Description

GOGO was written up as a short on this site about two and a half years ago, and the crux of the thesis remains today: GOGO is an unprofitable company that burns cash, has leverage, and plays in an increasingly commoditized space. Even when we ignore the massive losses in the international business, we are left with a company with significantly negative earnings, mounting competitive pressures, and a changing business model with economics to its detriment. The business model is structurally impaired and we believe this could ultimately be a zero.

Background

GOGO is the global leader in providing in-flight connectivity (“IFC”) to commercial and business jets. IFC first developed in the US, and GOGO was the first mover in the space. GOGO built out an Air-to-Ground (ATG) network on Verizon cell towers that covers the US. ATG was largely a stopgap solution that was very economic (for the airlines) to roll out as GOGO footed virtually all the capital costs; the airline simply began receiving a check in exchange for allowing GOGO to put IFC on its aircraft. Current ATG has significant performance limitations: max speed does not support video streaming and there is performance diminution as usage increases. ATG also does not work outside of its ground tower network and only works when the plane is above 10ksf.

Thesis

The core thesis is that A) GOGO’s dominant share in North America is under pressure as they face both competitive losses and changing economics which are to their disadvantage; and B) the international market is highly competitive, GOGO lacks advantages, and the business model there is inferior; while in the meantime C) GOGO burns cash and has debt, while continuing to have high capex needs. There is a reasonable scenario of GOGO entering a fatal tailspin (pardon the pun) in the not too distant future.

Segments

GOGO operates in three segments. Two are currently “profitable” on an adj EBITDA basis: Business Aviation (~33% of total revenue, ~50% of adj EBITDA ex-intl) and Commercial-NA (~63% of total revenue, ~50% of adj EBITDA ex-intl). The third segment is the Commercial-Int’l segment (~4% of total revenue, generates large EBITDA losses).

We say “profitable” with quotations because they are only profitable on an Adj EBITDA basis as the company reports it. The most recent quarter’s annualized run rate is about $152mm of Adj EBITDA from these two segments, but stock comp runs at about $18mm, and interest expense and D&A/cash capex each exceed $100mm. Thus even on just the two more developed businesses (i.e excluding the massive losses in int’l), GOGO is deeply in the red on a pretax earnings basis.

North America

The North American market is virtually fully penetrated, with GOGO holding an unsustainably high market share, despite mgmt’s claims otherwise. On the BA side, most currently unpenetrated aircraft are small planes have no wifi need. The maturation is already present in the numbers – GOGO has reported yoy declines in BA unit shipments for 7 of the last 8 quarters. Growth is slowing. On the CA-NA side, virtually every plane has been equipped with wifi to date, including most suitable regional jets. The bull case is that GOGO can grow in NA primarily from a combination of higher pricing and usage (“take rate”).

The reality though is that inflight wifi has elastic demand. Also, the current quality of inflight wifi from ATG service is terrible. If you are the only person on the plane using it, the bandwith is still insufficient to support streaming video, and once 10 people are using it on the plane there is significant diminution in speed. Passengers have noticed and the GOGO brand is not viewed positively, to say the least. Again, you can see this issue in GOGO’s numbers: the take rate for CA-NA has been down yoy in 5 of the last 7 quarters as GOGO has priced to the point that passengers simply won’t pay for the service.

GOGO’s response to this conundrum has been to spend capital and invest in new technologies, including new ATG offerings. They recently introduced “ATG4” which promises ~3x higher bandwith, and they recently announced a new “Next Gen ATG” which promises bandwith at ~10x ATG4 (at some undefined point in the future, and at an unquantified cost to GOGO). The simpler answer to the problem is satellite, which supports bandwith up to 5x that of ATG4 and >16x ATG. GOGO has developed a satellite offering too, but this is an area where they lack the competitive advantages that have in ATG. Airlines like Southwest and JetBlue use competitor satellite offerings. Recently, American Airlines, which constitutes 40% of GOGO’s CA-NA business (and 22% of total company revenue), announced it was potentially moving up to 20% of its GOGO planes away from GOGO to a competitor.

We think the American Airlines situation is the harbinger of doom for GOGO. Over time, its dominant market position in NA will be eroded, and/or it will maintain customers by dramatically reducing its economics. Further customer losses or lost earnings from this segment may present existential risk to GOGO given the company’s leverage and capex needs.  

International

GOGO’s ATG network does not work outside of North America. Elsewhere in the world, GOGO is effectively a commodity reseller of satellite spectrum, which it leases from the satellite operators like Immarsat and Intelsat. Here, GOGO is faced with many strong competitor including Panasonic, Viasat, Row44, Thales, and others. Many of these competitors have established relationships with International airlines for other services like in-flight entertainment, technology hardware, etc, which we believe serves as a competitive advantage for them vs GOGO (not only are they a preferred provider, but they don’t need to be as profitable on a stand-alone basis with their IFC offering). Regardless, reselling satellite bandwith in a competitive environment is far less attractive than GOGO’s effective monopoly position in NA.

The international business currently generates over $90mm of annual negative Adj EBITDA. The quarterly losses have more or less been the same for the last 9 quarters. GOGO does have numerous contract wins internationally, but so do competitors. Although GOGO claims to have a superior satellite offering vs the competition (its “2Ku”), our due diligence (and competitor wins) suggest that this is mostly spin by management. The path to profitability for GOGO’s international business is likely to be extended, and in the meantime the business will burn cash.

Business Model under assault

An important issue is that GOGO does not control its end users – the airlines do.  JetBlue offers its basic wifi for free – if this catches on as more of an industry standard offering, it is hard to see how GOGO’s economics over time can be anything close to what they look like now. GOGO’s model of charging passengers for its service and paying a piece to the airline is under assault – more and more airlines now want to pay GOGO a fee for the service and control the pricing to the end customer. The economics to GOGO under this scenario will inevitably be inferior to their current model. And GOGO really has no say in the matter – if an airline demands this, they more or less have to acquiesce for fear of losing the airline to a competitor.  

Leverage

GOGO raised debt in the beginning of 2015 and again earlier this year in order to fund its operations. Prior to each raise, the company claimed to be on a path to self-funding from cash flow development, which turned out to be overly optimistic (they say the same thing today). To give a sense of what the credit market thinks of GOGO, their $525mm bond sale in June of this year priced at 12.5%. Net debt currently sits at ~5x Adj EBITDA as defined and ~7x EBITDA less stock comp, and an infinite multiple to EBITDA less capex, which as we mentioned is negative. Meanwhile, GOGO continues to have substantial capex needs to fund installs and new technology development.

How this plays out

The way we see this playing out is that some combination of A) continued cash burn, B) competitive losses, C) reduced economics to keep customers, and D) increased capital needs due to new technology investment/plane installs will cause a significant cash crunch at GOGO. Loss of a major customer could put the entire business in question immediately. GOGO’s business model simply does not make sense in the changed environment and economic forces will eventually overwhelm it.

Risks

We see risks to the short as follows:

1.      GOGO could be acquired by a satellite or telco provider (there have been persistent rumors about Verizon), but we see limited strategic value given the structural challenges

2.      On the surface, GOGO trades for only ~7.5x Adj EBITDA from the “profitable” North American businesses, which may strike some as reasonable. But as we indicated, this is a capital intensive, leveraged, and cash flow negative company (and there are huge losses in the int’l segment), making this valuation somewhat irrelevant.

3.      GOGO is very much a “story” stock with a promotional management team that issues a press release seemingly every week and has made numerous promises over the years about game-changing products, only to later abandon them (such as the hybrid GTO product from last year) – new announcements may spur more hope and sentiment can drive the stock up.

Disclaimer: This write up is not investment advice or a recommendation or solicitation for any fund or person to buy or sell any securities now or at any time. The author and related persons may hold a position in the securities discussed above and makes no representation that it will continue to hold long or short positions in the securities and disclaims any obligation to notify the market of any changes. You should not assume that an investment in the securities identified was or will be profitable.

Catalyst

Cash burn

Competitive losses

Reduced economics to keep customers

Increased capital needs