FAA opens the skies
Gogo (GOGO) is the leading provider of in-flight connectivity. Gogo has the largest number of online aircraft in service. Gogo is a pioneer in wireless digital entertainment and other services in the commercial and business aviation markets. Gogo focuses on helping airline partners and business aircraft operators and their passengers realize the full potential of the connected aircraft by delivering in-flight connectivity-based services to passengers and connecting the aircraft and its crew with ground-based operations teams and systems. Gogo has three divisions: Commercial Aviation North America, Commercial Aviation Rest of World and Business Aviation.
In the Commercial Aviation segments, Gogo provides internet connectivity to airlines through their proprietary network. In North America, Gogo has over 2,000 aircrafts online, over 7,000 flights and 81% market share. Gogo recently started its international operations and quest to provide in-flight connectivity around the world. Gogo has signed up a number of major airlines including Delta and Scoot, a subsidiary of Singapore Airlines. Gogo's international segment and product continues to show strength. On October 28th, 2013, Gogo announced a new contract to provide in-flight connectivity to Japanese Airlines domestic flights.
In the Business Aviation segment, Gogo has installed over 6,800 operating systems with a 63% market share in Narrowband and a 93% market share in Broadband.
Gogo's Value Proposition
With internet connectivity now an expectation of daily life, commercial airlines are seeing significant demand for internet connectivity. An example for the commercial aviation market is a statement from Doug Parker, CEO of US Airways Group, who stated "We have a lot of anecdotal evidence, including ourselves, of people switching airlines because of whether or not there is there is Wi-Fi on the airplane or not." The importance of connectivity is further illustrated by a Gogo commissioned survey, 70% of our users are likely to recommend Gogo Connectivity to others and 33% of Gogo users indicated they are likely to switch airlines to be on a Gogo-equipped flight. According to a separate Gogo survey, 23% of Gogo users changed their flight plans to be on a flight with in-flight internet. In 2012 Egencia survey, 70 percent of North American respondents and 72 percent of European respondents cited mobile device/functionality as important or moderately important to their travel programs.
In the business aviation market, this desire for connectivity is illustrated by a statement from Alex Wilcox, CEO of JetSuite, who stated "We know people pay more for Wi-Fi equipped airplanes."
The In-flight Connectivity Market Opportunity
According to Gogo s listing prospectus, in 2012, commercial aircrafts carried 2.97 billion passengers, with 736 million of those passengers in the US. In that same year, approximately 32% of commercial aircraft in the North American market and approximately 12% of aircraft in the global market were equipped to provide connectivity to passengers in 2012. Gogo is the leading brand with an 81% market share in the commercial internet connectivity segment. According to Gogo s Q3 2013 quarterly report, only 5.8% of total passengers on Gogo's flights connected to the internet. In 2012, less than 1% of total global commercial aircraft passengers connected to the internet. With consumers expecting and demanding internet connectivity in all facets of their lives, there is a huge opportunity for Gogo.
Gogo also has a significant opportunity in the business aviation business. According to Bombardier, between 2011 and 2021, 9,800 business jets will be delivered, representing a 5.1% growth rate. Given the growing importance of in-flight connectivity for business users, the vast majority of these jets will have in-flight connectivity.
Why Buy Gogo Now?
First, Gogo is best positioned to take advantage of the opportunity. Gogo is already the market leader for in-flight connectivity. Gogo's offering is much cheaper than competitors. Deutsche Lufthansa (OTCQX:DLAKY) has installed 80 of 105 long haul aircrafts with its FlyNet in-flight connectivity system quoting an installation cost of $450,000. Gogo's cost of installation is only $100,000. Gogo's fee for connectivity to the customer is also cheaper at $14 per 24 hours compared to $26 per 24 hours for Lufthansa s FlyNet. The cost advantage for both carrier and customer should increase as Gogo increases its install base as fixed costs are spread over a much larger sales volumes creating a sustainable competitive advantage.
There is also seems to be difficulty maintaining an in-flight connectivity system. Airbus sold its 33% stake in OnAir, one of the largest in-flight connectivity providers. Boeing (BA) dropped a similar program called Connexion in 2006. Australia's Quantas stopped its in-flight broadband project in December 2012 provided by OnAir due to weak demand as its commercial attracted less than 5% of passengers. Gogo is seeing similar connectivity rates or the percentage of total passengers connecting to the internet. During Q3 2013, Gogo reported a connectivity rate of 5.8%.
This connectivity rate should increase as internet speeds increase and the transition between ground connectivity and in-flight connectivity becomes seamless. Currently, Lufthansa offers bandwidth of 6Mbps and Gogo offers 3 Mbps compared to typical bandwidth of 25Mbps in New York City. Gogo is upgrading its offering in Late Summer 2014 with an expectation of 70Mbps bandwidth. This should do a great deal to increasing adoption levels and increasing connectivity rates.
Second, Gogo is expanding its product offering. On November 8, 2013, Gogo announced it will offer in-flight talk and text. To use Gogo Text & Talk, passengers will be required to download an App from the Apple App Store or Google Play. Once passengers have the App, they will be able to send and receive text messages via Gogo's in-flight Wi-Fi system.
Gogo is also expanding their international operations. On October 28, 2013, Gogo stated it would partner with Japanese Airlines to provide in-flight connectivity for their domestic flights. This is a huge opportunity as only 12% of airlines provide in-flight connectivity compared to 32% in the US. Many airlines have announced rollouts of in-flight connectivity including Air France-KLM, Russian airline Aeroflot, and Nippon Airways (OTCPK:ALNPY). As more airlines offer in-flight connectivity, it will become a must to provide this service otherwise airlines will be at a significant disadvantage if they do not.
Third, the FAA recently relaxed regulations on Portable Electronic Devices allowing customers to use their PEDs throughout the whole flight. All major US airlines are expected to comply by the end of 2013. This should be a big driver of connectivity rates as customers continue to use their devices throughout their trip without any disruptions.
Finally, on November 11, 2013, Gogo announced strong Q3 2013 results with revenues up 48% year on year, from continued adoption of Gogo's product, higher connectivity rates and higher spending per passenger as well as positive EBITDA despite heavy investment costs
What is this opportunity worth?
To value the Gogo's opportunity, The Focused Stock Trader looks at 2 key value drivers including total market size and Gogo's market share.
Looking at Gogo commercial opportunity, according to Companiesandmarkets.com, in 2011 the global in-flight Wi-Fi market reached $225 million and will further increase to $1.5 billion in 2015 representing an annual growth rate of 60%. At the end of 2011, Gogo had 71% share of the global in-flight Wi-Fi Market. The Focused Stock Trader assumes Gogo market share decreases from the 2011 market share of 71% to 50% market share in 2015, as competitive pressures increase. In 2015, Gogo will have total revenues of $750 million representing an annual growth rate of 47%.
The Focused Stock Trader values Gogo using an EV/Sales figure. The EV/Sales multiple is the appropriate valuation method as Gogo is investing heavily for future profitability which is dragging down current profitability. Gogo's lack of profitability is very typical with early stage technologies such as in-flight connectivity. The chart below illustrates sales and profitability relative to the product life cycle.
The introduction phase lasts until the growth stage when the mass market adopts. This mass market adoption typically starts at a 15% penetration rate. In-flight connectivity is currently at a 12% penetration rate. Gogo's sales and profitability are typical for the stage of the product. This is the stage when sales and profitability grow at a very rapid pace.
To identify the appropriate EV/Sales multiple to apply, The Focused Stock Trader uses the average EV/Sales multiple of internet companies over the past 5 years. The chart below illustrates the average EV/Sales figure for all listed internet companies.
Using an average multiple of 6.53x on 2015 sales of $750 million leads to an Enterprise Value for Gogo of $4.9 billion. Given historical investment rates, Gogo will have a net debt position of $386 million at the end of 2015 leading to an Equity Value of $4.512 billion or a 2015 target price of $53.66 per share. Discounting the 2015 target price per share of $53.66 at a discount rate of 15%, which is double the rate of the highest quality companies, leads to a target price per share of $40.57.
GOGO has been on a tear since mid August having tripled in price in about 90 days! Just since last week its exploded from near 17 to 28.50 today and has now reached a short term oversold condition near the top of it intermediate up channel. However because of its very strong momentum we would look for any periods of pullback/retest for better entry opportunities because we feel that technically GOGO appears destined to move higher and we're projecting prices n the mid 30's ,then low to mid 40 over the next weeks and months
Gogo is the clear market leader of an industry that could be worth more than $1.5 billion in 2015 and is growing at 60% per year. Given Gogo's market position, they have a tremendous opportunity to take advantage of their first mover advantage and create a gap between themselves and their competitors.
Note: I have been assisted in writing this article by Marc Melendez.