Intelsat – With Pressure on Video, the Worst is Yet to Come

Intelsat S.A (I), is trading at 3.9x earnings, and is about to launch it next generation high throughput EPIC satellites which will dramatically increase capacity. It now trades at all time lows, down over 60% from its 2013 IPO. At first glance, Intelsat might seem like a buying opportunity. But greater downside, potentially even restructuring, awaits as a result of extensive pricing pressure, the extent of which is not well understood by the investment community.

Pricing Pressure in Perspective
To put the satellite industry pricing pressure in perspective, Intelsat’s revenue is down approximately 5% year over year despite nearly identical transponders utilization. But due to its long-term contracts, Intelsat sells less than 20% of its revenue of a given year in that year. For renewals/replacement contracts of less than 20% of its business to reduce revenue by 5% in one year, the underlying prices of new contracts are likely down be down in the order of 25% during this period. As these declines work through renewals over the next few years, Intelsat faces significant additional revenue declines, even if pricing stabilizes, something few industry observers expect given the onslaught of new capacity.

Intelsat has been obfuscating the new capacity trend by citing various sources suggesting a 6-7% annual increase in industry capacity. However, these numbers refer to traditional satellite capacity. Euroconsult, for example, projects high throughout satellite (HTS) capacity to increase 43% annually between 2014 and 2017, similar to our internal estimates. This would more than double total industry capacity during this time period.

Segment Analysis Suggests Pressure on Media Business to Increase
Intelsat leases satellite capacity to corporate clients with three main businesses segments – each of which is facing significant serious challenges:

1) Network services (45% of q2 revenue) involves applications that generally transmit to a limited number of users at a time, including corporate networks, communication in remote locations such as oil rigs or ships, and wireless backhaul. This segment has been under considerable pressure as global satellite capacity has been increasing dramatically. Newer high throughput technology is increasing capacity on new satellite by an order of magnitude compared to traditional satellites. The number of satellites launched is not slowing, and there are few signs that demand is growing at anywhere near the rate of this new capacity.

The magnitude of Intelsat’s problems in this division is not well understood by the market. New operators are now pricing as low as $500 Mbps/month vs. Intelsat’s legacy contracts that generally several times that level. As contract’s come-up for renewal and pricing continues to decline, Intelsat’s Network Services revenue could be crushed. Even if the market grows as a result of new high throughput satellites, it is not clear how much Intelsat will benefit. The recently announced deal between Facebook (FB) and Eutelsat (EUTLF) for capacity on Spacecom’s AMOS-6 satellite over Africa appears to be for under $200 per mbps/month – well below where Intelsat can be profitable. And prices will probably fall further still!

2) Government Services (16% of q2 revenue) sells capacity to the US government. This division has seen declines due to troop withdrawals from Iraq and Afghanistan. Intelsat believes demand from this sector has stabilized. While demand may have stabilized, industry pricing has not and government users have been quite aggressive at negotiating the lowest possible price. Intelsat recently lost renewal of a five year US Navy contract worth as much as $450 million to Inmarsat over its  life.

3) Media (37% of q2 revenue) largely sells capacity for broadcast video distribution to large numbers of users in wide geographic areas simultaneously. As a result, Media Services clients generally don’t benefit from new high throughput satellites that increase capacity by transmitting in small geographically-focused spot beams. For this reason, this business has been considered “safe” from the pressures in other areas of the industry. But not anymore.

Intelsat’s media services division is facing challenges from fiber distribution including Over-the-top (“OTT”) video services. This is particularly true in the US. which accounts for a disproportionate amount of Intelsat’s media revenue. As the price of storage has fallen, content provides are broadcasting fewer time zone feeds and simply telling the cable companies to store the feeds to do their own time shifting. Additionally, newer compression technologies, including MPEG-4 require less capacity.

We understand that approximately 70% of the North American satellite video contracts come up for renewal over then next five years. Several industry sources suggest that less than half of this will be renewed and what is renewed will be renewed for a much lower unit price with shorter-term contracts. Ultra D TV, including 4K HD seems unlikely to fill the gap. Few industry experts are projecting material 4K HD transmissions over satellite until after 2020 at the earliest.

EPIC is Unlikely to Save Intelsat
Intelsat’s five EPIC satellites will be launched starting in mid 2016. While these high throughput satellites will dramatically increase capacity compared to conventional satellites (by approximately 10x), it’s unlikely to offset the potential revenue declines on Intelsat’s 50 other satellites. EPIC will largely be focused on the lowest priced segment of the market – network services, where pricing on new contracts are already a fraction of what they were a few years ago in many regions. With other high thoughput satellite operators (Avanti, Hughes Network Services [owned by EchoStar Corporation (SATS)], Inmarsat’s (IMASF) Global Express, O23B, ViaSat (VSAT)) adding more capacity and pushing pricing lower to get marketshare, EPIC seems “too little, too late.”

Intelsat’s retort has been that EPIC will open new markets that it could not previously access. However, we have seen not evidence of this. And the satellite industry has traditionally been poor at growing its markets and customer base. Intelsat’s potential share of the growing aviation and marine markets do not seem large enough to save it. On their Q2 2015 conference call, Intelsat management highly touted an Epic presale to Axesat. But Axesat was to an existing customer – not a new market. When asked if Axesat buying enough capacity to offset the lower unit pricing on EPIC, management could only say that they hope the customer “will grow into it.” Essentially, the only customer they could find to brag about was an example of cannibalization of their existing business!

Risk Outweighs any Upside
Recently, press reports indicated Intelsat was seeking to sell assets to reduce debt. Many in the industry thought this was unworkable as its assets are likely worth less than its debt. Later at a Deutsche Bank conference, Intelsat CFO Michael McDonnell poured cold water on the idea that idea assets would be sold. But he would not deny the rumor of a sales attempt. It seems likely that Intelsat management is fully aware of the challenges facing them and explored at a sales process to reduce debt, but quickly realized they would not get the prices they needed and the effort was abandoned.

With nearly 8x EBITDA in debt, declining revenue with no end in sight, and the ever-present risk of a satellite failure that could require an increase in capx to replace and/or lower revenue in the interim, Intelsat’s future is bleak.