SES / Intelsat - OpCo/PropCo and Downstream Integration - Initiation
All,
Please find our initiation of SES/Intelsat, here.
SES / INTELSAT | Live Discussion
Wolfgang Felix - Senior Analyst, Head of Desk
Wednesday, 12 Feb, 3 pm UK time | 10 am ES
How complete will the replacement be? Are LEOs taking over almost everything? Satellite communication is a high fixed, low incremental cost business. So once a constellation is up, it will drive down prices for any service except those it is truly unsuitable for - and in the case of LEO constellations, they are suitable for almost everything except cheap broadcast. However, the game may change in another way too. Operators are passing on some of the pressure by integrating downstream to offer own service level agreements to customers. Also, OneWeb and potentially more LEO constellations rent their capacity wholesale to GEO and MEO operators. So propcos are separating from opcos, which is what this merger is all about. So there is a lot to consider in this name.
Investment Considerations:
- We are not taking a position at first for lack of a trigger in the short term. The company reports Q424 and Q125 together towards the end of April and with the exception of Government, we are expecting all other segments to report falling revenues. The general expectation is already priced into the bonds - some of which have significant duration.
- Overall, the slow development of the situation makes any short impracticable and if anything, 8% YTM on such long duration might be attractive in a falling interest rate environment.
Leverage and Interest Coverage:
- We see leverage through the Senior Debt broadly stable in the next two years as the high expansionary CapEx soaks up most any excess cashflow and falling revenues are somewhat offset with synergies, which we think the company can legitimately expect.
- FCCR should be poor during that time (below 1.5x) due to the high CapEx. However, it could be argued that this is expansionary and on a maintenance-only basis we have no reason to model much deterioration in in the short to medium term.
- However strong the migration to LEO constellations becomes (we are divided on the desk) noticeable changes in leverage stats should be at least two years away.
Background:
- LEO (Low Earth Orbit) satellite constellations have been on the drawing boards for a long time. However, they need vast up-front investment to cover the globe, as single satellites roam and only have a narrow beam. Enter Elon Musk. Launched by Space X, Starlink are 15% into the roll-out of a vast 42k satellite LEO constellation, which is becoming increasingly operational.
- Across all major satellite connectivity markets, including Video, Networks, Mobility and Government, NGSOs (non-geostatic satellite operators) led by LEO (Low Earth Orbit) and MEO (Medium Earth Orbit) constellations are set to tear into the revenue of GEO (Geostatic) satellite operators, which sets the stage for consolidation in that space.
- The two largest traditional players have announced plans whereby SES is to acquire Intelsat, to create by far the largest company in the market to save cost and play for time while trying to contain the attrition to lower latency LEO constellations, led by Starlink and to a lesser extent OneWeb and to cocoon themselves into the high-latency broadcast and low-end business that will remain once LEO constellations are a reality.
- LEO constellations have only begun to be viable and we are already seeing the decline in revenue. But so far it is anyone's guess how much of the capacity will eventually be substituted.
Key Value Drivers:
- Satellite Broadcast is cheaper via GEOs and should form a resilient core demand to survive LEO roll-out.
- SES have begun rolling out a fleet of MEOs. If the combined entity can stay in front of its customers while that fleet grows to size within the next five years, then it may be able to hold on to a substantial portion of the business.
- OneWeb rents its capacity wholesale, allowing legacy players to offer an integrated service to their clients. The danger is if OneWeb decide to pursue a vertical strategy at some point.
- Intelsat is still expecting final payments of C-band compensation. 57.5% of those payments would remain within the combined entity.
- In the near term, the Government segment should show growth. As defence budgets are raised across the world, we expect all satellite operators to benefit.
- Regulators, particularly in Europe, could require Starlink to sell capacity wholesale. That would separate opcos from propcos and validate the current strategy SES are pursuing with the merger.
Key Risks:
- The CMA might turn down the acquisition entirely or to a large extent. In itself that would not be a disaster, but bonds would trade down.
- Satellite operation is a high CapEx / low incremental cost business. We therefore think the substitution will be near total, except for some basic low-margin broadcast.
- Quarterly reportings should only focus on how fast the company shrinks.
- Refinancing the capital structure should become increasingly difficult and expensive.
- The combined entity has plans for high CapEx. We expect that to be spent on a fleet of MEOs (that would be good), but we have not received details. As ever. the cash first leaves the business, before revenue returns it.
- The state of Luxembourg owns 33% of the shares. This could be positive, but it could also mean limited upside in a D/E swap if one day the debt stack becomes unsustainable.
Looking forward to discussing this name with you,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk