For you headline lovers out there here is the quick 35,000 foot summary (please appreciate the awful pun).  Gogo, Inc. ("GOGO") operates in a nascent commoditized market.  GOGO is unprofitable (from both a FCF and net income basis), has huge capital spending upgrades over the next few years due to outdated technology, is quite levered (with a near-term maturity and high yielding debt), their two competitive advantages are rapidly become moot (technology obsolesce and contract renewal periods), and their customers hate them.  The market is currently looking the other way and is blinded by revenue growth (hint it’s really easy to grow at high growth rates from zero) and is ignoring obvious economic and strategic challenges that could sink the company in the not too distant future.  I think GOGO is materially overpriced and now (pre-earnings: announcement is on March 13th and post run-up) represents a great time to short them.  I think they are worth around $12 per share or about 50% downside versus their recent close of $24.80.       

For those who stuck around to see how the sausage is made let’s dig in:

GOGO operates in a highly commoditized market (GOGO, LiveTV (JetBlue's unit), Row 44 (part of Global Eagle), Panasonic, OnAir, ViaSat, etc.).  GOGO provides inflight connectivity (IFC) and wireless in-cabin digital entertainment solutions.  GOGO operates in two segments commercial aviation (CA) and business aviation (BA) segments both domestically and abroad (although practically speaking it’s just domestic - the international market is far more crowded and GOGO leads its key domestic advantage when it tries to move internationally).  In the CA segment GOGO offers subscriptions on a daily ($14), monthly ($39.95 or $49.95) or annual basis.  The BA segment (which is about half their trailing revenue) serves 89% of all business jets connected with broadband and 63% of narrowband business jets and 93% market share in broadband (from GOGO investor presentation).  Business planes hooked up with GOGO's technology generate average monthly revenue of $1.9k (a massive premium to some of the satellite offerings).  

One key thing to understand when looking at the IFC industry is that Airlines ultimately control the customers and as a result IFC providers are beholden to airlines.  This is why GOGO uses a revenue share model to win airline contracts.  This revenue share has increased from 11% in 2012 to approximately 20% in 2013 – this amount will increase as airlines demand larger shares of the pie or threaten to switch to another IFC provider. Based on industry channel checks airlines hate GOGO and can’t wait to switch off them once alternative solutions become more viable for global fleets.  An interesting mapping exercise is to look at how the rollout of internet connectivity occurred in the residential segment - at first it was slow and price and speeds were crappy and high but they quickly became commoditized.  Additionally I would encourage people to learn more about airline dynamics - airlines like partners that come in and are willing to rollout substantial amounts of capex for free but object when the partner wants to get paid (Airphone is the perfect analogy on this one).      

GOGO has painted the veneer of long-term contract and customer stickiness but the reality is each contract permits airline partners to: “terminate its contract with us [GOGO] if another company provides an alternate connectivity service that is a material improvement over Gogo” so airlines can and have switched whenever they want to with no penalty (there is some install time which can be avoided if it is worked in with regularly scheduled maintenance).  The contracts start to expire in 2017/2018 and in speaking with a number of industry sources it seems really apparent that most folks are heavily shopping for alternatives.  GOGO's initial advantage was that they bought spectrum from Verizon (1mhz and 3mhz spectrum licenses from Verizon) this helped them roll out their Air-to-Ground (ATG) network.  ATG is a stop gap solution that was very economic to rollout (since it took advantage of existing cellular technology and did not require a turnable raydome or anything like that and the equipment was small and light making it really feasible for narrow body planes).  ATG was feasible economically but the downside is it is based on old technology with limiting speeds (on a typical ATG serviced CA plane you would be lucky to get ISDN like speeds aka a couple Mhz vs high Mbps speeds offered by satellite solution providers).  GOGO's ATG technology supports peak rates of 3.1Mbps if even 10 people on the plane are on their service it quickly diminishes the user experience - making only emails feasible on flights.  This shows the catch-22 that GOGO has gotten themselves in: they want to charge high rates so only the top tier of the segment will use their service since if more people use their service it quickly becomes terrible and results in a bad user experience.  To make matters worse, in the CA segments consumers view IFC as a right that they shouldn't have to pay for: JetBlue is rolling out free WiFi on select flights (via their LiveTV unit) and it will be interesting to see how consumers respond to this - is IFC the peanuts of the 21st century?  In order to get caught up to present day technology GOGO is rolling out their ATG 4 Technology which has the promise of 9.8Mbps - while this sounds like a huge improvement it’s still slower than existing satellite technology which presently ranges from 10-50Mbps (and is expanding to 50+Mbps as Ka rolls out and Ku spot beam technology becomes widely rolled out).  It is also worth mentioning that satellite doesn’t suffer from the same linear bandwidth diminution that ATG does - in fact through new developments like spot beam you could actually not really noticeably diminish since the bandwidth ceiling would be silly high to begin with.

As GOGO tries to expand internationally their ATG technology will not work so they are licensing satellite spectrum from: Inmarsat and Intelsat.  GOGO has made a public goal to have Ku bandwidth rolled out in late 2014 this is looking increasingly unlikely (it was originally supposed to come out in 1H 2013).  They are also targeting a 2015 launch of their Ka services which frankly will be a stretch for them to reach that goal, and when they do they will almost already be too late (other providers have Ka solutions today and many more will be rolled out prior to GOGO's introduction).  Panasonic and Row 44 are online presently with Ku bandwidth and LiveTV is launching their Ka band this year (which based on recent channel checks seems very much on schedule).  To make the satellite transition GOGO will have to sprint to maintain any current form of market share.  They are widely hated by their customers - based on channel checks with Row 44 and LiveTV the amount of inbound interest calls they have gotten from major airlines has increased substantially as GOGO's performance has continued to suffer and their rollout of a satellite solutions continues to be plagued by delays.  Delta - GOGO's flagship account is even upset with them since they can't get raydome certification (which is a low hurdle as a number of competitors have already received raydome certification) - GOGO has developed the reputation amongst its customer base of overpromising and under-delivering (not a recipe for success).  This market is likely to gravitate towards a winner take all (or at least most) mentality - this is why GOGO was able to sign so many folks initially since they were able to point to marquee wins like Delta and US Air.  As customer switch off (Southwest, AirCanada, etc.) and they lose mindshare on the international side to LiveTV and Panasonic the picture will start to look even more bleak due to the long-term contract nature of this business (and frankly the annoying and potentially expensive rip and replace cycle).       

Substantial capex will be required as part of the pending rip & replace cycle.  Capex should be at approximately $150m in 2014 rising to nearly $300m in 2019.  GOGO has positioned their transition as follows: ATG=>ATG 4=>  Hybrid (ATG + Satellite) => Satellite.  The only advantage this company had was its first mover advantage with an economic solution.  Now that the technology has become outdated and their reputation in the industry has soured there is almost no way they can win. 

To properly value GOGO I conducted both a discounted cash flow analysis as well as comparables analysis.  As GOGO builds out their international offering they will have considerable capital expenditures making them FCF negative until 2017.  I projected GOGO’s financials out until 2019 (longer time line was needed to see margin inflection point).  The bulls believe that GOGO will be able to grow their revenue rapidly based on increased utilization rates and substantially higher average revenue per session (ARPS) (see chart below).  

This will be tough as more competitors have entered the space (especially with GOGO’s already high domestic CA marketshare) and are doing so with equal or superior offerings at vastly lower prices: Row 44 on Southwest offers WiFi for $8 per day versus $14 for GOGO and JetBlue is in the process of rolling out free WiFi on all flights (via their LiveTV unit which provides IFC to JetBlue, WestJet, Frontier, Continental, Virgin Australia, and Azul Brazilian Airlines).  The CA segment will drive most of the forward value as the BA segment is fairly stagnant going forward in comparison (this is mainly due to GOGO’s high market share making the forward growth in the BA segment substantially more limited than the CA segment).  I assume CA-NA ARPS grows from an estimated $10.58 in 2013 to $12.63 in 2019 and utilization (take rate) grows from 6.1% in 2013 to 10.2% in 2019.  The CA-ROW ARPS grows from effectively $0 today to $18.59 by 2019 and utilization (take rate) grows from 0% today to 16% by 2019 (I assume higher monetization and take rates on ROW flights as international flights are longer and are far more likely to have power users who take advantage of higher satellite connectivity speeds to maintain their productivity / internet habits during long flights).   This results in a 2013-2019 revenue CAGR of 23.4% (2019 revenue is projected at $1,130m or 3.5x 2013 revenue) and margins ramp but not at an accelerated pace due to increased competition and necessary R&D expenditure (2019 EBIT margins are 16.9% versus margins of -11.7% in 2012). 

GOGO additionally has a lot of hope and hype on their text & talk and GOGO vision product.  I will be surprised if we ever really hear much out of text & talk.  Text & Talk was announced in November 2013 and almost immediately after announcing the service most airlines prohibited cell phone calls on planes and I would be surprised if consumers really feel the need to pay up the egregious prices required in order to text their friends from a plane (Airphone never worked so I am not sure why this will).  GOGO vision is their attempt to offer a full inflight entertainment solution.  On their server they will host streaming entertainment (on a different band than the WiFi so it won't bog browsing speeds).  The main reason for rolling out this product is to answer the BYOD demand that could potentially result in airlines removing seat-back entertainment costs (again goes back to the idea that airlines love pushing spend to others and if consumers are all bringing tablets why would airlines spend the money and sacrifice the weight of installing seat-back entertainment solutions).  This is not a widely used service and is mostly smoke and mirrors at this point.  I think it’s hard to believe that folks will really want to subscribe to this once the browsing speeds get fast enough that they can just consume their normal media in-flight on their tablets Netflix, HBO Go, YouTube, etc. (currently those are all blocked since they are not feasible on GOGO's network).  

The sellside is almost silly with their expectations. They have CA-NA ARPS growing to north of $16 by 2019 - I find this a tough pill to swallow at a certain point companies will push back on rates - if they don't it will become prohibitively expensive.  This coupled with the fact that airlines will continue to demand larger revenue shares if they start to see IFC players making substantial amounts of money off of their customers (that or they will try and take it in-house - similar to what JetBlue has done).  Additionally the sellside has assumed that the take-rate (aka utilization rate) will continue to rise from 6.1% to nearly 15% - this is far in excess of the historical growth rates (in a nascent market that is really impressive to assume) and really is hard to swallow considering the presumed prices they will be charging.  The assumptions are equally egregious on the CA-ROW side.  They also assume a re-acceleration in growth in the BA segment which would be impressive considering how developed this market is and their substantial (claimed) portion of market share (maybe they know something we don't about the forward growth rates of the private jet market).  

GOGO has funded its business to date via raising equity and debt initially as a private company and then through their IPO which took place in June of 2013 at $17 per share (they raised $180m).  As of Q3'13 (they have yet to report Q4) they had $242.1m in debt that was due in 2017.  This debt is expensive and yields 11.5%.  I find it quite telling that they have been unable to refinance into a lower rate in the most favorable rate environment of all time.      

On a DCF basis I arrive at a valuation of $11.92 (using a terminal FCF multiple of 16x which I thought was appropriate (if not generous) given their growth rates).  $11.92 implies 27x 2017 P/E and 15x 2018 P/E.  On a comparables basis GOGO trades at a substantial premium to its comps.  Many people like to try and position them as a tower company of the future but that is just inaccurate.  The only relevant comparable there is that in theory there is single tenancy - which strangely enough is currently being challenged in the Northern California court with Judge Edward Chen presiding.  The lawsuit is arguing for multitenancy (GOGO is involved) and the judge has said that the plaintiffs offer "plausible antitrust claims" and that GOGO overcharges for their service.  I think this lawsuit is mostly bogus (the multi-channel equipment would have to be rolled out on all airplanes and there would need to be an agreed upon industry standard: ATG, Ka, or Ku - making it highly unlikely anything will come out of this) but it does offer nice optionality to my short thesis.  The closest publicly traded comparable to GOGO is a company called Global Eagle Entertainment which is a $1B NASDAQ traded company that provides IFC and entertainment content - they own Row 44.  Global Eagle trades at 14.5x 2017 earnings versus GOGO's current 2017 P/E of 56x.

So in conclusion I think the key value drivers to this short are:

• Unprofitable levered business in an increasingly commoditized market facing substantial capital expenditure requirements trading at excessive multiples due to unrealistic expectations in spite of increased competitive pressure and customer indifference to new offerings.
• Inevitable evolution to satellite connectivity will damage GOGO as they struggle to keep up.  As part of industry diligence I spoke with a number of industry consultants, VCs, competitors, and even heads of large airlines.  The takeaway from this diligence process is as follows: to date industry participants have been disappointed with how GOGO has handled themselves, they are frustrated with GOGO’s poor operational performance, lack of viable business model, and poor product evolution.
• The competitive dynamics in this industry just suck - a company that doesn't own its customers but has substantial capex requirements in order to give them the bare minimum service (just enough so they don't get fired) and overtime prices will come rapidly lower while service requirements and expectations continue to march upward.
• GOGO has unsustainably high market share (80% of CA North America and 93% of BA North America).  They are insignificant ROW.  This will only be eroded overtime as airlines switch off their outdated products.  The market seems to be rolling forward these glossy marketshare assumptions and silly ARPS and take-rate assumptions into infinity.  
• Another telling sign is that Ripplewood Holdings, the primary backer (former 38% owner) raced to exit their holdings via an LP distribution after the lock-up despite GOGO management commentary that they would likely not sell until 2014 and would do so in an organized secondary.  

The risks to this short are as follows:

• New beta tests by commercial airlines could move the stock upward temporarily as investors get overzealous about pipe dreams - GOGO trades mostly on sentiment as today’s results are relatively immaterial at the present valuation.
• Another threat could be an acquisition by a satellite provider seeking to enter the market (unlikely given the valuation, and lack of real traction beyond mild brand name recognition, and shift in strategic focus).

I think this is a pretty easy way to play off the hopium in the market and make a nice 50% or more in the process.  Please fasten your seatbelts and place your tray tables in their upright, locked position - this could be a rough landing.