In-Flight Cell Phone Call Ban Proposal: How To Take Advantage Of It

| About: Gogo (GOGO)

Summary

A bill put forward by U.S. aviation authorities could see an existing ban for cell phone calls on interstate flights become law.

There are two potential outcomes that could occur if it becomes law: Airlines could go on like business as usual or they could review their current business practices.

Two potential beneficiaries would be Gogo Air and Global Eagle Entertainment, as airlines could adopt their technology as a means of effectively enforcing the new legislation.

I outline my reasons why I believe GOGO offers superior exposure to this opportunity compared to ENT based on financial analysis and analyst estimates.

Background

On Feb. 3, a lengthy Federal Aviation Administration Reauthorization bill called the Aviation Innovation, Reform, and Reauthorization Act was announced by the chairman of the House of Transportation and Infrastructure Committee. If you are interested in seeing the bill for yourself, you can check it out here:

The majority of the bill's content is fairly dull and uncontroversial and it has essentially been put forward in order to renew the FAA's authority for the next six years. However, there are several new changes being proposed which are summarized at the beginning of the bill, as shown in the image below.

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Source

The focus of this article will be on the 'other purposes' section of this bill, which is the ban on cell phone communications in flight. This article will cover:

  1. What is the new legislation and how will the airlines react?
  2. Which companies stand to gain from this potential cell phone call ban legislation? and finally;
  3. From those companies who stand to gain, in which company should you invest?

In-flight cell phone ban proposal

The exact phrasing and location of the proposed legislation can be found on page 237 to 238 of the bill and is as below:

Source, p. 237-238

As you can see above, this legislation is regarding 'voice communication' only, so it is quite clear that the purpose is to prevent air passengers from talking on their cell phones during flights. There are two reasons why this is beneficial;

  1. It ensures that passengers won't be disrupted unnecessarily by others during their flight, and, most importantly;
  2. It eliminates a safety and security risk. Flight attendants have said that there are instances of violent confrontations erupting on-board flights as a result of others physically engaging talkative passengers. There are also many other additional security concerns which will be addressed in more detail below. Source


Could this situation turn into a brawl? Flight attendants say yes.

This propensity for confrontation makes sense when you consider the fact that U.S. flight passengers have a particularly negative view on cell phone use on flights. According to Delta (NYSE:DAL) vice president in comments filed with regulators:

U.S. customers aren't so tolerant [of in-flight calls compared to other countries]. Delta, in a survey, found 64 percent of its customers viewed the potential for phone calls negatively.

Source

Another spokesman for Delta also added:

Voice communications, or voice calls, in a confined space such as an aircraft is simply something our customers do not want.

Source

Finally, an article published in the Huffington Post also echoes similar sentiments about the potential for harm:

Congress is also getting into the act. Lawmakers are pushing legislation to require transportation regulators to implement a ban on the calls. Echoing some travelers' concerns, the Transportation Department said in its notice... that it believes allowing passengers to make cellphone calls "may be harmful or injurious" to other passengers.

Source

How would codifying the existing ban through legislation change the current situation?

I will try to be as crystal clear as I possibly can to avoid confusion. If this section of the bill does eventually pass into law, it is very difficult to predict how airlines will react. I see two potential outcomes:

Outcome 1: Nothing changes

No review by airlines is undertaken, airlines don't change any of their practices or attitudes toward the existing ban and they treat the new law as a means of simply codifying what has always been. Essentially, the status quo is maintained. A spokesperson for the company OnAir, for example, downplays the issue:

We haven't heard of a single complaint about people making calls... An aircraft is a noisy environment, so the sound of a conversation doesn't carry very far.

Source

Outcome 2: Action is taken to readdress the issues outstanding

Because this section of the bill has been put forward due to safety and security concerns, airlines will review their current policies and procedures once the bill is passed into law. This review would take place because, ever since 9/11, airlines are continuously updating their policies regarding the safety and security of their passengers upon its vessels. The new law could therefore prompt airlines to investigate methods of more effectively enforcing the pre-existing ban.

Airlines which minimize all possibilities of violence and maximize the safety of all on board would be viewed as fulfilling their duty of care. When we consider the words of a spokeswoman for the Association of Flight Attendants union, this duty of care has become increasingly more apparent:

Allowing passengers to use cellphones during commercial flights will add unacceptable risks to aviation security, compromise a flight attendant's ability to maintain order in an emergency, increase cabin noise and tension among passengers and interfere with crew members in the performance of their duties as first responders in the cabin.

Source

What's the probability between outcomes 1 and 2 occurring?


Heads or tails?

How airlines will choose to react to this legislation is impossible to predict with absolute certainty. Therefore, the best we can do is attempt to make an educated guess as to the probabilities of each outcome occurring. To me there appear to be just far too many security issues still outstanding that have all been recently touched upon in the press. I, therefore, do not believe that this bill has merely been put forward for the purposes of 'codifying' the existing ban, but rather to address legitimate concerns in the industry.

Personally, I put the odds of outcomes 1 and 2 occurring at roughly 50% each - or a coin flip, based on what I have presented thus far. If outcome 1 occurs, this issue isn't even worth thinking about and it won't have any material impact on airlines or their suppliers. However, with outcome 2, I can foresee see a significant impact to some companies if airlines begin to implement new procedures.

What would be the impact of outcome 2?

If outcome 2 were to occur, I think it is reasonable to assume that airlines would look more closely at the alternative communication methods that they could offer to their passengers. Why would they do this? Because with an alternative communication system in place, the instances of phone calls in flight by passengers would be reduced and this in turn reduces the chance of the security issues already outlined above. Such an outcome would be in line with the intent behind this potential new legislation that would codify the pre-existing ban.

To illustrate, let's consider an example. Perhaps the family member of a particular passenger on board a flight has fallen ill or perhaps there is some other emergency that requires their attention. In such instances, it would be unreasonable to expect the law to be effectively enforced upon this passenger if no viable communication alternative is offered to them by the airline. They will, therefore, likely go ahead with the phone call anyway which carries with it all the potential security issues already outlined above.

Finally, there is also the possibility that airlines could ban all cell phones on flights outright in order to ensure compliance; however, I think this measure would be far too drastic and has a very low likelihood of occurring.

What is the communication alternative?

If airlines are serious about reducing all instances of in-flight calls to an absolute minimum, they must offer their passengers the only viable remaining alternative: Typing messages through in-flight Wi-Fi. This proposal would, therefore, be of immense benefit to companies that provide this technology as potentially every passenger aircraft in the U.S. would need to be outfitted to handle the hardware as shown in the image below.

Click to enlarge

Source: Gogo Air website

Not only this, there is a logistical component associated with managing and maintaining this hardware, again as shown below:

Click to enlarge

Source: Gogo Air website

There are 2 companies that specialize in providing these services, Gogo Air (NASDAQ:GOGO) and Global Eagle Entertainment (NASDAQ:ENT). For those that think outcome 2 and its impact is likely to occur, the question boils down to this: In which company do you invest, GOGO or ENT? By analyzing the financial statements and analyst consensus figures for both companies, I believe the answer is GOGO.

GOGO vs. ENT, a side by side comparison

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Market Cap, EV & Performance

First, a bit of perspective is in order. Both GOGO and ENT have underperformed the S&P 500 to the tune of 40% to 43% over the past 2 years as shown below. This deep retrace, therefore, offers investors the chance to enter this growth story at a more reasonable price.

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GOGO and ENT are both of similar market capitalization and equity value, with GOGO at $1.12bn market cap/$1.31bn EV, and ENT at $731.8mn market cap/$586.0mn EV. Because of this similarity in their size, comparing their financial ratios is immensely beneficial.

Liquidity

Liquidity

Quick

Current

Cash

GOGO

1.71

1.95

1.39

ENT

1.62

1.89

1.13

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Source: Financial statements

As you can see from the table above, both companies have adequate short-term liquidity as indicated by their quick, current and cash ratios, so there are no problems on this front.

Profitability

Profitability

G.P. Mar

Oper. Mar

N.P. Mar

ROA

ROI

ROE

GOGO

48.72

-12.40

-20.70

-11.16

-10.67

-62.30

ENT

27.30

-9.54

-14.80

-4.16

-7.77

-7.22

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Source: Financial statements

This is where both companies begin to differ. GOGO has almost double the gross profit margin of ENT. This is not just a one-off occurrence. The chart below illustrates this relationship has held each of the past 3 financial years. Not only this, but analyst estimates for the 2016 year also show that this trend is expected to continue. Such a huge gross profit margin for GOGO relative to its closest competitor is strongly indicative of a durable competitive advantage.

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Source: Financial statements, consensus analyst estimates

Furthermore, as illustrated below, quarter-on-quarter revenue growth shows that GOGO has been outperforming ENT quite convincingly in terms of its consistency. Although ENT was able to grow revenues both rapidly and consistently from FY13-14, revenue growth has begun to struggle and stagnate since that time. GOGO's quarterly revenues, on the other hand, have seen consecutive revenue growth every quarter since 2012. Analysts also expect this trend to continue over the following 2 quarters.

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Source: Financial statements, consensus analyst estimates

Financial Leverage

Leverage

Debt to A

Debt to E

Int Cov

Cap Ratio

GOGO

40.68

157.90

-1.55

60.42

ENT

0.57

0.96

N/A

0.72

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Source: Financial statements

ENT is clearly superior on this front as it has a cleaner balance sheet. Although GOGO has $388mn in cash and equivalents, it is carrying $576mn in debt, compared to ENT which has $218.1mn in cash and equivalents with 72.3mn in debt. Flexibility in ENT's balance sheet can be used to fund future growth, but GOGO is already stretched. Negative interest cover is obviously not a good sign.

Valuation and Cash flow

EV/EBITDA for both GOGO and ENT have remained fairly similar over the past 6 months and are now both sitting just under 40, which is almost half of what they were 6 months ago, as shown below.

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Source: Financial statements, consensus analyst estimates

Free cash flow for both companies have remained negative over most quarters, as capital expenditures for both companies remain high, as shown below. GOGO's quarterly free cash flows, however, seem to be trending with an upward trajectory.

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Source: Financial statements

GOGO's operating cash flows have been positive for 6 consecutive quarters and also appears to be trending upwards, as shown below. According to analyst estimates, this trend is also expected to continue. ENT, on the other hand, has struggled to achieve consistent positive operating cash flow over the same period of time. GOGO is, therefore, able to fund some of its CAPEX requirements out of its operating profits, but ENT will likely need to tap its cash reserves and begin chewing into its healthy balance sheet.

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Source: Financial statements

The winner: GOGO

Based on the financial analysis above, I prefer GOGO over ENT. I will stress, however, that ENT is a "safer bet", and this is because ENT has more flexibility in its balance sheet due to the cash on its books and lack of debt. GOGO is restricted in this regard, and a capital raising to bolster its balance sheet may eventually become a necessity. However, I believe these concerns are more than offset by GOGO's:

  • Massive gross profit margin which has consistently been almost double that of ENT's. This is strongly indicative of a durable competitive advantage;
  • Consecutive quarter-on-quarter sales growth since 2012, which is truly remarkable, and;
  • Positive operating cash flows, which can be used to fund future growth and capital expenditures.

Conclusion

  • A new bill means that in-flight use of cell phones for calls could be potentially legislated against in the U.S. and would codify the existing ban already in place.
  • There are two foreseeable outcomes that could occur if this section of the bill becomes legislation: Airlines will either maintain the status quo or be prompted to improve their systems.
  • The potential beneficiaries of this legislation are GOGO and ENT. In order to effectively enforce the legislation, the adoption of their technology by airlines will become essential.
  • After a side by side comparison of ENT and GOGO's financial data and forecast earnings, I prefer GOGO. However, ENT, although inferior to GOGO, is a safer bet due to its flexible balance sheet.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.