Description

Recommendation: Long ORBC

Timing: 24 months

Quick Info:

• Stock Price: $3.41
• Shares out: 46.8mm
• Market Cap: $160mm
• Cash: $75.4mm (as of June 30^th, 2012)
• Debt: $4.6mm
• Revenues (ltm): $65mm
  • Growing 15-20%+
• EBITDA (ltm): $18mm
  • 75% incremental EBITDA margins on Service Revenue
• Book Value:  $3.77 (0.90x Price/Book)
• EBITDA (2016e): $50-60mm
• Catalysts
  • Successful launch of OG2 constellation in mid-2013
    • Improved latency & Improved Data throughput
    • Expansion opportunities in existing and new markets
• Accelerating revenue growth and high operating leverage.
• Long term re-capitalization of under-leveraged balance sheet. 
• Bull Case: $10.00 = 300% over next 2-3 years
• Bear Case:  $3.00 = -10%

Description:

Orbcomm operates in 100+ countries, offering machine-to-machine (M2M) global asset monitoring and messaging services through its constellation of 27 low-earth orbit satellites and related ground/control infrastructure, and through reselling terrestrial wireless services.   M2M is a two way telematics service which can track, monitor, and control mobile and fixed assets.   www.orbcomm.com

Thesis:

We think that over the next 24-36 months, Orbcomm will experience an accelerating growth rate in revenues and even faster growth in EBITDA and cash flow.  Once the second generation (OG2) satellites are in the sky there will be ample opportunity to grow within existing markets, reinstate the AIS revenue stream, and also penetrate new markets.   The company has no debt, $80mm of cash, and can easily fund the deployment of the satellites with cash on hand, cash flows, and some minimal vendor financing.   The operating leverage in the business is substantial with incremental revenues dropping 75% to the EBITDA line.  The management team owns 20%+ of the stock and have proven they know how to operate a niche satellite business.  This is becoming an execution story as they have already proven a market exists for their services.  If the management team properly executes its stated strategy of launching OG2, adding new functions and features to its network, it will grow the subscriber base in new and existing market, and become a much larger and significantly profitable company in 3-4 years.    

We think that in 24-36 months, ORBC could generate $100-110mm in revenues, 55% EBITDA margins, and trade at 9x EBITDA.  Additionally, what is missed by analysts is the capital structure opportunity at maturity whereby the company could add 3-4 turns of leverage to the business and pay out a special dividend.  In total, we think the stock is worth $8-10 within 24 months.

It is an execution story with growing revenues, increasing operating leverage, and the potential for a higher multiple.

Business Model

• Orbcomm sells satellite and terrestrial communication through a network of value added resellers.  The ecosystem of 150+ VARs has developed around ORBC’s technology.  These VARs design applications catered to specific markets and utilize an ORBC receiver to communicate with ORBC’s satellite network.  These VARs will often mark-up the monthly fee charged by ORBC.  In this sense, ORBC is a wholesaler and the VARs are retailers.
• Recurring revenue with very low churn.
  • 700,000+ “subscribers” today.  (Each receiver is considered a subscriber.)
    • Subs pay on average $5.50 per month
      • VARs will often mark this up to $15-20 per month depending on the market and the application.
• Current Markets served 
  • Heavy Machinery:
    • Catepillar, Komatsu , Hitachi, etc…
      • In these markets, ORBC works directly with the OEM and (in most cases) is integrated into the assembly line.
      • For a nice example of a system at work check out this link: http://www.komatsuamerica.com/komtrax
• Dry Trailers - 57,000 Wal-mart trailers
• Cold Chain Distribution - 90% market share, yet market only 10% penetrated
  • Vertically Integrated
    • Acquired the top two VARs in the market Startrack Systems (#1 player) and PAR Logistics (#2 player)
    • These acquisitions increase ARPU by moving up the value chain and capturing the retail margin as well.
    • Adds engineering talent for accelerating adoption of OG2 receivers/applications for other markets.
• AIS – Automatic Information Systems
  • Can track all ships above a certain size around the globe.
  • Data business – sells data to Coast Guard, Bloomberg, etc…
  • 100% incremental margin business (satellites are already going up for core business)
• Some Future Markets
  • Security, Alarm; Weather Instrumentation; Home Metering; Drilling Rigs, Off Shore Platforms; Commercial Metering; Pipelines; Storage Tanks; Generators; In-Cab, Trucks; Rail; Recreational Ships; Containers; Military Land Vehicles
  • Frost & Sullivan has estimated that there are 170mm+ pieces of equipment that could be serviced.

Competitive Advantages

• Focus – Orbcomm is focused on the M2M market.  The entire architecture of the business, from the network design to the marketing approach is focused on this market.  For their main competitors this market is an afterthought, as they are more focused on higher ARPU markets like voice.
• Low Cost Structure – majority of assets (including ground/control infrastructure) was purchased out of bankruptcy.  ORBC satellites are relatively small and the cost to replenish the constellation is less expensive than larger LEO satellites and larger geostationary satellites.  The low cost satellite architecture allows ORBC to provide M2M services at prices that are the lowest in the industry.
• Sole commercial satellite operator licensed in VHF spectrum – Only commercial satellite operator licesnsed to operate in the 137-150 MHz VHF spectrum across 100+ countries (including the oceans).  VHF spectrum has advantages for M2M because it uses a longer wavelength, which allow for reliable communications over longer distances at lower power levels.  The higher power requirements (shorter wavelengths) of commercial satellite systems in other spectrum bands are a significant factor in their higher cost and technical complexity.
  • The company estimates it would take a new start up 5 years and a significant investment to develop the capability to offer comparable services as they have today.
• Significant Market lead over satellite based competitors – ORBC has 700,000 subscribers on its network in the M2M market, 3x larger than nearest competitor.  For example, ORBC has an 80% mindshare in the heavy machinery market, and nearly 90% market share in the “cold chain” distribution market (yet this market is only 10% penetrated today).
• VARs integration & Customer applications integrated – ORBC works with over 150+ VARs who have spent considerable time and resources over the last 10 years developing applications to ride on the ORBC satellite network.  Furthermore, OEMs like Catepillar and Komatsu have integrated ORBC into their assembly line.  There are significant switching costs for these customers and VARs.
• AIS Business – AIS is a shipboard broadcast system that transmits a vessel’s ID and position to aid navigation and improve safety.  The International Maritime Organization has mandated AIS on all vessels over 300 tons.  Current terrestrial-based AIS systems provide only limited shore-based coverage.  ORBC was selected by the Coast Guard to develop this technology to capture the AIS signal from space, allowing access to AIS data well beyond coastal regions.  ORBC is the only provider in the market today.  This will be a relatively small business, and there is not a strong business case to launch satellites to capture this market alone.  For ORBC, this is purely incremental as they are already launching a new constellation and can add this capability with minimal incremental cost.  
• Backward Compatibility – Unlike cellular technology, ORBC’s technology expansion and enhancements are designed to be backward compatible.  Since the assets being tracked tend to have very long useful lives, the cost to replace the receiver in the field is prohibitively expensive.
• Recent Acquisitions – Through Startrak and PAR, ORBC is moving up the value chain and becoming more of a complete end-to-end solutions provider.  These solutions will be used to create a global technology platform to transfer capabilities across new and existing vertical markets to help reduce the cost and speed up the development time for channel partners.

Current Situation

• Current satellites launched in late 90s are nearing end of life (3-7 years remaining estimated)
• Despite growing subs from 500,000 to 700,000 from 2010 to 2012, ORBC’s marketing efforts have been in “maintenance mode.”
• OG2 planned for launch in mid-2013 (8 satellites) followed by another launch in 2014.  Expected to launch a total of 18 satellites.
• Company expects to spend $180mm for 18 satellites
  • Includes cost of satellite, cost to get it into orbit, and insurance
  • Have already paid $60mm.
  • Will fund remaining $120mm with $75mm cash on hand, $20mm vendor financing, and cash generated from the business ($15-20mm per year).

OG2 Improvement

• Backward compatible with OG1 receivers. 
• Higher Capacity – 12x OG1
  • Larger messages, lower latency, increased data rates
  • Smaller antennas on subscriber equipment
  • Reduced power requirements
  • AIS receiver on all 18 satellites
    • Will provide near real time reporting on all large ships in the oceans.

Why down?

• On Oct 9^th, 2012 SpaceX rocket carrying a prototype OG2 as secondary payload launched.  Due to an engine anomaly, the OG2 satellite was placed in a much lower orbit than expected.
  • This was termed a failure, and the satellite subsequently burned up in the atmosphere
  • The company will collect $10mm insurance policy
  • However, the company was able to perform several necessary tests to ensure that the equipment works as designed.
• Why is this not too concerning?
  • Future missions, ORBC will be the primary payload and SpaceX has done a good job getting to the specified orbit for primary missions.
  • The company’s balance sheet is unchanged given insurance policy
    • This will allow the company to build a new OG2 satellite
    • Stock has fallen over $0.70 after new that the satellite was not placed in proper orbit, despite the long term irrelevancy of this news.

Management Team & Insiders

• Insiders  have 22%+ ownership, worth about $40mm today.
• Jerome Eisenberg – Chairman
  • Been in satellite industry since 1993, helping found Satcom
  • Marc Eisenberg – CEO since March 2008
    • Son of Jerome Eisenberg
    • We are not concerned with any nepotism.  We have met Marc several times and conducted a handful of background checks.  By all accounts he strikes us as a very good manager.
• Previously held Head of Sales & Marketing role at Orbcomm from 2002 to 2006.  Then COO from 2007-2008
• Robert Costantini – CFO
  • Not just a bean counter, Robert strikes us as a very strategic thinker.
• Management acquired business out of bankruptcy in 2001.
  • Over the next 4 years they turned the business around.
  • Revenues have grown from $3.3mm in 2001 to $65mm ltm.
• We think they’ve proven to be capable operators and capital allocators.  They’ve proven to be opportunistic as evidenced by the acquisition of the business out of bankruptcy, leading to very low cost basis in ground infrastructure (estimated at $100mm to replace), and also by the move to vertically integrate and move up the value chain.  We think they have a sound strategy to capitalize on the large market opportunity.  We like that they are truly “owner-operators” with 22%+ of outright stock ownership in the company.

Competition – How else can you get the job done?

• Cellular – addressed below in “Terrestrial vs. Satellite”
  • But generally cellular does not have consistent global coverage.  Coverage is concentrated where the “people” are, whereas assets tracked with M2M are often in places with very few people. 
• Low-Earth Orbit Satellites – Globalstar & Iridium
  • Their systems are generally tailored for voice which requires a dedicated circuit which is less efficient for M2M.  Their operating structure is built upon a very high average revenue per user (ARPU) as compared to the low ARPU for ORBC. Furthermore, the market size is sufficiently big that even if they did compete aggressively, all 4 companies could continue to grow.   
  • Iridium – The only meaningful competitor to Orbcomm. Their focus is on high ARPU Voice services. The 2^ndlargest, Iridium has only 200,000 subscribers in M2M vs. 700,000+ for ORBC.  IRDM satellite network is architected for voice, not data.  They have 66 satellites that need to talk to each other to send an undropped call signal.  It has to be switched and can’t be packetized.  Their infrastructure is not designed for data, whereas ORBC is specifically designed for data, whereby each satellite acts as if it is alone…if one goes down, the system will still work.
    • When asked, the CFO has said, “we rarely if ever see IRDM competing with us; we see terrestrial far more frequently”
    • One key point to keep in mind is that it is not a mutually exclusive market…there are 15 million pieces of heavy equipment in the world today and 800,000 are built yearly.
• Geo-Stationary
  • Companies like Inmarsat plc (operating in the L and S bands) have networks designed for high speed data and voice services.  The equipment cost and service fees for ‘smaller packet’ data communications with these systems is significantly more expensive than Orbcomm’s dedicated system.
  • Other limitations include requiring a clear line of sight between the communicator equipment and satellite and can be affected by adverse weather.  Orbcomm’s satellites require no line of sight and are not affected by adverse weather.
  • However, ORBC has an agreement to resell satellite service from a large geostationary satellite provider.

Terrestrial (cellular)  vs. Satellite?

• It will depend on the application and location.  Sometimes it makes sense to just use satellite, sometimes just terrestrial and sometimes a dual mode.  Orbcomm resells terrestrial service for customers seeking dual mode coverage.
• Terrestrial guys are really good at taking BIG data and pricing it cheap on a per byte basis.  M2M is less than 1% of the cell phone industry’s business.
• Terrestrial Cellular Networks cover only 8% of the world’s surface.  If you want a global tracking service, satellite is required.
  • For example:  Long haul trucking, railroads, oil & gas, agriculture, utility distribution, and heavy construction have significant activity in sparsely populated areas with limited or no terrestrial coverage. 
  • Typically M2M applications are not heavy data.
• With satellite you get PURE coverage, not just where “people” are.  With satellite there are not roaming coverage issues, and you don’t have to worry about CDMA, GSM, etc…  It will work anywhere in the world.
• The assets being tracked are very long life.  Cell phone technology evolves too quickly for how long these assets last.  Customers do not want to go in and replace a receiver with new technology.  They just want to put it on and have it work for the life of the equipment.
  • Ships: 10-20 years
  • Railcars: 10-20 years
  • Heavy Equipment: 10-20 years

Financials & Bull Case

Subs

• 2012 – 767,000
  • ARPU of $5.66/month
  • Growing 25,000 subs/quarter
  • Ticks up to 30,000 to 35,000+ subs/quarter post OG2 launch
  • 2015e: 1.1mm subs
  • 2016e: 1.3mm
  • 2018e 1.7mm
  • (The company has said they think they could get to 2mm subs by 2016 and grow well beyond that.  Our assumptions are much more conservative than the company’s).

Revenues

• 2012 - $65mm
  • $48.5mm service
  • $2.2mm AIS
  • $14mm hardware
  • 2015e: $100-110mm
    • 1.1mm subs, $6.00 monthly ARPU.
    • $80mm in service revenue
    • $12mm in AIS revenue
    • $15mm in hardware revenue
  • 2016e: $124mm
  • 2018e: $155mm

EBITDA Margins

• 2012: 28%
• Significant Operating Leverage
  • Incremental EBITDA – 75%-80%+ of incremental service revenue
  • With 2mm subs, could generate 65%+ EBITDA Margin 
  • 2015e: 42%+ EBITDA margin
    • $45mm EBITDA
    • 2016e: 45% EBITDA
      • $55mm
  • 2018e: 50% EBITDA
    • $78mm

NOLs

• $40mm of federal and state NOLs.  Expiring various times through 2031.
• Furthermore, there will be substantial depreciation tax shields.  As a result we think cash taxes will remain low for some time. 

Cash Flow

• Next 2-3 years: Cash From Operations will be positive.  Free Cash Flow will be negative as they invest in the OG2 satellite constellation. 
• Long term - Expect EBITDA converts to cash flow at a 75-80% flow through rate.
  • Given the tax shields from depreciation, cash taxes should remain low over time.

Maintenance Capx – virtually nil

• However, you should assume they will launch OG3 in 12-15 years and accrue for that.  Estimated that $8-10mm per year in “replacement satellite capx” accrual.

Valuation

• This will likely be the area with the most variation of opinion. 
• I think multiple between 5.5x and 11x EV/EBITDA is within the realm of reasonableness for profitable satellite businesses.
• I would argue that given the market growth potential, the accelerating revenue growth for ORBC, the high operating leverage, significant cash flow generation capabilities, underleveraged balance sheet, and lower risk profile (once satellites are in the air) that the company should be awarded a EBITDA multiple on the higher side of my range. 
• Using 2016 numbers // discounted back at 11%
  • 6x = $7.70  //  $4.60
  • 8x = $9.80  //  $5.80
  • 9x = $10.80  // $6.40
  • 10x = $12.00 // $7.00
• As a sanity check, in 2016 the “economic” Free Cash Flow (after a $10mm OG3 constellation accrual.  Reported cash flows would be higher) would be approx. $35mm.  A $10.80 stock price implies a 7% economic FCF yield, which seems reasonable.
• Furthermore, keep in mind that in 2016, the company could take out 3-4x of EBITDA ($160mm to $220mm) in debt for a special dividend or stock buyback.
  • Disregarding the further interest tax shields, this alone however, should not meaningfully change the EV/EBITDA valuation cited above. 

Bear Case

• I’ll attempt to illustrate a very negative but possible bear case.
  • The new satellites make it to orbit.  Several of the older satellites stop working within 12 months. 
  • Economic weakness ensues leading to slow to zero growth in subs
  • Customers are uninterested in the added features/benefits of OG2
  • IRDM and Terrestrial change their strategies and decide aggressively pursue the M2M market and operate the segment at a loss…and as a result win majority of any new business.
  • 2016 Bear Case Assumptions
    • Subs: 800,000 (1% Growth)
    • ARPU: $5.75 (0% growth)
    • Revenue: $73mm
    • EBITDA Margin: 35%
    • EBITDA: $26mm
    • Depressed EV/EBITDA Multiple: 5.5x
    • Net Debt: $45mm
    • Price: $2.20 = -34%
• This is slightly worse than my downside projection.  At this valuation, the ground/control infrastructure and satellite constellation is worth more than the stock.  If the reasons cited are why the business fails to hit its goals, new management (either a strategic or private equity) would find this an interesting asset.
• I maintain that $3.00 is a fair estimate of the downside.
• A “dire” bear case would be the following:  new satellites do not make it to orbit, old satellites stop working immediately, and the company’s revenues dry up overnight.  While anything is possible, I find this to be an extremely low probability event.   This is basically a “liquidation” as I am assuming they no longer have a business since they would have no satellites in orbit.  In this scenario, there would still be some equity recovery as the new satellites that fail are covered by $180mm of insurance.  Let’s say there is $120mm of liabilities against that $180mm in cash.  That is $60mm of equity value = $1.30 per share.   

Capital Structure

• It is rare that satellite providers operate with zero leverage.  (Net Debt /Equity Ratios)
  • Iridium:  55%
  • Globestar:  141%
  • Orbcomm:  (-38%)
• And rarer still to remain under-leveraged after launching a new constellation of satellites
  • ORBC stands alone here.  We estimate the company will have modest ($20-30mm of debt) and $15-30mm+ of cash after the satellites launched.
• Once ORBC has reached a stable mature base in 2015/2016, they could easily put on 3-4 turns of leverage and pay out a special dividend to shareholders and optimize the capital structure
  • The market underappreciates the cash flow generation capabilities of this business.

Public Peers EV/EBITDA multiples & Growth Rates

• IRDM
  • EV: $936mm
  • Revenue: $387mm
  • EBITDA: $175mm
  • 5.4x EV/EBITDA
  • Approx. 10% revenue growth
• GSAT
  • EV: $859mm
  • Revenue: $73mm
  • neg EBITDA
  • Approx 10% revenue growth

Misc Points

• Company does not operate in China, India, or Russia today.
  • Those markets either will not (China), or are yet to (India/Russia) approve Orbcomm’s satellites to operate. 
  • Countries control the spectrum over which messages are sent/received.
  • China has not approved any foreign owned satellite company from operating.
    • However, should they ever be approved, they will hit the ground running as several pieces of used equipment in China will already have Orbcomm receivers installed.
• India is a bureaucratic nightmare, it will just take time.
• Russia recently approved Iridium, and Orbcomm should follow.
• Brian Bell – EVP of Sales & Marketing was terminated on Oct 1^st, 2012
  • When asked, CEO responded... (Paraphrasing)… “I was promoted from that role, so I know it very well.  We have been in maintenance mode with respect to sales, and we need to become hunters when OG2 is up. We are going to get very aggressive, and we need to have the right talent on board”

Risks

• It is very likely that the June 2013 launch date for the SpaceX rocket carrying Orbcomm as the primary payload will slip by, the nature of launches are that they rarely happen on schedule.  I am expecting an October 2013 launch date to be conservative.
• A SpaceX rocket fails
  • There are 2 missions before ORBC’s next mission. 
  • A severe failure on either one of these could cause a VERY long delay before ORBC can get OG2 up.
• Satellites, once launched do not work.  This would likely be covered by insurance, but would still cause a very long delay for the company.
• Competition intensifies and/or new unforeseen entrants figure out a way to break into the market.
• Economic slowdown.  While the current subscriber base is very stable regardless of the economic environment.  (ORBC grew subscribers from 351,000 in 2007 to 515,000 in 2009 through the Great Recession)  Long term economic weakness could make the growth rate slower than it otherwise would be.

Variant Perception

• Multiple Ways to win:
  • Higher valuation awarded due to accelerating revenue growth
  • IRDM could acquire the business to gain scale in M2M market.
  • Perfect candidate for private equity (once satellites are up) given high cash flows and underleveraged balance sheet.
  • Stock sold off after prototype satellite failed to make designated orbit as secondary payload on Falcon9 SpaceX launch on October 9^th. 
    • The company was able to verify that the satellite responded and tested it before it burned up in the atmosphere.
    • The company will receive $10mm from insurance claim.  This cash will be reinvested in another satellite.
  • Market doesn’t appreciate the strength of ORBC’s position in the M2M market and accelerating growth opportunities once OG2 is in the sky. 
  • Market does not fully appreciate the power of operating leverage embedded in the model.
  • Market does not appreciate the potential for significant changes to the capital structure at maturity.  Estimated the company could borrow 3-4 turns of EBITDA in 3 years and pay out a special dividend.

History

-          Like most satellite companies, there is HUGE upfront investment.  Companies often borrow heavily to fund the capital expenditures of getting the satellites in the air and building the ground infrastructure.  If the revenues don’t follow through, the debt burden becomes overwhelming.  This is the rough description of the early days of Orbcomm.  The company spent hundreds of millions of dollars building out the initial satellite constellation and ground/control infrastructure in the late 1990s.

-          Thankfully, we are long past that stage.  Orbcomm has proven the markets exist, generates revenues and positive cash flow, and has a pristine balance sheet today.

-          Here’s a link to the S1: http://www.sec.gov/Archives/edgar/data/1361983/000095012306006330/y19769sv1.htm

Links & useful sites
Company Website

http://www.orbcomm.com/

Company Presentation

http://www.orbcomm.com/Collateral/Documents/English-US/InvestorOverviewSeptember2012.pdf

Ways to track satellites:

http://www.celestrak.com/

https://www.space-track.org/perl/login.pl

Articles about the SpaceX Launch:

http://cosmiclog.nbcnews.com/_news/2012/10/08/14297705-spacex-launch-problems-come-to-light-dragons-ok-but-did-satellite-go-awry#comments

 Forum about SpaceX

http://www.nasaspaceflight.com/2012/08/spacex-conduct-successful-wdr-falcon-9/

Catalyst

• successful launch of OG2 constellation in mid-2013
• Improved latency & Improved Data throughput
• Expansion opportunities in existing and new markets
• Accelerating revenue growth and high operating leverage.
• Long term re-capitalization of under-leveraged balance sheet.