|Shares Out. (in M):||158||P/E||NM||NM|
|Market Cap (in $M):||4,074||P/FCF||21||24|
|Net Debt (in $M):||13,253||EBIT||881||816|
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Intelsat is the world’s largest satellite operator by revenue, managing a fleet of geostationary satellites that provide communications services to end customers like telecom companies and the TV industry. The company is on the verge of monetizing a unique, high-value asset: its C-band downlink spectrum (ranging from 3.7 to 4.2 GHz). Today, Intelsat and one major competitor, the European satellite operator SES, use the C band in the US primarily to shuttle TV programming from content creators like Disney and Fox to distributors like Comcast and Charter. (Two other operators, Eutelsat and Telesat, also provide C-band service in the US, but on a much smaller scale; a handful of other companies have the theoretical authority to provide C-band service in the US but haven’t managed to gain a single customer or dollar of revenue.) This US C-band business is fairly small-scale, with roughly $300mm of annual revenue industrywide, resulting in a likely fair value for the whole band in its current configuration of just $1 to $2 billion. But the spectrum in and around the C band has another, much more valuable potential use: 5G.
5G, the next generation of wireless communications technology, will offer much faster data speeds, greater network capacity, and lower latency. In the near future, 5G will mean improved performance from familiar devices like smartphones; longer term, 5G is designed to enable use cases like autonomous vehicles and enormous networks of far-flung sensors that bump up against the limitations of current LTE technology. In Europe and Asia, spectrum overlapping with or adjacent to the 3.7-4.2GHz C band has already been auctioned off and is widely acknowledged as the first and most important band in which 5G will be deployed. In particular, a technology incorporated into the 5G standards known as massive MIMO, which, in simple terms, means the coordinated use of many different antennas at once (rather than the 1-2 antennas per coverage area as in LTE and previous generations), is a perfect fit for the C band. In Australia, for instance, operators are beginning to offer residential fixed wireless broadband service using this spectrum – that is, allowing people to replace wired internet access in their homes with comparable wireless access. In the US, Verizon is already doing something similar in a different band, while T-Mobile hopes to do something similar using Sprint’s 2.5GHz spectrum (which has physical properties similar to those of the C band). With 5G and the C band, then, we’re not just talking about slight improvements to existing customer experiences; we’re talking about the possibility of opening up brand new verticals for mobile network operators (MNOs).
We believe the C band is extremely valuable to those operators, and all the more so because of its uniqueness. In the US, there is no other mid-band spectrum of remotely comparable bandwidth and commercial potential that will be available to MNOs in the foreseeable future. It makes sense for this valuable spectrum to move from the satellite operators to the MNOs – but doing so is easier said than done. Under existing FCC rules, rights to the spectrum are shared by Intelsat, SES and the two smaller C-band competitors. Within a given orbital slot (i.e. a location in space that is fixed with respect to the earth’s equator), just one entity can use the spectrum, but across the whole range of available orbital slots, the spectrum “belongs” to all the licensees, and no one licensee “controls” any individual subset of the band. Today, the spectrum is currently licensed just for satellite use.
Many times in the past, the FCC has reallocated spectrum from low-value legacy uses to a less prescriptive flexible-use model, but it’s been a slow and extremely difficult process. Today, the FCC and other policymakers feel a great sense of urgency around what many on both sides of the aisle call the “race to 5G.” Faster deployment of 5G will impact virtually every industry in the United States, leading to immense productivity gains much like the transition to 4G from 3G and to LTE from CDMA. As well, the "race to 5G" is often framed as a matter of national security and appears to be in line with recent government efforts to push back against the China-based telecom equipment vendor, Huawei. The concern seems to be that the Chinese government will use Huawei equipment to spy on other countries, and if Huawei is at the forefront of wireless technology then Western firms will feel compelled to buy its wares. To prevent this, American policymakers are keen to have American firms at the forefront of trends like 5G, which will require not just new devices but new spectrum to flourish. All of this helps to explain why the FCC has been so unusually active in pushing forward the reallocation of the C band to terrestrial mobile use.
How does this policy initiative benefit Intelsat? Intelsat wisely recognized early on that policymakers had designs on the C-band spectrum it was using in the US and that the company didn’t have the political clout to permanently block those efforts. Instead, it has channeled them in a positive direction by proposing a fast and elegant solution to the problem of how, mechanically, to go about efficiently reallocating the band. Under Intelsat’s plan – now fully accepted by SES, Eutelsat, and Telesat, as well as supported (to varying degrees) by all the major US MNOs and publicly praised as the most promising option by multiple FCC commissioners – the FCC would allow the satellite operators to jointly sell access to their spectrum to MNOs and other interested parties. The operators will be responsible for shifting the current users of the sold-off spectrum to the remaining portion of the spectrum (or, potentially, to other options like direct fiber connections, though those seem less practical in the near term) and reimbursing those incumbent users (e.g. Disney, Fox, and the cable companies that carry their networks) for the costs they incur in the process. Under this arrangement, the satellite operators – the only parties in a good position to understand how the C band is actually used today on a detailed level and what steps need to be taken to rearrange it to accommodate 5G – have the right incentives to clear spectrum quickly and at the lowest possible cost. The FCC doesn’t have to master the intricacies of this obscure band itself, nor does it have to spend years developing complex auction rules, seeking comment on them, refining them, and so on. In a policymaking environment that puts a hefty premium on speed and winning the race to 5G, the Intelsat proposal is clearly the leading (and, in our view, the only realistic) contender for an approach to reallocating the C band. It’s also important to note that prioritizing 5G is a not a particularly partisan issue.
How will the reallocation play out? Conceding again the difficulty of getting regulatory timelines precisely right, we believe the FCC can finalize the rules governing the reallocation of the C band by the first half of 2019. This will pave the way for the satellite operators to conduct a private auction of a portion of the C band – likely, at first, 180 MHz of MNO-usable spectrum plus a 20MHz “guard band” of spectrum that will lie fallow to protect remaining satellite users from 5G interference – within a few months of the final order. The winning bidder or bidders will put their money in escrow as Intelsat and the others go about working with incumbent users who had been operating in the lower 200 MHz of the band to move to the upper 300 MHz. When this is done, the money will come out of escrow, much of it will flow to Intelsat, and the winning MNOs will be ready to begin to deploy 5G on a national scale.
Importantly, we believe that the FCC in fact would love to see the entire band reallocated but understands that it’s not possible to do this extremely quickly without causing great disruption to the existing TV industry. Over time, however, assuming the continued gradual decline of linear TV, it will become possible for the industry to make do with much less spectrum. Indeed, based on our analysis of the band and existing compression and other technologies, all of the TV channels currently carried via C band could theoretically be handled in 80-100 MHz of spectrum if the existing fleet of satellites serving the US were fully utilized. While this may be an unrealistically extreme scenario in the short term, Intelsat and the others are strongly incented to move in this direction – recall that the value of the existing use of the C band is only on the order of $1 billion, while MNO usage will likely be worth many multiples higher – and all signs point to the FCC consciously writing its rules to allow multiple future rounds of reallocation (sale and clearing). Thus the initial 180MHz sale is unlikely to be the final one. While incumbent users may not want to face this reality, they’re not really in the driver’s seat. After all, there’s one easy way for Intelsat and SES to clear the whole band: just let all their customers’ contracts expire and don’t renew them. That’s not the most pleasant outcome or one the FCC wants to see, but it highlights the fact that the satellite operators have a major practical advantage over foot-dragging incumbents.
So how does the likelihood of a near-term monetization event flow through in terms of value to Intelsat? We use a simple framework of dollars per MHz-pop (a common metric in spectrum investments). In the UK, Australia, South Korea, and Italy, spectrum directly comparable to the C band has recently been auctioned off for $0.17, $0.38, $0.19, and $0.41 per MHz-pop, respectively. Every spectrum auction has its idiosyncrasies, but what’s striking is that US spectrum prices have always been dramatically higher than spectrum prices in any of these countries – indeed, generally in a range of 5-10x higher, not just a little bit higher. US C-band prices of $0.50-$1.00/MHz-pop are therefore easily justified by these comps. Furthermore, in light of the advent of 5G and the way that massive MIMO can improve propagation and enable C-band spectrum to work well from existing cell-tower infrastructure, the C band should be viewed as fairly similar to Sprint’s 2.5GHz spectrum, which has historically underperformed but has now been targeted by T-Mobile as a major 5G-enabling asset. That spectrum has recently been valued by analysts and the capital markets (including via Sprint’s spectrum securitization transactions) at ~$0.80/MHz-pop to well over a dollar. Indeed, at the high end of the range, the real problem becomes not justifying “high” C-band prices through comps but imagining how the MNO sector can afford to foot the bill if a large amount of spectrum ends up being sold. But we need to keep in mind that this is a sector in the habit of spending many tens of billions of dollars on spectrum, especially during major technology shifts; given the uniqueness of the C band, we believe this is the main target of that spectrum budget over the next half a decade.
Assuming a range of prices of $0.50-$1.00/MHz-pop and a range of bandwidths from 180 MHz to 400 MHz, the gross spectrum value is roughly $27 to $120 billion to all four satellite operators. Assuming Intelsat takes 45% of that total (roughly in line with its revenue share), we have $12 to $54 billion for Intelsat. The costs to earn those amounts won’t be comparably large: for instance, launching a whole new C-band satellite at a new orbital location only costs roughly $175 million, while installing filters to protect remaining satellite users from 5G interference will likely only cost a few thousand dollars for reach of ~17-18,000 downlink antennas. If we assume $1 to 2 billion of costs to Intelsat (overall costs will be ~2x higher, with the other ~half borne primarily by SES), then the pretax profit to Intelsat will range from $10 billion (in a scenario with a low price and a small amount of spectrum ultimately cleared) to >$50 billion. Cash taxes will likely be lower than the full 21% statutory US tax rate because Intelsat is domiciled in Luxembourg, where it has some $3.8 billion of unused NOLs. At a 15% cash tax rate, the gain to Intelsat would then range from $8.5 to ~$43 billion. Intelsat’s current market cap, inclusive of the as-converted value of its in-the-money convertible debt, is $4.1 billion, so, looking solely at the value of its C-band spectrum, the equity is somewhere from a double to a ten-bagger.
What about the core business? There’s likely not much value flowing from the core business to the equity holders because of Intelsat’s high leverage, but we do believe there’s some. With net debt of $13.2 billion and 2018 EBITDA of ~$1.6 billion, Intelsat is clearly highly levered, but our DCF valuation for its core satellite business is $14.4 billion, creating some breathing room. While the implied EBITDA multiple of ~9x may seem high for the fixed satellite services industry, this doesn’t really reflect any especially optimistic assumptions on our part but rather results from relatively low near-term capex (that we assume bumps back up to more normal levels over time) and low cash taxes. All we really need is for the value of the satellite business to cover most of the value of the debt and a clean near-term maturity profile. Intelsat clears that low bar, allowing the C-band spectrum story to play out.
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