5.727% YTM 05/13/2015
EchoStar Corporation (SATS) develops, designs and distributes hardware for satellite TV media. Most notably is the TV set top receiver which enables consumers to watch, record, and order programing via satellite transmission. In the beginning of 2008, EchoStar became two entities. This was viewed as a means to split satellite TV marketing and distribution from the hardware and signal infrastructure in EchoStar. DISH Network (DISH) is currently EchoStar’s main customer with contracts signed through 2012. Charlie Ergen Chairman of the Board of EchoStar Corp and founder, is also the Chairman and Chief Executive Officer of DISH Network. The companies do not have ownership in each other, even though Mr Ergen is a significant stock holder, along with running both companies. However the companies do use each other as there main suppliers.
At Durig Capital, we have developed a process to review, select, purchase and monitor corporate bonds on an ongoing basis. Enclosed is our review, along with supporting documents/links, showing why we believe EchoStar corporate bonds make sense in clients’ portfolios. We reviewed thousands of separate corporate bond listings to find what, we believe, is currently the best corporate bond for investors. The following illustrates our selection criteria.
Step 1 - Yield Curve at 4-7 Years Out.
Investor sentiment has seemed to take an uptick with the change in the calender month but we are still apprehensive of long term economic policy. Having a cloudy long term outlook has kept our radar focused on this limited maturity range. Although we are targeting the 2015 issue, one of the inputs we liked about EchoStar is that it has five different shorter term maturities to offered investors. The four to seven year time frame puts maturities between 2014 and 2017/2018. EchoStar has three different issues floating that mature in this time frame with each offering a yield to maturity of at least 5%. The one year issue is not on our radar but still does offer a yield to maturity of 2.124% which is 187 basis points higher than a similar treasury. The one and three year maturities also assist with the visualization of the the yield curve as discussed in more depth later.
Step 2 - We like companies that are profitable.
EchoStar had its has quarterly glitches even though most quarters it’s significantly profitable. So far in the calendar year 2010, they have earned $.36 per share. Accounting changes have been made and write offs taken creating negative earnings per share for the most recent quarter. Investors like to see positive earnings, as does Durig Capital, however what is important to look at is the drivers of those earnings. Year over year the revenue has increased 50% for the quarter and six month period. As important as revenue, is that the cash flow from operations has remained intact comparing it to previous years. Companies generating cash flow from operations will continue business operations because they are profitable.
Step 3 - We like companies with low long term debt to cash/short term investments ratio.
EchoStar has an excellent debt to cash ratio of .415 ($382,357million/$919,553 million). This means that they could pay off their debt twice over if they chose to. Of the $919.553 million that is classified as cash/short term investments, $122.318 million is cash. They rest is made up of $312.630 million invested in variable rate municipal demand notes, $308,419 comprising corporate and government bonds and $176.186 million in what management has labeled and described as strategic speculative investments. Taking a more conservative view, removing the strategic speculative investments to mitigate some of the volatility of the holdings overall, still gives EchoStar a strong .514 ratio. Although this is an impressive ratio already and one shouldn’t include the following due to established guidelines, EchoStar has an additional $611.21 million worth of marketable securities classified as restricted.
Step 4 - We like companies that have flexible balance sheets
EchoStar has an attractive balance sheet. Total shareholders equity sums to $2,664 million and the debt on hand is $803.218 million meaning a debt to equity ratio of .30. This gives EchoStar an advantage if they were in a position that they needed to raise capital. They currently are involved, plaintiffs and defendants, is a couple law suits. The largest is litigation filed by TIVO (TIVO) about patent infringements. This has been lingering since 2004 and a final decision is expected in early 2011. At Durig Capital we believe that the stock markets are efficient. This means that all the positive and negative information about firms such as the close and intertwined relationship with Dish and the lawsuits have been factored into Echostars stock market value. Information flows freely and thus the market cap, $1.6 billion, reflects the value of EchoStar with the above issues and information.
Step 5- We like companies with strong coverage ratios.
Looking at EchoStar’s last quarterly report, there are a couple interesting ways to look at coverage ratios. First, they generated $31.313 million of net income. The net income cover interest expense ($10.206 million) about three fold. Second, their EBITDA, earnings before interest, tax, depreciation, and amortization, was $200.326 million for the six months ended June 30, 2010. For comparison reasons, the interest expense over the same time period, six months, was $21.801. This creates a superb ratio of just under ten meaning they make almost ten times on a EBITDA basis than they are obligated to pay. Finally, remember the $900 plus million that EchoStar has in cash and equivalents? This position had quarterly interest income of $3.8 million. This income partially offsets the interest expense.
Step 6 - We like higher yields in shorter time frames
Important Yield Forecasts
We recommend the issue with the yield of 5.727% and maturity of 2015. We are targeting this issue because it demonstrates the optimal return for clients in the EchoStar’s yield curve. The 2014 issue matures seven months before the 2015 issue and represent a 70 basis point less difference. One can see this on the chart below due to the steepening of the yield curve thus we believe the markets have miss priced the 2015 issue. EchoStar’s different maturities have the same underlying financial frame work so each issue would work well when filling in the rungs of a fixed income ladder giving the investor the option to pick and choose in order to fill their needs. We would recommend using several of the shorter maturities for proper infilling for portfolio laddering purposes. They received a rating of Ba3/BB-, which in our opinion gives them a much higher yield, which we investors are seeking. As for risk to principle, our common sense argument of being profitable, having good cash flow, low overall debt, and pile of cash would suggest that they do not deserve the lower ratings they have received.
Enclosed is a link to other high yield corporate bond offerings so you can conveniently compare EchoStar’s current yield to other similar rated issues.
Although each issue could fit into different opening portfolios currently have, we like the additional compensation due to the apparent miss pricing of the 2015 maturity. The lack of investment grade rating does not overly concern us due to the large amount of cash, strong balance sheet, good cash flow, positive earnings and superb coverage ratios. EchoStar has similar metrics to our previous bond reports such as Coventry Health Care (CVH), Seagate Technology (SPX), Expedia (EXP), Interpublic (IPG) and Unitrin (UTR), which have done quite well for are clients.
Yield to Maturity 5.727%
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Disclosure: Durig Capital’s is currently recommending this issues and it’s client’s currently do have positions in EchoStar’s bonds.