsat has barely enough money to replenish its fleet (Note – see April 7 update below on this issue). If the company is completely stable or grows, that may not be problematic. But an industry downturn, even a modest one, or a company setback, could upset this delicate debt balance of operating cash flow vs. CapX requirements. As Intelsat does not have cash flow to materially retire debt, it may be exposed to the risks of perpetually needing to refinance the debt as it comes due.
The customer pre-payments are an area to watch because they can eat into future cash flows as the company is obligated to provide service in future years but can’t collect additional revenue. If this balance increases, and customers at some point stop effectively extending credit to Intelsat, it may have to provide significant services without revenue. This could lead to a cash crunch. So far, we have seen no evidence that this is happening.
Update 3/21/13 @ 12:10pm — Please send any comments or questions to amusey@SummitRidgeGroup.com. We’d like to make sure we are communicating as clearly and accurately as possible when presenting this somewhat complicated financial issue.
Update 4/7/2013 @ 6:07pm — It’s been pointed out to me that I was being conservative on the replacement capx assumptions. Typically replacement capx is higher than depreciation because new Capx is replacing old PP&E. The new PP&E has generally increased in cost since it was purchased several years earlier. Thus to account for inflation and revenue growth (assuming no real revenue growth in this case), the replacement capx should be: depreciation * (1 + nominal growth)^(average life of assets * .5).
Intelsat’s 2012 depreciation of $673M on $9,421M of total assets (gross of depreciation), suggests an average of a 14 year depreciation life, roughly consistant with the average life of satellites, their largest asset. According to the St. Lewis Federal Reserve, the producer price index for equipment has increased 1.6% annually or about 12% over the past 7 years. Thus the replacement CapX should be (1.12 *673M) or $753M. If Intelsat has to replace its assets at higher rates based on inflation, it becomes much harder for it to juggle its cash flow vs. capX requirements.