Description

I propose a short position in Iridium as:

a) company will have to reduce handset pricing to control churn / business generates c. $35 - 45m of EBITDA in handset sales, which is unsustainable

b) pricing in core satellite voice business likely to come under pressure in fy'11 as handset voice will become key growth area for Inmarsat

c) Iridium is currently procuring a new constellation, which will cost c.$3.0bn. Thus far Iridium has received a $1.8bn credit facility. In my view, the EBITDA shrinking due to 1 & 2 will make it difficult for Iridium to generate an additional c.$1.2bn over the next few years (c.$200m likely to be contributed by hosted payloads)

d) If Iridium is unable to finance a new constellation, this business will go bankrupt, simply because the old constellation will stop working at some point --> this is my most likely outcome at the moment yet key risk is that French banks waive covenants...

e) Street is very far off on this name (three buy recommendations on the name) & do not factor in increased competition and not even the increased interest costs... think this is positive as stock will de-rate once street will adjust due to above

Company overview

• Iridium is a global satellite voice and data solutions provider
• The company operates 66 low earth orbit (LEO) satellites, which have been in operation since 1997 / 1998
• Key products include: satellite phones (100% global coverage), maritime voice & data, asset tracking & fleet management devices (M2M)
• Based on the latest quarter c.21% of revenue is generated by the US Department of Defense (mainly satellite phone communication requirements), c.50% is generated in commercial services (i.e. private individuals using satellite phones / asset tracking demand) & c.29% is generated in equipment sales

Thesis summary

• New competition in handset: Iridium generates c. 29% of revenues from equipment sales (i.e. selling satellite phones). Inmarsat (Iridium's major competitor) has recently entered this market selling a similar quality phone for $500 versus Iridium at $1,200. I estimate that Iridium generates c. $35 - 45m of EBITDA annually in this segment, which is unsustainable given competitive pressure (i.e. Iridium will have to cut handset pricing)
• Pricing in voice likely to deteriorate: Iridium has been the only global provider of satellite mobile phone services over the last few years / this is changing as Inmarsat has entered the market and is looking to gain market share as their other segments are starting to show limited growth (this is likely to be one of Inmarsat's key growth areas)
• New constellation: Iridium has recently announced the procurement of a new constellation. This constellation will cost between c.$3.0bn / in addition Iridium has recently received credit facilities from COFACE (French credit agencies) of $1.8bn to finance their new constellation. The new constellation will start operation by 2017 yet interest expense until then will reach a maximum of $106m annually (this includes 0.8% annual commitment fee) versus fy'10 estimated EBITDA of $125m! In addition, Inmarsat has recently announced a KA-band constellation, which will have speeds up to 5x faster than Iridium's new constellation (this is due to differences in spectral efficiency)
• Old constellation: As an added bonus Iridium is currently running a constellation, which was initially estimated to be running until 2008. In 2008, the lifetime of the satellites was increased to 2014 (without a plausible explanation). I believe that there could be a servicing gap for Iridium as the new constellation is only fully operational by 2017 & the old constellation could stop working any day as we are already 2 years beyond initial assessment of lifetime value

Running through thesis

New competition in handset / pricing implications:

• Inmarsat (leader in satellite data with particular focus on maritime & on-the-go data) has recently entered the handset / satellite voice market
• The key to understand here is that any additional traffic that Inmarsat manages to monetise over its satellite constellation is margin accretive simply because there is no significant additional cost connected with that traffic (as the network is already there, capacity is available). Thus, in essence this means that Inmarsat can price their voice product in a very competitive manor as any additional traffic is value accretive
• There are two implications:

o       a) Inmarsat chose to make no margin on their handsets (selling this at $500 versus $1,200 on Iridium)

o       b) Inmarsat (in my view) is likely to become more aggressive during next year as handset will become one of their major growth drivers and hence pricing in voice likely to become more competitive

• Iridium implications from a) & b) above:

o       a) Iridium will have to lower handset prices in order to keep customers. Two key observations:

           1) A satellite handset customer typically keeps his / her phone for 4 years (i.e. 25% churn annually). This means that in a worse case scenario Iridium could loose 25% of their customers within a year

          2) It is important to factor in the network capacity filling notion. A customer that Iridium looses is not being offset by lower overall costs (i.e. there is no additional cost for adding / loosing a customer / this is a very high operational leverage business, which swings either way though). As a result it is better to reduce prices in handset than to loose the customer altogether

       --> As a result in my view Iridium will have to cut handset pricing to 1a) minimise churn 1b) keep customers. As a result the business will see deteriorating equipment sales. Iridium generates c.$35 - 45 of EBITDA in the equipment segment, most of which is under threat  

        b) Inmarsat is a business that is desperately looking for additional growth drivers as current business streams are increasingly looking ex-growth. As mentioned before any additional traffic routed over their constellation is value accretive (as no additional capex required) and hence Inmarsat can be more aggressive in their pricing. In my view their aggressive handset pricing is only the beginning, I think it is likely that they will start to reduce pricing on voice minutes during next year 

 New constellation:

• Company is sourcing a new constellation at the moment, this will be launched during 2015 - 2017
• As a result of this new constellation this business will run up significant new debt over the next few years (historically Iridium has taken care of this additional debt by writing it off during a bankruptcy...)
• New debt implies additional interest charges where the commitment fee of 0.8% alone implies $14m of annual interest charges (this is without even borrowing)
• The business will generate $125m in EBITDA this year and likely less during the next years and hence it appears difficult to see how this business will:

o       a) manage to close the financing gap of c. $1.2bn (i.e. Iridium has received COFACE financing of $1.8bn yet overall cost of new constellation is anywhere from c.$3.0bn)

o       b) be able to meet any type of covenant requirements, especially with a declining EBITDA

• Inmarsat has recently announced a KA-band constellation: a) this spectrum will allow for 5x faster data speeds b) Inmarsat's constellation will be ready by 2015 c) Inmarsat has above 90% market share in satellite data, difficult to see this change even with new Iridium constellation out there

The key take away with regards to the new constellation is that Iridium will become a highly indebted business over the next few years, where the first potential payout from the new constellation will only accrue in 2017 (this should also address the bull argument of this business being cheap on an ev basis...). In my view, it is unlikely that Iridium will survive until 2017 as pricing pressure mounts / ebitda comes under pressure

Old constellation:

• The current constellation was supposed to be running until 2008
• During 2008 the lifetime of the constellation was increased to 2014 (for no apparent reason, no explanation was given)

--> As a result, the added bonus on this short is that the current constellation could break down at any point

• This has recently happened to Globalstar, which operates constellation focused at Americas and has had to cancel services due to loss of satellites
• Iridium could face the same fate as Globalstar, if this would happen EBITDA would melt away and any financing capability would be gone & business would like terminate

--> There is a chance that the current constellation will not survive until 2015. Yet the best part about this short is that one does not even necessarily need this to happen in order to make a return on this investment simply because of handset / voice pricing pressure going forward

Catalyst

Inmarsat cutting voice pricing

Iridium cutting handset pricing / loosing market share to Inmarsat --> c.$35 - $45m of EBITDA at risk over next 12 - 18 months

Over time market will start to get concerned over financing of Next constellation due to EBITDA loss