Gogo Has Tremendous Potential Upside: Taking Advantage Of The Selloffs

| About: Gogo (GOGO)

Summary

Market is significantly underpricing Gogo because of its reputation.

GOGO is worth $19.62 without taking into account its biggest opportunity.

The DCF valuation shows that the company is 82% to 137% undervalued.

Click to enlarge

Image Source: Gogo's website

Gogo (Gogo) has a long perception of being a "speculative" and high-beta stock. Momentum traders love to move the stock around and the stock price can swing violently in one direction or the other. Recently, due to the global selloff, Gogo is at risk of reaching its all-time lows again. In this analysis, I model Gogo's future cash flow and show investors that Gogo is severely underpriced at the moment.

Cost of Equity

There are two methods to estimate the cost of equity. One method uses CAPM, and the other one uses risk premium and cost of debt.

I like the risk premium and cost of debt method because it is more reliable and less fluctuate.

Cost of debt

In Gogo's most recent 10Q, the company discloses that their interest expense for their Tranche B-1 loan and Tranche B-2 were 11.25% and 7.5%. Its debts are issued in the earlier stage of its development when the capital market was not as available to Gogo as it is now. That being said, I will still use 11.25% as the cost of debt in the model.

Risk Premium

The risk premium that I used in this case is 5%, I think 5% is a good figure to justify the risk for the shareholders.

The estimated WACC

Cost of debt 11.25% Debt 576.6 Debt 33%
Cost of equity 16.25% Market Cap 1180 Equity 67%
WACC 14.61%
Click to enlarge

Assumptions

Growth for 2016-2020

I estimate different growth speeds for different sectors in Gogo.

North America Business Aviation (NA-BA) is the most mature product in Gogo product portfolio, and it is currently growing at 10% YoY. The revenue for the nine months ending September 2015 is 129 million. I estimated that the growth rate will continue to be 10% for the next five years and 4% forever thereafter.

North America Commerical Aviation (NA-CA) contributes to approximately 65% of Gogo's revenue in the nine month ending 2015. The revenue has grown around 25% YoY to 227 million in the nine months of 2015. I estimated that the growth rate for the next five years will be around 15% because of their technology roadmap and upgrades. Afterwards, it will be 4% forever like NA-BA.

The international market: Commerical Aviation-rest of the world(CA-ROW):

This segment is still in its initial startup stages. Any estimates will be very rough but the company did gave some guideline in their Q&A session. The CA-ROW segment has already received enough backlogs(which is 550 aircrafts) for it to break even and the installation is likely to take another 2-3 years. Currently, the ROW loss is 56.2million in the nine months ending September 2015.

It is very hard to model revenue for the NA-ROW segments using DCF models. I use the average revenue per aircraft (ARPA) and the number of estimated aircrafts in the rest of the world market instead. All the figures are provided by the management team. The average monthly revenue per aircraft is around $11,000. But the management mentioned an upgrade from ATG4 to Ku would increase the ARPA of around 30%.

Therefore a conservative ARPA estimate for 2Ku technology for the ROW segment would be:

ARAP $ 11,000.00
Year ARPA $ 132,000.00
ARPA increase with 2Ku 30%
With 2Ku upgrade $ 171,600.00
Click to enlarge

Click to enlarge

Source: Company Presentation

I talked about this market in my other article about Gogo. Currently Gogo has around 12.5% of the total connected commercial aircrafts in rest of the world. I created three scenarios under the assumption that 50% of the market are saturated in 2020 and beyond: 1) Gogo sustained their current market share of 12.5% 2) Gogo increased their market share to 20% 3) Gogo increased their market share to 30%.

I believe the above market share assumptions are very conservative considering Gogo currently has 80% of the market share in NA with technology two to three years ahead of its competitors.

Beyond 2020, I assume that the growth rate will be 4% forever like in other segments.

Profit margin

NA-BA's profit margin's will be assumed to continue at the current run rate of 40%.

NA-CA's profit margin's will continue to trend upwards. The company said on their earnings call that the profit margin for its NA-CA will like converge to where NA-BA is. To be conservative I assume that it will reach 35% by the end of 5 years, and stay there forever.

Click to enlarge

Source: Company Presentation

CA-ROW:

The profit margin for ROW is likely to be lower than NA-CA and NA-BA because the variable costs for satellites is significantly higher than the current ATG system that NA-CA and NA-BA have. I assume that the profit margin will be around 25% in 2020.

All the profit margin estimates does not include depreciation and CAPEX. But the company estimated that the total cash CAPEX is around 100 million a year which I will add back at the end and I assume CAPEX will also grow at 4% forever.

Valuation

NA-BA:

2015 9 months 2016 2017 2018 2019 2020 Terminal Value
129 Revenue 189.2 208.12 228.93 251.83 277.01 FCF 110.80
2015 FY estimated FCF 75.68 83.25 91.57 100.73 110.80 Growth 4%
172 WACC 14.61%
Profit Margin Terminal Value 1044.45
40% PV FCF 66.03 72.64 89.66 100.42 110.75 PV FCF 528.20
Total PV 967.70
Click to enlarge

NA-CA:

2015 9 months 2016 2017 2018 2019 2020 Terminal Value
227 Revenue 363.2 435.84 523.01 627.61 753.13 FCF 263.60
2015 FY estimated Profit Margin 23% 26% 29% 32% 35% Growth 4%
302.6667 FCF 83.54 113.32 151.67 200.84 263.60 WACC 14.61%
Profit Margin Terminal Value 2484.70
20% PV FCF 72.89 98.87 148.50 200.21 263.48 PV FCF 1256.57
Total PV 2040.52
Click to enlarge

CA-ROW:

Scenario 1 in mms 12.50% Scenario 2 in mms 20.00% Scenario 3 in mms 30.00%
Number of aircrafts 3525 Number of aircrafts 5,640 Number of aircrafts 8,460
ARPA $ 0.17 ARPA $ 0.17 ARPA $ 0.17
Revenue $ 604.89 Revenue $ 967.82 Revenue $ 1,451.74
Profit Margin 25% Profit Margin 25% Profit Margin 25%
FCF $ 151.22 FCF $ 241.96 FCF $ 362.93
Terminal Value Terminal Value Terminal Value
FCF 151.22 FCF 241.96 FCF 362.93
Growth 4% Growth 4% Growth 4%
WACC 14.61% WACC 14.61% WACC 14.61%
Terminal Value $ 1,425.45 Terminal Value $ 2,280.72 Terminal Value $ 3,421.08
PV FCF $ 720.88 PV FCF $ 1,153.41 PV FCF $ 1,730.11
Click to enlarge

All of the company's information is taken from the company's SEC filings, presentations or my own estimates.

Results:

Scenario 1 Scenario 1 Scenario 1
NA-BA $ 967.70 NA-BA $ 967.70 NA-BA $ 967.70
NA-CA $ 2,040.52 NA-CA $ 2,040.52 NA-CA $ 2,040.52
NA-ROW $ 720.88 NA-ROW $ 1,153.41 NA-ROW $ 1,730.11
Total $ 3,729.10 Total $ 4,161.62 Total $ 4,738.33
Tax rate 35% Tax rate 35% Tax rate 35%
After Tax $ 2,423.91 After Tax $ 2,705.06 After Tax $ 3,079.91
CAPEX $ (90.41) CAPEX $ (90.41) CAPEX $ (90.41)
Net Debt $ (178.00) Net Debt $ (178.00) Net Debt $ (178.00)
Equity $ 2,155.50 Equity $ 2,436.65 Equity $ 2,811.50
# of shares 86 # of shares 86 # of shares 86
Value per share $ 25.06 Value per share $ 28.33 Value per share $ 32.69
Click to enlarge

Under the current model, Gogo has an upside ranging from 82% to 137%. The valuation of its NA-CA and NA-BA operations alone is worth as much as $19.62.

Conclusion:

I believe currently the market is significantly under pricing Gogo due to technical factors. Gogo is loved by momentum traders and most of the shares are owned by either institution or insiders. The stock swings violently, and because of the recent sell off it is reaching its all-time lows again. With the fundamentals intact and a bright future ahead, Gogo, with the current pricing, represents a tremendous opportunity for long-term value investors who can weather the storms.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GOGO over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.