Description

Summary

SES SA (SES) is a satellite company. The Company provides feeds for cable television networks, Internet access, corporate networks, network facilities, telecommunications services, and audiovisual broadcasting. SES and satellite companies act as spectrum wholesalers to broadcasters, owning and operating the satellite infrastructure. See RSJ’s write-up on SES from 2019 (and comments) for additional background on the company, particularly around the C-band auction process.

SES is attractively valued, trading near all-time low valuations, with potential catalysts for significant rerating. These include the launch of the next mPower satellites, increased backlog, and full visibility on C-band payments. The company has a strong balance sheet and several growth opportunities as well as a solid track record of returning capital to shareholders.

Investment thesis

Core components of the investment thesis are as follows:

1. Attractive valuation – SES common stock trades at ~4.5 EV/EBITDA 2024E (including hybrid bonds and restructuring charges). Many European incumbents and US cable companies trade above 7x EV/EBITDA, while US telcos typically trade at 6.0-6.5x. Public markets are overemphasizing declines in the core business and extrapolating Eutelsat’s ill-conceived OneWeb takeover.

2. Prospects of stabilisation and growth – Management expectation stabilization in Video and growth in Networks. The core business remains cash generative with cumulative free cash flow to equity. There is potential for the mPower constellation to generate revenue growth from 2024.

3. Greater clarity on spectrum value provides downside protection – Downside is protected through contractual value of C-band spectrum. SES's net proceeds from the Phase II C-Band auction are expected to be sufficient to reduce its leverage ratio to near 1x within the next 12 months.

4. Low leverage & limited balance sheet risk – Balance sheet concerns have pressured the sector in the past. SES has few near-term maturities. Management favors a strong balance sheet approach to C-Band proceeds and capex phasing.  

5. Numerous upcoming catalysts – The next mPower satellites will be launched and operational in 2023. The backlog will continue to increase, providing better visibility into revenue growth in 2024 and 2025.

Full visibility on C-band payments will occur by Q42023 or Q1 2024. The market is looking for confidence that a reasonable percentage will be deployed in shareholder returns. SES has a track record of meaningful shareholder returns, most recently in the EUR100mn share buyback progamme launched in 2021.

SES has also announced that it will be part of a consortium of satellite, equipment, and telecommunications companies to bid for a concession contract for the €2.4bn IRIS² European Commission project. The company has not yet specified the type of investment that would be involved, and the tender process for the concession contract will run through 2023.

 Key risks include capital allocation (poor investments or failure to return capital to shareholders) and a non-shareholder friendly merger with Intelsat.

The opportunity likely exists due to (1) the perception of structurally declining video segment, (2) potential merger with Intelsat creating uncertainty and complexity for many long-only institutional investors, and (3) losses incurred following the C-band spectrum auction still deterring many hedge funds from reentering the sector.

Company description & background

SES SA offers global satellite broadband communications services.  The Company provides feeds for cable television networks, Internet access, corporate networks, network facilities, telecommunications services, and audiovisual broadcasting. SES and satellite companies act as spectrum wholesalers to broadcasters, owning and operating the satellite infrastructure. Areas of satellite usage include emerging and rural markets, where terrestrial communication is either expensive or unavailable, and transmission of media content (mainly TV programming) by distributors. SES has been listed on the Luxembourg Stock Exchange since 1998 and on the Euronext Paris Stock Exchange since 2004.

The Company has issued two classes of shares: A-shares and B-shares. Each share is entitled to one vote. One B-share carries 40% of the economic rights of an A-share. The ratio of A-shares to B-shares must be maintained at 2:1 as required by the Articles of Incorporation.

The listed security is the Fiduciary Depositary Receipt (“FDR”), listed on the Luxembourg and Euronext Paris Stock Exchanges. Each of these is backed by one A-share and has all the rights attached to that share, except the right of attending General Meetings of shareholders.

The State of Luxembourg holds a direct 11.58% voting interest in the company and two indirect voting interests, both of 10.88% each, through two state-owned banks, Banque et Caisse d’Epargne de l’Etat and Société Nationale de Crédit et d’Investissement. These shares constitute the company’s B-shares. A B-share has 40% of the economic rights of an A-share.

Sector outlook

Communications satellites are launched into one of three orbital altitudes: low Earth orbit (LEO), medium Earth orbit (MEO), or geostationary Earth orbit (GEO). The International Telecommunication Union (ITU), an agency of the United Nations, manages orbital locations and allocates them on a first-come, first-served basis.

The characteristics of each orbital altitude vary. LEO satellites are the closest to Earth and have the fastest communications speeds. However, they also require the most satellites to provide global coverage. MEO satellites are in between LEO and GEO satellites in terms of altitude and communication speeds. They require fewer satellites than LEO satellites to provide global coverage, but their speeds are not as fast as LEO satellites. GEO satellites are the farthest from Earth and have the slowest communications speeds. However, they require the fewest satellites to provide global coverage.

Most publicly quoted satellite companies have the bulk of their satellites in GEO. This is because GEO satellites provide the best balance of coverage and cost. GEO satellites are at an altitude of 35,786 kilometers and appear to be at a fixed-point relative to the earth's surface above the equator. This means that the equipment to receive signals from GEO satellites can be relatively simple as it doesn't move.

GEO satellites are more expensive to launch than lower-altitude satellites. This is because more energy is required to reach a higher altitude. For example, a SpaceX Falcon 9 Full Thrust rocket can deliver almost 23,000 kilograms to LEO or just 8,300 kilograms to GEO.

Satellite TV distribution (Video) faces structural challenges due to the rise of over-the-top (OTT) / subscription-based video-on-demand (SVoD) services. OTT services such as Netflix and Amazon Prime Video offer a wider range of content at a lower price than traditional satellite TV providers. As a result, satellite TV providers are losing subscribers and revenue.

Eutelsat’s recent investment in OneWeb is a sign that satellite operators are aware of the challenges they face and are looking for ways to adapt. OneWeb is a low-Earth orbit satellite constellation that is designed to provide high-speed internet access to rural and underserved areas. By investing in OneWeb, Eutelsat is hoping to tap into a new market and diversify its revenue streams.

Financial analysis

Earnings outlook – SES's 2023 outlook suggests that the company's return to growth may come later than investors currently anticipate, with lower margins at least in 2023.

The company has said that revenue growth is likely delayed given a later mPOWER service date. mPOWER service introduction is still expected in 3Q23 but it has been delayed by a few weeks (end of 3Q). A meaningful growth acceleration is therefore unlikely to be seen before 2024.

SES has also said that EBITDA margins are likely to be lower in 2023 due to lower-margin revenues. The company has said that this is at least partially one-off in nature given costs related to mPower were deferred to 2023.

Looking forward, a shift in SES' revenue from video broadcasting to communications services may help the company top sell-side consensus expectations for sales growth. This could boost confidence in the profit outlook and lead to mid-single digit increases in consensus EBITDA for 2024. In addition, the successful completion of a new constellation by late 2024 is set to expand SES' MEO capacity dramatically, supporting sustained double-digit growth in Network-segment revenue, which already accounts for half of total revenue.

Capital structure and financial leverage – SES's net proceeds from the Phase II C-Band auction are expected to be sufficient to reduce its leverage ratio to near 1x within the next 12 months. This would alleviate pressure on the company's credit ratings and allow effectively reset its capital structure.

At its recent 4Q results, the company reduced its leverage target to below 3x from 2024 (previously below 3.3x). SES has been working to reduce its debt burden, and it has made significant progress in recent years; The company has reduced its leverage from over 5x in 2017 to below 4x in 2022. SES is targeting a leverage ratio of below 3x by 2024 and will be well ahead of that goal.

Valuation summary

C-band proceeds –  SES remains on track to clear 280 MHz of spectrum to speed deployment of 5G services in the United States and is now focused on completing transition activities to meet the Phase II deadline of 5 December 2023. Successfully completing the Phase II activities by that deadline makes SES eligible for a further $3 billion accelerated relocation payment. C-band proceeds, discounted & taxed, are worth €5-6 per share, depending on tax and FX rates assumptions.

Overall valuation – SES’ intrinsic value is likely >€8 per share assuming fair value for the core business is ~5.5x and the company receives ~€2.3bn after tax (19% tax rate, 1.07 EURUSD). That would still be well below SES’ average historical valuation (~6x EV/EBITDA), current valuations of European incumbents, and US telcos.

Risks

Operational risks include satellite launch delays and faster than expected declines in the video segment.

Intelsat merger – On March 29, 2023, SES announced that it had entered into exclusive discussions with Intelsat regarding a potential merger of the two companies. The proposed merger would create a global satellite communications leader with a combined fleet of more than 120 satellites and annual revenues of over $4 billion.

The market is understandably skeptical of the deal, particularly given the ill-advised Eutelsat/OneWeb merger. Depending on the funding structure, it may eliminate the significant upside case in SES common stock based on significant shareholder returns.

However, there is strategic rationale for a SES/Intelsat combination. Intelsat's large fleet of GEO satellites and proven track record of operating them would be a valuable asset for SES, which also operates a fleet of GEO satellites..

Given Intelsat’s recent bankruptcy, the market understandable concerns about Intelsat's leverage. At is approximately 6x, which is higher than SES's but still manageable. Intelsat has been working to reduce its debt burden and has made progress in recent years, falling from over 7x in 2017 to below 6x in 2022. Intelsat is targeting a leverage ratio of below 5x by 2024 and is supposedly on track to achieve this goal.

Intelsat is also expected to receive higher C-band income than SES. C-band is a valuable spectrum band that is used for a variety of applications, including mobile broadband and satellite television. Intelsat has a large portfolio of C-band licenses and is expected to generate significant revenue from these licenses in the coming years.

Failure by management to return capital to shareholders – SES has said that it will use the proceeds from C-band payments to invest in new technologies, expand into new markets, and reduce its debt. The company has also said that it may use some of the proceeds to return capital to shareholders. Any major investment program that management chooses to undertake will be treated with skepticism by the market, especially if it comes at the expense of shareholder returns and/or debt reduction.

Catalyst

C-band proceeds, shareholder returns, debt reduction, mPower launch