Description

“The Last of the Mohicans”

This write-up has nothing to do with the movie. However, given the high valuations of most equities, I refer to LORL as “The Last of the Undervalued Securities”.

LORL currently trades at a 15% FCF yield.  I believe a potential near-term catalyst could propel LORL to $55.00 - $60.00 per share, providing for 30%-45% upside.

Write-up can be viewed here: https://www.scribd.com/document/353782752/LORL-Write-Up

Company Overview

Loral Space & Communications (NASDAQ: LORL) is a holding company, so it won’t come up on any value screens.  LORL’s main asset is its 62.7% economic interest in Telesat Canada (“Telesat”, or “The Company”).  LORL also holds about 20% of its market cap in cash, or ~$9.00 per share.  Canadian pension plan PSP owns the remainder of Telesat.

Founded in 1969, Telesat is a Canadian satellite communications company headquartered in Ottawa.  It has a fleet of 15 geostationary satellites plus the Canadian payload on ViaSat-1, in addition to two more satellites under construction (Telstar 18 Vantage and Telstar 19 Vantage to be launched 2018).

Telesat produces a significant amount of free cash flow.  Revenue visibility is high as blue chip customers such as Shaw, BCE and Hughes sign long-term contracts prior to satellite construction, resulting in a very stable, non-cyclical business.  The company provides the following services:

1. Broadcast – Direct-to-home TV, video distribution, occasional use services

2. Enterprise – Telecommunication carrier, government, consumer broadband, energy, resource, maritime, aeronautical, retail

3. Consulting

Geographic revenue split: Canada 46%, US 33%, RoW 21%.

Aside from its main GEO satellites business, Telesat is working on an advanced, low latency global low-earth orbit (LEO) constellation.  This constellation would be used to provide low latency satellite broadband services.  The Company is currently constructing two prototype satellites for launch into low earth orbit.  This area has seen significant interest from a myriad of technology and industrial companies including OneWeb (backed by Softbank), SpaceX and Boeing. While Telesat has asked the FCC for a license to operate 117 LEO satellites, any significant progress on this development is years away.

Financial Overview

Historically, Telesat has grown revenue in the low-single digits.  The broadcast business is in decline while the enterprise business is growing.  Q1 2017 revenue increased 1% YoY (ex-F/X).  I assume this growth rate going forward.

Valuation

LORL is trading at a 15% levered free cash flow yield vs its unsecured bonds yielding 6.6% (note that its secured term loan represents about half of the enterprise value).

A conservative discounted cash flow analysis results in an estimate intrinsic value per share range of $50.00 - $55.00 at a 10% discount rate. 

LORL currently trades at a discount to its comps, despite being relatively higher quality (higher margin, North American focus, business stability, LEO upside, potential near term catalyst)

At an 8.5x – 9.0x EBITDA multiple, LORL would trade at $55.00 - $60.00, representing upside of 30% - 45%. 

At a premium 10x multiple (upside on takeover), LORL would trade at $75.00. 

While presenting interesting upside optionality, I do not assign any value to the LEO initiative nor a potential buyout.

Why Does This Opportunity Exist?

• F/X – Telesat has US$2.9bn of debt, which is 1.6x its current market cap.  Only 33% of its revenue is from the US (almost half is Canadian).  Previously, Telesat hedged its F/X exposure.  But in an ill-advised lapse in judgement, it let its F/X hedges (short CAD / long USD) expire Oct 31 2014, right before the CADUSD began its jaw-dropping decline.  This had the effect of causing Telesat’s debt to balloon in CAD terms, and the resulting equity value to decline given a constant enterprise value.  The Company has not implemented F/X hedges since.  On a positive note, the CADUSD has risen from the ashes and has appreciated markedly.   While LORL’s stock tanked along with CADUSD in 2015, LORL has not matched the current CADUSD rally (ie. LORL’s valuation has compressed).

• Failed sale – Chairman Mark Rachesky controls LORL through his firm MHR’s ~40% stake.  While LORL owns 62.7% of Telesat, it only has voting interest of about 1/3. He rejected a friendly offer from Ontario Teachers for $80.00 per LORL share (valuing Telesat at $7bn or roughly 10x EBITDA) in 2014: http://www.reuters.com/article/us-loral-space-sale-idUSKBN0EY2Q220140624 . Teachers lost interest once the CAD began to tank, then event-driven funds exited the illiquid stock en masse.

• Strategic alternatives process has not borne fruit – Since the failed sale, LORL has been attempting to IPO Telesat, which would remove the holding company structure.  In July 2015, LORL exercised its right to require Telesat to IPO.  This has not occurred yet because LORL and PSP have been unable to come to an agreement on governance.  While I’m not 100%, presumably this is because LORL and PSP have a contentious relationship.  In addition, there was a slump in satellite stocks Intelsat, Eutelsat and SES.

Catalyst

Near the end of 2016, Telesat refinanced its debt.  This freed up cash to pay its shareholders a US$400mm distribution (LORL received US$243mm).  In January, LORL stated it would distribute this cash, which is about $8.00 per share (20% of the current market cap).  Six months later, why hasn’t this been paid?

I believe LORL is now holding onto the cash as it is currently planning to merge Telesat into LORL in order to eliminate LORL’s holdco structure and increase stock liquidity.  Combining Telesat and LORL into one company will unlock value and allow LORL to trade in-line with its comps, which would imply ~$60.00 per LORL share.

LORL’s current complicated holdco structure presents the following issues:

• Screens poorly as Telesat’s performance does not flow through LORL’s financial statements.

• No analyst coverage, despite $1.3bn market cap

• No presence in ETF or quant portfolios.  Given index investing is taking over the world, not being in ETFs is a death knell for share price performance. 

• Tax inefficient.

• Canadian dual-share class company held in a US dual-share class holdco.

• Generates significant free cash flow but does not pay regular dividend (only random, large special dividends).

If the Telesat / LORL combination failed to come to fruition, LORL will likely pay a dividend of about $8.00, or 20% of its market cap.

Earlier this year, Softbank-backed OneWeb reached a friendly deal to merge with Intelsat.  However, the deal was rejected by Intelsat’s bondholders, who were trying to extract more value.  While the bondholders were playing hardball, Softbank declared that it has “been approached by and has been in discussions with several other potential merger partners over the past few months”.  Telesat has been rumored as a potential merger partner:

Conclusion

A confluence of mostly-temporary factors has caused LORL stock to trade down to an attractive valuation with a significant margin of safety.  LORL is likely to restructure its complicated holdco structure which may allow the stock to rerate to $55.00 - $60.00 per share, representing upside of 30% - 45%.  If this fails to come to fruition, LORL will distribute cash equal to ~20% of its current market cap.  In the meantime, LORL shareholders hold a stake in a stable 15% free cash flow satellite business with intriguing upside potential.

Catalyst

- Merger with Telesat

- Simplifcation of holdco structure

- Special dividend