I’ve neglected the blog for a while as I am working on my forthcoming “Spectrum Handbook 2013.” I expect to release it in a few weeks. Please contact me if you’d like a copy. But I did have a chance to review Intelsat’s Q1 results. Results were somewhat better than I expected – modest growth, stable margins, etc. A few thoughts – none of which should be viewed as a recommendation to buy or sell securities or any kind:
A) IPO WAS PROPERLY PRICED — Intelsat’s IPO looks like a success. Priced at $18 below its filing range and with a sharply reduced size, the stock has held its own and even exhibited a respectable IPO “pop.” While the IPO valuation represents little upside for Intelsat’s private equity investors and I was skeptical there would demand based on the company’s risk, it seems the valuation was right for the market.
But we are still a bit confused about who owns the stock. We surveyed the leading industry consultants and none of them received more than a single investor inquiry during the IPO process! Moreover, not a single investor asked a question during the recent quarterly conference call! We’ve not sure if this is good or bad, but is certainly seems strange. Please let us know if you have any insight into the mysteriously silent Intelsat shareholders.
B) CORPORATE STRUCTURE SIMPLIFIED — Intelsat continues to flatten its corporate structure. The entity formerly known as Intelsat S.A. (the highest reporting entity) will be renamed Intelsat Investments SA and will cease to report as the only debt at that level has been retired. The top level, formerly know as Intelsat Global Holdings, will be renamed Intelsat, S.A. and will be the reporting entity of most relevance to equity owners. This will make life easier for those following the company but may put some org chart designers out of work.
C) Q1 REVENUE WAS OK — Management emphasized the 2% growth year over year compared to Q1 2012. We are not sure this is quite apt. A more relevant comparison is the drop-off after Q4’12 compared to Q4’11. Intelsat’s Q1’13 revenue of $655.1M was $21.3M lower than Q4’12 revenue of $672.4M. By contrast, its $644.2M of revenue Q1’12 was only $9M lower than its Q4’11 revenue of $653M. Thus, Intelsat had a larger revenue drop from Q4 to Q1 than in the prior year – over twice as large. Moreover, in 2012 Intelsat saw five satellites come on line to help increase its growth through 2012. This will not be the case in 2013 when it does not plan to launch any satellites. Some possible reasons for the large Q4 to Q1 drop-off include:
- Possibly due to an effort to “shore-up” Q4’12 prior to a planned IPO left fewer low-hanging sales in Q1’13 as well as the impact of management’s expected distraction during the IPO process. To be clear, we are not suggesting management engaged in anything improper.
- Sequestration is hitting the industry, reducing government related sales.
- We have heard from multiple sources in the industry (but not enough to have a solid conclusion) that Intelsat sales efforts have been lackluster compared to other players in the industry. Intelsat made sharp cuts to its G&A costs over the past few years as previously discussed. These cuts may be starting, at the margin, to hamper sales efforts. This could be particularly true with government sales where contract lengths are getting shorter, increasing the volume of contracts and associated administrative work. Intelsat may have prioritized its staff to work on longer-term, higher margin media business.
- Media revenue was up 6% – this suggests Intelsat is competing well in that market – slightly higher than the overall media market. This contributed to an increase of 5% for transponder services and 4% for network revenue as a whole.
- Channel services and Internet trunking is declining at a rate of $30M annually. We think this trend is likely to continue as the fiber build out continues, particularly in Africa.
- Off –network services declined $13M or 17% – largely due to lower hardware sales and 3rd party sales. These sales are lower margin than Intelsat’s overall business, causing a decline in direct cost of revenue by $7
D) SHRINKING BACKLOG? -– Intelsat’s backlog fell by approximately $300M during Q1’13 t0 $10.4B. This represents a dismal book to bill ration of approximately 0.5:1. However, major contracts are often lumpy by nature and one quarter is not sufficient to indicate a trend. However, CEO Dave McGlade indicates that the decline was due to lack of launches that normally increase backlog. As there are no launches scheduled until the second half of 2014 (and launch dates are often delayed), this seemed to suggest Intelsat’s backlog would continue to decline. At a $300M loss per quarter, backlog would still by $8.6B by the end of Q3’14. We are not suggesting backlog will fall this far.
E) FLAT 2013 REVENUE GUIDANCE — Intelsat is projecting 2013 Revenue of $2,615M to $2,640M. At the midpoint, this is an annual growth rate of 0.665% versus 2012’s 0.840% growth. Given the lack of new satellite comes on line in 2012 and the impact of sequestration, this may be somewhat aggressive, but not unreasonable.
F) SUCCESSFUL DEBT REFINANCING — Intelsat has done a great job of leveraging the strong bond markets to lower its interest rate and spread-out its debt maturities to eliminate the bulge of debt maturities it previously had in 2017. The effect of these transactions is to lower debt payments by $170M. Pro-forma for the 2013 transactions, Intelsat lowered its debt to adjusted EBITDA multiple from 7.85x to 7.55x. Of course, these calculations do not include the $854M in deferred revenue that, in our view, is effectively debt.
G) INSURANCE PAYMENTS RECEIVED — Intelsat received at total of $491M in insurance proceeds from Intelsat 19 and Intelsat 27. Most of this was used for debt repayments. As we mentioned, earlier, the Intelsat 27 failure seems like a blessing in disguise.
H) AMBITIOUS SATELLITE CONSTRUCTION — Intelsat announced four new Epic satellites in addition to the one under construction. One was generally expected, the other three were not. This represents a bold bet that Intelsat will be able to replace multiple satellites with a single Epic satellite. The first will be go into service until 2016. Intelsat also has for “regular” satellite under construction, bring a total of nine satellites currently under construction.
Dave McGlade indicated that approximately 20% of the first Epic satellite, IS29, has been presold to Panasonic Avionics, Harris Caprock and MPN. We suspect this represents significant portion of Intelsat’s $854M of customer prepayments. CFO, Michael McDonnell indicated IS29 has the equivalent of 270 transponders. If 54 transponders equivalents (20%) have been pre-sold and pre-paid, that represents a lot of capacity for which Intelsat will not receive additional cash after the launch. McGlade indicated Intelsat would seek similar customer pre-commitments for the other Epic satellites.
I) CAPX GUIDANCE — Capx Guidance is $600M to $675M for 2012, $575M to $650M for 2014 and $775M to $850M for 2015 when their launch cycle ramps-up. Although management did not provide guidance, we’d expect high Capx in 2016 and 2017 as the rest of the Epic satellites are launched. So its not clear Intelsat’s Capx holiday will last.Note that Intelsat’s Capx guidance includes capitalized interest. After satellites launch, this interest is then expensed. This is proper accounting, but it makes Intelsat’s true total interest payments somewhat confusing to track. For example despite all of Intelsat’s refinancing over the past 15 months that lowered Intelsat interest costs by hundreds of millions annually, Q1’13 interest expense was $318.4M vs. $312.9M in Q1’12. This was due to the five satellite launches that resulted in expensing interest related to those satellites as opposed to capitalizing them.
BOTTOM LINE: Intelsat ‘s quarter was decent give market condition. But its debt situation, in our view, remains precarious. Intelsat has approximately $2B in annual EBITDA with little to no growth, over $1B in interest expense and $500M to $1B in annual Capx. This leaves little room for handling setbacks such as satellite failures or business slowdowns. In 2004, for example Intelsat lost two satellites in orbit. We understand that Intelsat only insures its launches and does not generally carry in-orbit insurance. At $300M per satellite, each with average annual revenue of $40M to $70M and a 3-4 year replacement cycle, an in-orbit satellite failure or two could be quite challenging. Intelsat is also exposed to other risks including refinancing its debt as it comes due when the markets may not be as cooperative. The IPO, however, gives Intelsat additional options to handle financial setbacks. These include rights offerings and debt to equity conversions. But these are all potentially dilutive to stock holders.