ViaSat Inc.

VSAT

 

 

INVESTMENT SUMMARY

ViaSat is a very well-positioned and well-run company that provides satellite and other wireless communications and networking systems to government and commercial customers. The company's core legacy businesses are defense-focused, providing mission-critical products and services to the Department of Defense (DoD) and other government organizations. These businesses operate in duopolistic markets with significant barriers to entry and are likely to grow revenues 10%+ per annum over the next 5 years. In December 2009, Viasat purchased (from Liberty Media) a leading satellite broadband provider, WildBlue, which serves as a transformational acquisition for the company. WildBlue operates in a duopoly with Hughes in the North American satellite broadband industry.

 

ViaSat's current stock price does not reflect the likely robust cash flow to be generated from WildBlue and the company's soon to be launched satellite, ViaSat-1. The earnings power of the company could increase up to 3-6x its current rate of ~$1.50/share over the next 3-4 years following the successful launch of ViaSat-1. Given the quality of ViaSat's legacy defense business and likely explosive earnings growth from the WildBlue and ViaSat-1 combination, the stock appears to be materially undervalued. We believe an investment in ViaSat is an excellent risk/reward with low risk of capital loss.

 

 

THE BUSINESSES

ViaSat develops, manufactures and provides services related to satellite ground systems and other related government and commercial digital communication and networking equipment. The company's products are complex and have a concept-to-market timeline of several months to several years. ViaSat leverages its advanced technology and capabilities to capture a considerable share of the networking and global satellite communications equipment and services segment of the broadband communications market for both government and commercial customers. The company is organized principally in three segments: government systems, commercial networks and satellite services.

 

The government systems business is focused on network-centric government communications that provide secure tactical communication solutions to the U.S. military and other government organizations. Key products include:

?         Tactical data links - provide line of sight, jam-resistant, secure networking for voice and data.

?         Information assurance - provide network encryption devices that allow the transmission of secure, classified data across public networks.

?         Satellite communications - provide real-time intelligence, reconnaissance and command and control functions.

 

The commercial networks segment develops systems and products (hardware and software) for consumer, enterprise and mobile (aviation and maritime) broadband customers. Key products include:

?         Antenna systems - design, manufacture, test, install and maintain antenna and ground station systems critical to satellite communications.

?         Satellite products - two-way high speed internet over satellite equipment to WildBlue and its distributors in the U.S., Telesat in Canada, Eutelsat and its distributors in Europe, and Yahsat in the Middle East.

 

The satellite services segment primarily consists of WildBlue, which Viasat acquired in December 2009 for $568 million. WildBlue is a wholesaler and retailer of satellite broadband internet, providing broadband directly to residential and small office consumers in markets underserved by ground-based (i.e. cable and DSL) internet service providers. WildBlue currently has approximately 415,000 subscribers.

 

 

COMPETITIVE POSITION AND MARKET OPPORTUNITY

ViaSat has a collection of excellent businesses with significant barriers to entry and attractive growth characteristics.

 

Government Systems:

ViaSat's government businesses are well-positioned and likely to continue growing nicely over the coming years. Two of the company's key product segments - tactical data links and network encryption devices - essentially operate in duopolies with significant barriers to entry. These barriers to entry include development costs, technological expertise, customer relationships and reputation.  In many cases, Viasat's products are mission critical for military personnel, so the likelihood of new, unproven competitors taking share from ViaSat is quite low. Overall, the government businesses have grown at a 17% CAGR over the last seven years and are likely to grow 10%+ going forward. Approximately 80% of ViaSat's government business is based on fixed-fee, multi-year contracts, so it is quite stable and recurring. That said, the Department of Defense and other governmental organizations do not award new contracts at a specified time of year, so quarterly results can be lumpy. Given the recent defense budget pressures, several contracts have been pushed out and Viasat's government business was flat in fiscal 2011. (The company's fiscal year ends in March.) New contract awards have been delayed rather than cancelled, and management expects its government segment to grow 10% in fiscal 2012.

 

There are two factors that are likely to contribute to continued growth in ViaSat's government systems businesses. One factor is the critical role of collection and dissemination of real-time information in executing high-speed, high-precision, highly mobile warfare over dispersed geographic areas, which has two important aspects. The first is reflected in the DoD's transition to "network-centric warfare," which emphasizes the importance of real time data networks of all types via multiple transmission media. For example, this allows army commandos on the ground to communicate directly with air force pilots hovering at 35,000 feet rather than having to relay this information through an army helicopter pilot, to a joint-command center, to the air force pilot, and back. The second is the growing importance of satellite-based communications, in particular, as the most reliable method of connecting rapidly moving forces who may simply out-run the range of terrestrial radio links. Another factor contributing to future growth is that over the next decade or so many of the previous generation of defense communications satellite networks will expire or become obsolete. New programs are underway or in planning stages to define, develop, procure and deploy systems to replace them. While ViaSat has been successful in capturing defense satellite ground system business in the past, these new programs present more opportunities for bidding on new contracts than the company has seen historically.

 

In July 2010, ViaSat received a $477 million contract to supply the next generation of high speed, high capacity, low latency Blue Force Tracking (BFT2) equipment to the U.S. Army. Note the previous BFT contract had been awarded to Comtech, so this was an excellent win for ViaSat. Recent BFT2 orders have added $100 million to the government business' current backlog of $284 million, which is the highest in the company's history.

 

Commercial Networks:

The company's commercial networks business consists primarily of SurfBeam and antenna systems. Both are satellite network ground equipment (dishes on a residential roof as well as larger dishes in commercial areas) that connects orbital satellite bandwidth to specific end users (i.e. a home or business). The products are used by satellite operators such as Eutelsat in Europe. The products were used by WildBlue prior to ViaSat's acquisition of WildBlue (WildBlue made up 8% of ViaSat's total revenues before the merger), and the commercial networks business should benefit nicely from the continued growth of WildBlue and other satellite operators.

 

ViaSat's commercial networks business should benefit from the new capacity available when ViaSat-1 becomes operational and from the forthcoming growth in its satellite services business.

 

Satellite Services:

The company transformed itself in January 2008 when it announced plans to build its first satellite, ViaSat-1. The company saw that the demand for internet broadband services in underserved and un-served markets was growing rapidly, yet the two primary providers, WildBlue and Hughes, did not possess the capital resources to build additional capacity (via additional satellites). There are currently approximately 112 million homes in the U.S., and 10-15 million are un-served while up to 30 million are underserved. Between WildBlue and Hughes, there are approximately 1 million internet broadband subscribers today, so the market is significantly underpenetrated.

 

The primary target market for internet broadband providers is rural regions where it is not economical for cable and telecom providers to build out fiber optic networks, and the only other option is often dial-up services. In less rural areas, there are also a number of coverage lapses where cable and telecom operators have failed to fully build-out a broadband network. ViaSat partnered with Loral Space and Communications to construct its new satellite, and ViaSat-1 will cost the company approximately $315 million. (Including the cost of the launch and ground equipment, the total cost of Viasat-1 is ~$450mm.) The satellite is scheduled to launch in July 2011 and should be in operation by October 2011. There is approximately a 3-4% chance that a satellite fails during launch, but the company has taken out an insurance policy (worth $415 million) to mitigate that risk.

 

WildBlue (via its 1st generation satellite, WildBlue-1) currently offers 512kbps-1.5Mbps downstream speeds, which are slower than DSL and cable. WildBlue's service, as well as Hughes' offering, has struggled with capacity issues for several years, and in many high demand areas WildBlue has no bandwidth that it can offer prospective customers. WildBlue-1 currently is only at 60-65% utilization, but it is at full capacity on 35-40% of its beams¹.

 

[Footnote 1: Ka-band satellites, such as WildBlue-1 and ViaSat-1, provide broadband to particular regions through beams. Spot beam satellites focus multiple beams of satellite power onto different geographic regions, similar to the cells of a wireless phone network. This technology produces an increase of 4-6x the capacity of conventional Ku-band satellites that have one large "footprint," generally covering an area slightly larger than the continental U.S. With higher system capacity, WildBlue can offer lower cost airtime for users. This is the primary advantage of Ka-band satellites when compared to Ku-band satellites.]

 

With the additional of ViaSat-1, WildBlue will be able to add capacity where it is in the highest demand and will likely fill up its capacity quickly. Management recently announced that it expects initial uptake rates of 30,000 to 40,000 gross adds per month, and we believe it is likely that Viasat-1 adds ~1mm subs over 3-4 years. ViaSat-1 will allow much faster download speeds of 2-8Mbps, which rivals most DSL services as well as some cable offerings. Median DSL speed in the U.S. is 768 kbps and median cable speed is much faster, at about 4.5 Mbps. ViaSat-1 will allow distributors DirecTV, Dish and NRTC to price a basic service at 2Mbps compared to 512kbps now, raising satellite to about the 80th percentile of DSL. Premium plans would in fact surpass the best DSL service, and even put satellite above the current median for cable.

 

The company originally planned to sell most of the ViaSat-1 bandwidth wholesale (i.e. through DirecTV, Dish and NRTC rather than through its retail / direct-to-consumer channel), but Echostar's recent acquisition of Hughes has changed ViaSat's go-to-market strategy. Given Ergen's joint ownership of Echostar+Hughes and Dish, it is unclear whether Dish with remain a partner of Hughes' largest competitor, WildBlue. In our view, Dish will likely remain a WildBlue distribution partner until Hughes' Jupiter satellite goes into service in 2012.  (Hughes is planning to launch a new satellite, Jupiter, which will have approximately 70% of the capacity of ViaSat-1.) While is it uncertain how the distribution of Viasat-1 capacity will play out, a roughly 50/50 split of wholesale/retail is a good place to start. The primary difference between wholesale and retail adds for ViaSat-1 is that wholesale adds have lower SAC (and thus more initial cash flow) but retail adds have a higher ARPU and a higher IRR (ViaSat does not share the ARPU with a distributor). See figure below.

 

            Wholesale                    Retail

ARPU ~$25-30/sub                ~$60-75/sub

SAC    ~$0-50/sub                  ~$400-800/sub

IRR     Mid 30%s                    40%s

 

Note that even if Viasat-1's initial subscriber ramp is slower than we are projecting, the satellite's IRR remains very attractive.

 

The acquisition of WildBlue at 6X standalone EBITDA was an extremely savvy way for ViaSat to monetize its investment in ViaSat-1. This is truly a case where the value of the assets combined is much greater than either on a standalone basis, and ViaSat was able to achieve this benefit without paying-up for WildBlue. Once this satellite is operational and new subs cover the start-up costs, we believe the company's EBITDA and earnings will increase materially. Using what we believe are conservative assumptions, ViaSat-1 will likely increase EPS by ~$3.50-9.00 per share.

 

Essentially, ViaSat-1's satellite broadband service should increase cash flows dramatically, benefitting from the megatrend of rapidly growing demand for broadband by providing the low cost, high bandwidth solution to underserved customers. And our investment has downside protection because of the value of the defense businesses and WildBlue (excluding ViaSat-1's impact).

 

 

MANAGEMENT

ViaSat's management team is experienced, smart and highly focused on growing equity value over time. 

 

ViaSat was founded in 1986 by current Chairman and CEO Mark Dankberg and Co-CTOs Steve Hart and Mark Miller with $25,000. The company went public in December 1996. From its founding through 2000, ViaSat focused primarily on government contracting. In April 2000, the company purchased Scientific Atlanta's satellite networks business. Commercial revenue has been a major part of the business since and the predominant focus of acquisitions, although the commercial segment has yet to show significant profits. With the construction of ViaSat-1 and the December 2009 acquisition of WildBlue, Dankberg and his team have shown tremendous strategic thinking, and we believe they will continue to add value over many years. Importantly, the management team has significant skin in the game: they collectively own approximately 13% of the company, and Dankberg personally owns 5%.

 

 

PRICE

Given the quality of the company's legacy defense businesses and likely explosive earnings growth from the WildBlue and ViaSat-1 combination, we believe the stock is materially undervalued at approximately 6x 2014 P/E. Due to ViaSat's strong competitive position and the high barriers to entry in its duopolistic defense businesses, there is significant downside protection at the current stock price if ViaSat-1's launch proves unsuccessful, including the $415 million insurance policy. Given the asymmetric risk/reward profile, we believe an investment in ViaSat at the current price is an excellent investment opportunity that potentially is worth 2-4x the current price over 3-4 years with low risk of capital loss.

 

 

RISKS

ViaSat-1: 

Approximately 3-4% of satellite launches fail, and we estimate there is a similar chance that ViaSat-1 blows-up during its launch. While this is a risk, the company has purchased an insurance policy that will pay $415 million if indeed the ViaSat-1 launch fails. A crash will delay the ultimate outcome but won't change it permanently.

 

Technology-focused Industry:

ViaSat is, to some extent, a technology-focused company and its future results depend upon the company continuing to be able to innovate and improve upon its current base of products. Additionally, the satellite broadband opportunity depends to a degree upon cable and telco operators continuing to choose not to serve rural areas because the economics of building out a fiber optic network do not make sense. If companies such as Comcast and AT&T choose to compete more aggressively in these rural, underserved broadband markets, the market opportunity for ViaSat's satellite services will be adversely affected.

 

We are comfortable with the technology risks associated with an investment in ViaSat because of the high barriers to entry in the company's defense businesses, including high development costs and long-term relationships with high recurring revenue. The government contracting business is one in which the incumbent has an enormous advantage: the DoD is reticent to switch to a new supplier of mission-critical products. Additionally, the WildBlue business is consumer-focused and quite sticky with a churn rate of approximately 2%.

 

Capital Allocation / Future Investments:

The future success of ViaSat's business is partly dependent on management's ability to continue to allocate capital efficiently and prudently.  Given management's track record of investing (most notably ViaSat-1 and the WildBlue acquisition), we are comfortable accepting these risks given the hefty potential reward if these investments work out, as well as low risk of long-term capital loss in this investment. It is important to note the business is generally managed with no debt on the balance sheet, and management is quite risk averse with respect to financial leverage.

 

 

CONCLUSION

An investment in ViaSat is an extremely compelling risk/reward.  ViaSat's defense businesses have strong competitive positions in attractive niche industries, its WildBlue and ViaSat-1 combination provide explosive earnings potential, the company is run by a focused and smart management team and the stock is currently trading at a price that represents a substantial discount to intrinsic value.