Inmarsat PLC ISAT LN
February 21, 2006 - 12:31pm EST by
2006 2007
Price: 398.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,181 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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ISAT LN is an opportunity to invest in a business at close to fair value but gain exposure to some optionalities that could ultimately be worth several times the value of the existing business. Inmarsat is a UK-based company that operates satellites for global data and voice communication to ships, the armed forces, journalists, aid organizations, oil & gas companies etc. Through its existing business, ISAT LN has usage rights to some radio frequency spectrum but has historically been restricted to using this spectrum for satellite communications only. However, recent technological and regulatory developments in the US could enable ISAT LN to also use its spectrum for terrestrial (i.e. tower-based) communications, making the spectrum potentially extremely valuable. It appears that UK-based investors have overlooked or at least underappreciated these developments. Using an average of recent transaction multiples for PCS band spectrum to value ISAT LN’s spectrum would yield at least 3x the value of ISAT LN’s existing business. Similar opportunities may develop in Europe and Asia. Even at significant haircuts to previous transactions, the value of ISAT LN’s spectrum could lead to material upside in ISAT LN’s stock

ISAT LN has a strong defensible position in its core business with good prospects for revenue growth and operating leverage. The company operates a fleet of 11 satellites that allow for data and voice traffic to small portable terminals used by the maritime industry (most recently 56% of rev) and land-based users in remote areas such as the US DOD, CNN and international aid organizations. ISAT LN is the only company that provides data speeds (128+ kbps) on laptop-sized terminals with global coverage. Competing services are either lower speed and primarily for voice (Global Star, Iridium) or not global (Global Star doesn’t cover the oceans; Thuraya is a regional, Arab-owned operator). So-called fixed satellite systems (FSS) operators offer better speeds but terminals are much larger (dishes measure 6+ft in diameter), heavier and much more expensive. All ships above 300 gross tones are required to carry an ISAT LN terminal for distress calls and as far as I know, no other provider is even considering applying for distress call certification.

ISAT LN has recently launched 2 next generation satellites (and built one spare), which have increased the companies’ capacity 16 fold and allow for much greater speeds of up to 492 kbps as well as smaller terminals (comparable to small laptops and even smaller in the future). Also, the new satellites are expected to extend the commercial life of the fleet to around 2020. The new higher speed service is called BGAN (Broadband Global Area Network) and was launched in 4Q05. Once the satellites are in the air, there are few cash costs associated with providing the service and most of the BGAN-driven revenue growth from the current level of $500m will flow right through to FCF. BGAN revenues will initially ramp slowly given the need for new terminals as well as the long lead times associated with the DOD business. It is difficult to accurately estimate the potential for additional revenues, but I think it is reasonable to assume that EBITDA could grow from the $311-312m guided for 2005 to at least $350m, which would only require revenue growth of 10% or so. Prior to the launch of the new satellites, ISAT LN has been running at capacity, so this has been a revenue constraining factor.

With $350m in EBITDA and about $15-20m in maintenance capex, pre-tax unlevered FCF would come in at $330-335m. ISAT LN will not have to pay significant cash taxes until 08 or 09 due to the depreciation shield; so after-tax unlevered FCF should approximate $330-335m until then. Longer term, there will be some cash taxes, which I estimate at a normalized level of $39m. (For this, I’m assuming the $1.5b in capex for the new satellites are straight-line depreciated over 15 years and I add the current depreciation run-rate of $120m, which would yield normal annual depreciation of $220m. That would get me EBIT of $350-220m = $130m and with the UK tax rate at 30%, normal cash taxes would be at $39m.) This in turn would results in taxed unlevered FCF of about $294m.

With 456.7m fully diluted shares and the stock trading at 398p, ISAT LN’s market cap is GBP1.818b or US$3.181b (using a 1:1.75 exchange rate). As of 1H05 (the last reported consolidated balance sheet), there was $841m in net debt, so EV is at $4.022b and the company is trading at 11.5x EBITDA, 12.1x untaxed unlevered FCF and 13.7x taxed unlevered FCF.

I would further adjust the EV by adding the remaining $400m in capex associated with the new generation of satellites (the 2nd satellite was only launched in 4Q05 and the associated capex wasn’t reflected on the 1H05 balance sheet), so adjusted EV would be at $4.422b or 12.6x EBITDA, 13.3x untaxed FCF and 15.1x taxed FCF. Admittedly, this is at the high end of what the existing business is worth, but it’s clear that the vast majority of the current valuation can by justified by the existing business.

In North America, ISAT LN has usage rights for 28Mhz of L-band spectrum in the 1,600Mhz range. The spectrum used to be restricted to mobile satellite communications, but in November 2004, the FCC granted a license to Motient Communication (MNCP) owned MSV to build a network that would use MSV’s existing satellite L-band in combination with terrestrial tower-based infrastructure. The idea is to use terrestrial coverage wherever possible but use satellite coverage to fill in the blank spots. Handsets would have to be able to send and receive both terrestrial signals in urban areas and satellite signals in rural areas and it is expected that such handsets can be as small as convential handsets and only cost an additional $5 –20 per handset. This technology is called Ancillary Terrestrial Component or ATC. The FCC granted the license in an effort to improve wireless coverage in rural areas while recognizing the limitations of satellite coverage in urban areas. ISAT LN does not have a license yet, but since they bring their own spectrum and would improve competition, it is widely expected that ISAT LN will not have an issue in attaining a license.

Spectrum is a very valuable asset and is essentially the real estate on which wireless carriers operate. The US is considered spectrum-starved, with the incumbent carriers holding about 190Mhz of spectrum vs. about 250-350Mhz in most of continental Europe and 340Mhz in the UK. Spectrum requirements are driven by the amount of traffic carried within the coverage area of a given cell site. Subscriber and MOU growth and increased data traffic all lead to increased demand for spectrum. Furthermore, the demand for spectrum is fairly elastic because spectrum can be used as a substitute for expensive tower infrastructure. Grossly simplifying, if a carrier faces a doubling of traffic it could either cut the coverage area per cell site in half or double the amount of spectrum used in each cell-site. This means that even if there was significant unexpected new supply, spectrum should remain very valuable.

There are a number of parties interested in spectrum. For the dynamics highlighted above, executives of the existing wireless carriers maintain that a carrier can never have too much spectrum. T-Mobile in particular is in dire need of additional spectrum, without which it cannot upgrade to 3G. The cable companies are also pursuing a wireless offering in order to offer “quadruple play” and while it appears that they have addressed that need for now with the recent announcement of the MVNO partnership with Sprint Nextel, they may want more control over their wireless offering in the future. DirecTV and Echostar have publicly indicated an interest in partnering with one or more mobile satellite player(s) to offer voice and broadband service through WIMAX technology. DirecTV and Echostar have indicated that they might each contribute $750m - $1.0b within the next 6 months to a mobile satellite JV with MNCP and/or ISAT LN as well as technology players like Intel, Qualcomm and Microsoft etc. In DirecTV’s last earnings call, the CFO described the new wireless broadband technologies they are looking at as “quite robust”.

It is unclear when and in which way MNCP or ISAT LN will realize the value of their spectrum and how much the spectrum will ultimately be worth, but there are some helpful benchmarks. PCS band spectrum has historically changed hands for $1.60-1.70 per Mhz pop on a nationwide average basis as recently as last year. For ISAT LN’s 28 Mhz of spectrum, that would translate into 28Mhz * $1.65/Mhz pop * 300m people in the US and Canada = $14b (or $9b if the transaction was taxed). The L-band has some advantages over the PCS band (the signal travels further, requiring less ground infrastructure) though for the incumbent wireless carriers, using L-band would require some equipment modifications to antennas, base stations and handsets. Another benchmark is provided by MNCP, which, as a publicly traded company with virtually no existing operations, is essentially publicly traded ATC spectrum. With MNCP’s stock at $23.30, the stock currently implies a valuation of 31c per Mhz pop. That in turn would imply ISAT LN’s spectrum is worth $2.6b or 326p/sh, almost as much as the whole company.

Unfortunately, a straight spectrum sale is not an option for ISAT LN (or MNCP). ISAT LN and MSV do not technically “own” their spectrum but instead they have usage rights that are contingent on continuing usage. The idea is that an operator with existing satellites and terminals is protected from interference by new entrants but if operations are discontinued, the operator would loose the spectrum. Therefore parties interested in using the spectrum for ATC would either have to enter into a partnership of some kind that would allow ISAT LN to continue the operations of the existing business or the interested parties would have to acquire the whole company. ISAT LN maintains that dual use of its North American spectrum for its existing business and ATC is possible since existing volumes are very small.

There are some other new business opportunities for ISAT LN beyond ATC. The most interesting of these is ISAT LN’s participation in the OnAir consortium with Airbus, which is developing in-flight wireless services for commercial airliners. OnAir envisions mini cell sites (called a PICO cell) in airplanes that would allow cell phone and Blackberry users to roam in-flight at costs comparable to international roaming rates (i.e. $2-3 per voice minute). ISAT LN would carry the traffic from the plane via their satellites to ground networks and hopes to get a cut of up to 50% of revenues for this. ISAT LN is in a strong position here, since virtually all commercial transoceanic flights already have an ISAT LN antenna installed for cockpit communications, making retrofitting aircraft fairly cheap and minimizing aircraft downtime. On-Air expects regulatory approval for their services in about a year. OnAir looks at an addressable market of 700m business passengers in 2009 and with $1/voice minute in incremental revenues to ISAT LN and virtually no additional costs to ISAT LN, the upside could be very meaningful relative to ISAT LN’s existing $350m in EBITDA. Other optionalities include a satellite radio offering in Europe and a European alternative to existing GPS services which are based on US military satellites.

There is obviously a long list of risks associated with realizing the spectrum value including ATC technology risk, possible hesitation by the interested parties to get into the satellite business, consumer acceptance etc. In contrast to MNCP, ISAT LN already has state of the art satellites operating, alleviating the satellite design and launch risks and making a much faster roll-out a possibility. Still, I would find it hard to get comfortable with all these risks, if a large part of ISAT LN’s valuation depended on it. But the opportunity is real enough to wait for it to play out with downside limited by the existing business.


- Realization of the spectrum value through a partnership or an outright sale of the company.
- A transaction involving MNCP that would validate the value of their ATC spectrum would also be a strong positive for ISAT LN.
- Meaningful progress at OnAir
- Revenue and EBITDA growth due to BGAN
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