Description

Loral is a long – as shares have upside towards more than $75 through the (now) inevitable monetization of Telesat.  Previous write-ups (I have one on a related site) at much lower values focused on a fundamental mis-understanding of Loral’s asset base (given the 64% stake in Telesat was accounted for using the equity method, and hence somewhat hidden from investors).  That dynamic has now corrected, and shares are up meaningfully, but continue to offer attractive risk-adjusted returns.

Given the recently closed sale of SS/L (for a value much higher than I expected), the corporate structure is much simpler, and the path is set for an exit.  The recent pulling of PSP’s recent demand right regarding an IPO is a red herring for a sale (i.e. Telesat is likely exploring a sale in 1H 2013).  Given (i) timing (2007 LBO – likely one of the most successful LBOs in Canadian history), (ii) a simplified corporate structure (much easier for Loral to monetize Telesat via HoldCo sale given SS/L is gone) and (iii) operating momentum (Telesat will now get credit for Telstar 14-R, Nimiq-6, Anik G-1 and ViasSat-1, even while Nimiq-1 contracts a bit more) I think a sale can fetch north of $6.5bn.  In fact, I think a deal happens much closer to $7bn, given where real-time operating metrics have gone and are going.  The home-run possibility exists for a merger whereby Loral shareholders share in operating synergies (which tend to be quite material and tangible in this sector).  Downside should be muted (outside of mark-to-market given liquidity) given (i) operating performance trends and (ii) a nearing, inevitable end-game.  Upside is closer to $75 in my view.

Key Metrics

• Share Price – $58.50
• Total Shares – 30.7mm (21.2mm A shares and 9.5mm non-voting B shares)
• Market Cap – $1.8bn
• ADV – 50k shares ($2.5mm

The investment thesis; once overly complex, is now broken into two key points:

• Telesat is worth more than $6.5bn – Telesat explored a sale in late 2010, but never consummated a transaction as bids were deemed too low (bids were said to be in the ~$6bn range – New York Post has decent color here).  While no one on the public side knows exactly what happened, several issues come to mind; notably (i) awkward transactional structures, (ii) buyers’ un-willingness to pay for forward growth and (iii) untimely operational issues on Telstar 14-R.  Taking these in sequential order:

1. Loral purchased their ownership stake in Telesat via the 2007 LBO, whereby Loral contributed new cash & Skynet (Loral’s owned FSS business) and PSP contributed new cash.  The effective EV at closing was ~$3.3bn.  The business has grown meaningfully, generated healthy free cash flow and eaten through many NOLs.  Accordingly, LORL’s effective tax basis in Telesat is very low (this is not an issue for PSP, given they are a Canadian Crown Corporation and therefore tax-exempt).  If Loral were to sell Telesat for cash, the tax bill would be enormous.  I think they will eventually monetize Telesat through a ‘dragged’ sale of Loral.  This was difficult, if not impossible in the past, given FSS buyers may not have wanted an ‘attached’ satellite manufacturing business (despite being in the same notional sector, the two have much different operating characteristics and margin structures).  Given the recently closed SS/L deal, this is no longer an issue.
2. Telesat has grown revenue in the low-single digit range, with EBITDA growth a little bit higher given operating leverage.  During late 2010 and early 2011, Telesat was generating run-rate EBITDA of ~$650mm (put another way, they were asking ~10x EBITDA).  Since those processes, Telesat has grown both revenue and EBITDA.  The recent launches of Nimiq-6 (June 2012) and Telstar 14-R (mid-2011, although operating issues had slowed the revenue contribution) have driven an uptick in growth (see FQ3 2012 ramp in revenue and EBITDA).  Contractual rate reductions on Nimiq-1 (much older, having been launched in 1999) have been a headwind since Q1 2012, and are set to become much less meaningful.  Run-rate EBITDA is $700mm and growing (this will accelerate in early 2013 through Anik G-1).  Discussions with management suggest near / medium-term earnings power closer to $750mm.  Buyers and sellers always disagree on earnings power, but the starting point is now much higher (e.g. run-rate EBITDA is $694mm).
3. The 2010 / 2011 process was seemingly a comedy of errors.  Outside of shareholder-driven transactional issues, Telesat encountered a material defect (one of the solar arrays would not deploy) on Telstar 14R in mid-2011 (this one will have a shorter than expected useful life).  While defects and launch delays / failures are simply a fact of life in the satellite world (hence these launches are all insured), the timing of this specific issue was unfortunate.  Perhaps this delay halted momentum in what was otherwise a good process, or perhaps it was nothing.  In my experience, not the sort of thing you want to have happen when you’re trying to sell an asset for a big price.

• Tax-efficient monetization is achievable – Loral cannot and simply will not monetize the Telesat stake through a cash sale (the tax leakage would be enormous).  This means a deal must happen through the holding company (Loral – indirectly) and PSP directly.  As an added bonus, this structure eliminates MHR re-investment risk (that would exist with a cash deal).

1. This was a material issue in the past, given buyers were forced to purchase a lower-margin, lumpier satellite manufacturing division alongside the higher-margin, predicable FSS business.  Needless to say, this limited the marketability of Telesat (via Loral).
2. This issue has been resolved through the recent sale of SS/L to MDA.  Loral is now a much simpler, easily digestible company.  There are effectively three (non-cash) assets; (i) 64% stake in Telesat, (ii) 56% stake in Xtar (option value) and (iii) $101mm three year seller note through MDA (this note was attached to SS/L real estate).
3. The improved marketability will be visible when Telesat goes on the block.  My base case is a cash purchase of Loral shares.  The bull case would be a strategic merger with either Eutelsat (ETL FP) or SES Global (SES GR).  Intelsat will be interested but they are highly levered and lack public currency.  SES & Eutelsat would be the best buyers given non-overlapping footprints (more synergistic, fewer antitrust issues, etc.).  They can also pay in either cash or stock.

Pro Forma Valuation

Loral announced and paid a $29 special dividend in December (sale proceeds from the sale of SS/L), so the below balance sheet is pro forma.  While there are still several moving pieces, they are less material to the end-game.  Given recent & upcoming contracted (for life) launches, I think near-term EBITDA visibility is quite high.  L2QA run-rate EBITDA is $694mm, while LTM EBITDA is $655mm (you can see material growth in 2H 2012).  No idea how they ‘market’ this asset, but I would expect 2013E projections of something close to $730-740mm.

Target EBITDA multiples are inherently subjective and will almost certainly be ‘wrong’, however, a few things to come mind:

• Precedent transactions suggest EBITDA multiples of 9-10x
  • Intelsat is levered through 8x, and received new equity from BC Partners through an implied enterprise value of 11x
    • Apax (et al) purchased Intelsat for $5.2bn in January 2005, or 8.4x EBITDA
    • Intelsat purchased PanAmSat for $6.3bn or 10x EBITDA in July 2006
    • SES Global purchased NewSkies for $1.2bn or 8x EBITDA in December 2005
    • Albertis (investment fund) purchased a minority stake in Eutelsat for an implied 9.3x EBITDA multiple in December 2006
• Public market values suggest similar valuation multiples
  • Eutelsat trades at 9x 2012A EBITDA
  • SES Group trades at 10x 2012A EBITDA
  • Intelsat recently filed for an IPO, that I doubt gets done (given their leverage profile) which would suggest EV / EBITDA ~10x

9.5x EBITDA does not yet begin to consider a potential merger, whereby Loral shareholders can share in operating synergies.  Operating synergies have been meaningful in this industry (Skynet / Telesat saw ~$60mm in operating synergies, while Intelsat / PanAmSat saw >$100mm in operating synergies).  This type of structure would be pure upside, so not something I’m counting on but certainly reasonable (the business would fit nicely with either SES or ETL FP).

Regarding timing, I would expect a deal in the next six to nine months.  Mickey Targoff and the Loral management team now have a rather simple mandate – monetize Telesat (they are effectively dissolving the holding company).

If not, at an 8% trailing or almost 15% forward free cash flow yield, I think you’re (more than) happy to own the business here, and compound value.  I’m happy to share additional details or thoughts regarding modeling or assumptions, if people care.

Catalyst