An In-Depth Look at the Globalstar IPO

On October 27, Bill Simpson wrote an analysis of Globalstar, Inc. (GSAT). GSAT shares priced at $17 a share on November 2. The text of Mr. Simpson's original writeup follows:

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Globalstar plans on offering 7.5 million shares (assuming over-allotment) at a range of $16-$18. Wachovia and JP Morgan are joint book runners, Jefferies co-manager. Post-offering GSAT will have 82.5 million shares outstanding for a market cap of $1.402 billion on a $17 pricing.

The outstanding shares number includes shares yet to be purchased. GSAT for funding purposes has made a deal with Thermo Funding Company for Thermo to purchase a little over 12.4 million shares by 12/31/11 at a fixed price of $16.17 per share. Thermo Funding may purchase these shares at any time regardless of GSAT stock price. 180 day lock-up period applies to any purchases. Thus far, Thermo has purchased just under 1 million shares. It does not appear that Thermo must purchase these shares, just that they've a right to if they desire. Obviously if at some point GSAT's share price is well above $16.17, Thermo Funding will be purchasing these shares. If below, they will not.

This is really not ideal for new shareholders as it presents a pretty significant potential future stock price drag and shareholder dilution on shareholders post-IPO. If Thermo fulfills their purchase, GSAT shareholders would be diluted 15%+. For this sort of deal, I would much prefer a longer lock-up then 180 days for these shares. That's not the case though -- Thermo will be free to sell any shares purchased at any time, 180 days from purchase. Also other insiders have the same rights as Thermo for just under 800,000 shares, which can be bought anytime until 12/31/11 at $16.17 a share. In order to give as accurate a picture of market cap, I counted all of these shares into current share count.

Entities of Thermo will own 70% of GSAT prior to these upcoming transactions. Note that while it appears Thermo will be paying near IPO price for 12 million shares going forward, the 70% they already own on IPO were essentially free shares. Thermo's full position in GSAT assuming they purchase all shares would be roughly $3 a share overall. This is even a bit more deceiving as Thermo will only be a purchaser of additional shares if they're already 'in the black' and trading over $16.17.

From the prospectus:

We are a leading provider of mobile voice and data communications services via satellite, with an estimated 10.2% share of global subscribers in the mobile satellite services industry in 2005.

GSAT is one of three satellite communications companies IPO'ing this week. GSAT operates 43 in-orbit satellites and 25 ground stations to offer wireless services where traditional wireless and wireline do not and cannot. GSAT provides voice and data communications services in over 120 countries. In operation since 2000, GSAT currently has 236,500 subscribers.

GSAT offers voice communications, 1-way data communications and 2-way data communications over 27.85 MHz. GSAT owns a global license for this frequency. GSAT also owns a license to operate over 'ancillary terrestrial components [ATC] in conjunction with their satellite services. GSAT's ATC component allows them to operate in dense urban areas and inside buildings. GSAT services only operate with equipment designed specifically for their network. Equipment includes the usual communications devices such as data modems and fixed & mobile phones.

History - Globalstar was founded in 1993 by Lorel and Qualcomm. Much like ORBCOMM, Globalstar borrowed heavily to launch their initial fleet of satellites in the late '90's. This story is very similar to the landbased fiber build-out of the late 90's. Globalstar (symbol GSTRF) IPO'd in 1995 and reached a high of $50+ in early 2000. By 2001, Globalstar was swamped in debt and a lack of revenues and customers. Unable to service the debt, Globalstar filed for bankruptcy in early 2002. The stock which had fallen below $1 ended up worthless. Creditors now own a chunk of the new Globalstar, while equity holders of the old Globalstar lost their entire investment.

GSAT has contracted with Alcatel to build 48 new satellites for GSAT by 2013. GSAT plans on launching these satellites as they are ready (they'll be delivered in 2 'batches' of 25 and 23). the total cost through 2014 is budgeted at $1 billion. GSAT plans on paying for this over the next 7 years through proceeds from this offering, a $100 million credit line drawdown, the $200 million stock purchases from Thermo Funding and through cash flows. GSAT anticipates approximately $600 million in cash flows over the next 7-8 years going towards these satellites. The bulk of the new satellites will be replacing current satellite constellation and GSAT expects these launches to provide service through 2025. Keep in mind that if GSAT has overestimated cash flows, a repeat of the original Globalstar could occur.

Also GSAT plans to heavily invest in their ATC network, apparently in an attempt to compete with existing wireless companies. GSAT expects this to cost $2-$3 billion and anticipates a future joint venture to accomplish this.

GSAT largest market/customer group are US federal, state, and local government. US government entities accounted for 15% of 18 month revenues ending 6/30/06.

Key competitive strengths are the ability to operate inside buildings and in areas shielded from the sky. Also GSAT believes their global license provides an edge as well. Also GSAT is the only satellite network operator currently using the patented Qualcomm Incorporated CDMA technology. Not so coincidentally Qualcomm is the only GSAT compatible manufacturer for voice communications working on GSAT's network.

Competition
GSAT expects newer satellite competition from Iridium, ICO and TMI all three of which have 2G satellite licenses. The big threat to me though is the advances being made in traditional wireless coverage areas. This is the real threat in my opinion. As the branded wireless companies continue to expand their service areas into rural and mountain regions, the possibility exists for a lessening in demand for GSAT's services. GSAT has positioned themselves as an operator of wireless voice/data services for places not traditional serviced by the branded terrestrial wireless entities. With billion in capital expenditures on GSAT's horizon, they could potentially be in some trouble if the wireless services expand into GSAT's 'turf.'.

Financials
Factoring in future stocks sales to Thermo and the additional debt coming on and planned capital expenditures: No cash and $150 million in debt. Note that GSAT will have $5 a share in cash just after offering. All of this cash however is committed to Alcatel for replacement satellites. Note that even though the debt levels are not all that high, the annual interest rate here is a lofty 11%. It would appear after this business model resulted in bankruptcy a few years back, GSAT will have to pay through the nose to borrow going forward.

There were material weaknesses found in GSAT's audited 2005 statements. These appear to be a bit more serious then the usual. The usual these days being that small companies coming public just didn't have enough accounting staff on hand through the fast early growth stages. GSAT's issues appear more related to internal inventories and receivables, two areas I do not ever like seeing internal control deficiencies being reported.

Revenue have grown steadily since the bankruptcy. $84 million in 2004, to $127 million in 2005 to an anticipated $150 million in 2006. That would put 2006 revenue growth at 15% or so. Note however that the bulk of the growth here is from equipment sales. Direct costs to Qualcomm for this equipment grew at a faster rate then equipment sales growth. In other words, it appears there is a chance here that this is not actual equipment sales growth. GSAT lost money on this increased equipment revenue through first 6 months of 2006 - They're paying Qualcomm more for this additional revenue then they sold the products for.

2005 - Gross margins were 50%. Operating margins were 17%. Unfortunately pro forma debt(the debt that will be taken on post-ipo) would have eaten up 3/4's of operating earnings. Net margins were 3%(again factoring in planned future debt levels). Earnings per share were $0.05. On a pricing of $17, GSAT would be trading 340 X's trailing revenues.

2006 - through first 6 months it appears GSAT will grow revenues roughly 15% to $150. Much of that growth is due to equipment sales. This growth is sketchy to me as expenses to Qualcomm for these revenues increased faster. GSAT buying revenue growth ahead of IPO? This shows in gross margins, which dipped first 6 months of 2006 to 43%. Operating margins declined all the way to 8%. Factoring in future debt levels, GSAT will show a loss in 2006. Due to a tax benefit pre-IPO, GSAT will actually book a nice bottom line number in 2006, but don't be fooled. GSAT appears as if they're set-up to post a loss or breakeven number for 2007 based on '06 operations.

A very complicated internal structure here with a bunch of deals with major holder Thermo and former co-founder Qualcomm. I'm always leery when there are so many deals internally and with closely related partners. This is one of the more convoluted deals in this regard I've seen in a while.

Conclusion

A number of things I don't care to see:

1) Too many convoluted internal/external deals.
2) A very aggressive market cap based on revenues. GSAT on a $17 pricing will be trading nearly 10 X's 2006 anticipated revenues. This for a data/voice communications provider. Sprint for example, trades under 1 X 2006 revenue.
3) this business model has previously gone bankrupt. Yes the plan is a bit different this time, although it would appear to me GSAT's cash flow projections the next 7 years are a bit aggressive.
4) the annual debt interest rate is steep here, showing an unwillingness of bans to lend to this model.
5) the operating margins and earnings don't really justify the current market cap. GSAT has a lot of growing to do to justify initial in-range pricing market cap.
6) This big one: 2nd time around for this company. The first time around they loss stock investors 100% of their investment.

In a world full of stocks, why buy one that lost previous investors everything they invested? Pass.