Description

Long MacDonald Dettwiler (MDA CN Equity)

All values in $CAD unless otherwise noted

Thesis

MDA sets up with an attractive dynamic given the selloff following the announced acquisition of DigitalGlobe (“DGI”). We see 50% upside in our base case pro forma for the deal. We also think that MDA would trade up ~8% to its pre-deal stock price if the deal breaks. The stock is currently trading in deal purgatory, with merger arb selling moving stock prices more than fundamentals. Most of the sellside hasn’t done detailed pro forma analyses or recommendations. There is an equity issuance overhang as investors are concerned that MDA may do an offering to finance a portion of the deal. We believe that once the deal is closed, investors will be drawn to an inexpensive valuation and attractive vertically integrated market positioning in space / aerospace and defense with a data component. Additionally, a post-close listing on the NYSE should drive increased investor demand and eyeballs.

Business

We understand that there has been a lot of past debate on VIC on DGI’s business quality. We are not going to argue that this is a terrific business. There are drawbacks and satellite business do often destroy value over time. However, DGI’s monopoly position and long-term government contract give us some comfort. We do see platform benefits from the deal. We see a pro forma company that sets up with similar dynamics and business quality to other aerospace and defense peers with some characteristics similar to a company like Harris which trades at 12x EBITDA.

70% of current MDA is the Space Systems Loral (“SSL”) business. The business mainly makes Geo satellites and some low-earth orbit satellites. The company typically makes 5 – 6 satellites / year, and needs to make 4 / year to break even. MDA has 20% global market share and compete with LMI, BA, AIR FP, Thales. Some analysts are concerned about the volatility inherent in making 5 - 6 satellites per year, but historically it has actually been a pretty stable business.

The relationship between the satellite operators and manufacturers is quite integrated with a lot of repeat business, so the established customer base is important. It can be challenging for satellite operators to switch manufacturers.

Other 30% of MDA is more traditional aerospace and advanced robotics with a small imaging business that is focused on radar. The imaging business is quite synergistic with DGI and a source of a lot of the deal synergies.

In terms of the underlying DGI business (discussed in several past writeups), 50% of DGI is the Enhanced View contract. 10% is additional service revenue to the US Government. 40% of the business is selling the same imagery and services to international governments and companies.

DGI’s satellite business is a de facto monopoly with 55% global market share. The company has been doing this for the US Government across 3 different platforms for 15 years, so we have to believe that there is a strong mutual underlying relationship. There is a lot of concern around the end of the EV contract in 2020, but we would note that the government has always had the ability to cancel the contract annually. We believe that it is highly likely that the government will renew the contract in 2020, as DGI has a monopoly position in a vital service for the government. The government let them buy GeoEye, we believe that the government understands that they need to make money.

If you look at Worldview 1 and Worldview 3 which were dedicated to the US Government EV contract, the government prepaid for these contracts so satellite IRRs were actually ~30%. This is similar to the Eutelsat and SES video businesses where customers can’t switch, and they also get ~30% IRRs on their satellites. We think that the customer captivity for DGI will allow the company to continue to earn high IRRs on future satellites.

Deal

On February 24th, 2017, MDA announced that it was acquiring DGI for an EV of $US3.2b in cash, stock, and assumed debt. The deal is expected to close in H2 2017.

MDA’s CEO is the former CEO of Harris and advisor to Blackstone with a strong core competency in US Government work. His vision is to build MDA’s relationship and platform with the US Government, and is using the acquisition of DGI to spring-board this strategic vision. We also see the deal as an opportunity to consolidate data, customer touch-points, and IP in the earth observation satellite market.

The deal looks pretty pricey on headline metrics, but if you include the cost synergies, the acquisition is pretty reasonable at 8.5x EBITDA, 15x EBITDA - Capex. The platform to access the US government should also provide some real revenue synergies. MDA will also be able to push DGI’s satellite manufacturing through their own operations which should benefit the operating leverage inherent in that business.

Valuation

While flawed, many investors tend to value MDA and DGI on EBITDA. Historically MDA has traded at 9.5x EBITDA, while DGI has fluctuated widely. We think that the pro forma company will likely trade at 9x, at a slight discount to other aerospace / communications / data comps.

The high leverage amplifies the upside and downside. We do think there is a reasonable chance that MDA brings equity to finance the deal, which is clearly dilutive but will also cushion some of the volatility. 4x debt / EBITDA seems pretty high given the business characteristics.

Risks

The company loses the EV contract in 2020

Something blows up in space

High leverage PF for the deal

Regulatory issues surrounding the deal and/or future government work (again, we still think MDA trades up if the deal breaks so we are less concerned about this)

Catalyst

Listing on the NYSE

Deal closes people re-visit numbers

Deal breaks, MDA trades up

MDA wins new contracts with the US government

Equity issuance overhang is resolved