Investors who are long Iridium (NASDAQ:IRDM) are betting on the Company and/or its vendors executing on each of the following milestones in succession:
- Satellite construction: Thales Alenia and Orbital ATK will need to ramp from 12 vehicles in 'various stages' of production today (zero complete) to producing 6 satellites per month starting in July.
- Launch schedule: SpaceX will need to increase its launch cadence on the order of 2-3x the current ~1 launch per month while allowing Iridium to cut in front of other launches. A single launch failure ahead of Iridium (there are currently 44 on the manifest) would likely delay everyone by at least 4-6 months.
- Aireon funding: Aireon, Iridium's JV, will need to raise outside capital to fund $350 million of payments required by Iridium under its funding plan. It will need to convince a debt source to provide financing prior to being operational, and will need to get this third party to sign off on the use of proceeds, which are to be sent upstream to Iridium rather than be used to fund the business.
- Accelerated growth: In order to avoid a funding gap and justify the $3 billion investment in NEXT, Iridium must also see a dramatic acceleration in growth from under 1% in 2015 to 10-14% per year over the next 3 years (well in excess of market growth).
- Grow government business despite the DoD's new in-house capabilities: When Iridium signed its current 5-year contract with the DoD in October 2013, the government did not have a viable alternative for many of its satellite telecommunications needs. With the DoD's MUOS network operational, this will not be the case in the next negotiation. Iridium must retain and grow its DoD business in order to successfully delever the balance sheet as the government reasonably contributes more than 30% of EBITDA.
We believe Iridium is at risk of failing to meet each and every one of these milestones, as we will explain in the following pages. However, even if the Company were somehow able to meet these objectives, it would still only be generating $205 million of free cash flow under management's 2018 plan, which is then almost fully consumed by principal payments for 10 years and represents just a 6.6% yield to the fully loaded enterprise value of $3.1 billion. As such, we struggle to understand where long investors see upside in Iridium's stock, and if even one of these challenges is not met, the entire plan would be at risk with the potential for a restructuring that would result in Iridium's equity being rendered worthless.
In early July 2015, we published our short thesis on Iridium, and while the stock has traded down more than 25% since our initial report, we believe the market continues to misunderstand the growing operational and financial risks that imperil the Company. As anticipated in our July write-up, 2015 was another disappointing year for Iridium with sub-1% revenue growth and cash flow from operations increasing just 1.2%. Aireon, the Company's start-up joint venture aimed at providing a satellite air traffic control service, continues to have no clear path towards funding $350 million of payments being counted on under Iridium's funding plan. Iridium's launch vendor, SpaceX had to ground its Falcon 9 launch vehicle for six months following a launch failure last summer, zero NEXT satellites have completed construction and testing, and Iridium's first launch, planned on Dnepr, has been indefinitely postponed.
With the Company failing to meet expectations on all fronts in 2015, we believe that it is nearly certain that Iridium will approach its January 31, 2018, deadline for decommissioning its first generation satellite network without a fully deployed replacement constellation. The first generation satellites have been operating for 16 years and need to be decommissioned by this date in order to avoid the risk of having insufficient on-board fuel to physically deorbit the satellites in line with FCC requirements. Should the completion of NEXT extend beyond Iridium's target of "late 2017", the Company's existing constellation will be dissolved and service will be materially disrupted. We believe it is highly unlikely Iridium will meet its original target of year-end 2017 in light of the fact that: (i) there has now been at least a 16 month delay in the first launch (the entire launch schedule is now presumed to be compressed to 17 months start-to-finish vs. 33 months under the original plan), (ii) zero NEXT satellites have completed construction to-date and testing is inherently unpredictable (the Company blamed a 4 month delay last year on software glitches revealed during testing), and (iii) the revised launch schedule requires an unrealistic acceleration in launch cadence from SpaceX, Iridium's launch vendor.
Yet, against the backdrop of near-zero growth, launch delays, and no tangible progress with its Aireon venture, Management continues to insist NEXT will be fully deployed by year-end 2017 and 2018 guidance remains in reach. This would require Iridium to successfully transform Aireon from an idea into a real business while growing service revenue by 10-14% per year over the next 3 years (32-47% in the aggregate). Iridium is currently not gaining but losing its core voice and data commercial subscribers while its business with the U.S. government (currently >20% of revenue) is at risk following the launch of the DoD's own satellite network, Mobile User Objective System ("MUOS").
We believe Management understands it has no choice but to stick with its operational and financial guidance because acknowledging the reality of the situation would be catastrophic to the Company and cause the defection of partners, subscribers and investors. However, when assessing the reasonableness of these projections, we ask investors to consider the track record of this company in meeting expectations. We know of no other public company that has seen consensus EBITDA estimates get taken down more than 20% in five consecutive years (see Appendix), and we see no reason that this won't continue; growth has been disappointing because of the fundamental fact that terrestrial networks continue to expand and encroach on the limited use cases for Iridium's products. Industry participants have been forced to communicate unrealistic growth stories in an attempt to justify the multi-billion dollar capex investments that these projects require. Given the operational failings over the past nine months and our increased visibility into upcoming milestones (any one of which could derail the Company), we have elected to update our short thesis with a more detailed road map for how we believe Iridium will perform over the next 18 months.
In this report, we provide a detailed overview of our expectations for the near-term and long-term future of Iridium analyzing objective information independent of Management's promises. Up until now, long investors have shown a willingness to overlook 'short-term' disappointments because Management has repeatedly provided assurances that the Company remains on track to meet its long-term goals. Iridium's deadline for decommissioning its current network changes this dynamic; we have now reached the point where every near-term milestone carries added weight and progress against Management's 'long-term' guidance can finally be measured. In short, we believe there will be further material delays in launching NEXT, liquidity shortfalls, major service disruptions in the next two years with the inability to place the NEXT satellites in service before the first generation satellites are required to be shut down/de-orbited, and an extended period of no or low growth that, when combined, will render the Company unable to pay its required debt and capex. This creates a situation where its enterprise value does not exceed its debt and preferred stock balances making its common stock worthless. We believe that an independent analysis of these issues makes Iridium's troubled future capable of being fully understood today with a very high degree of confidence.
Elements of Management's Unreasonable Guidance:
Management Financial Guidance
Management has provided revenue guidance over the last 5 years which originally projected service revenue growth of 9-11% per year through 2015 (Company actually grew at less than 5%). Management now forecasts annual service revenue growth of 10-14% for the three year period 2016-2018 (service revenue grew 2.4% in 2015 driven solely by an escalating fixed-price government contract while total revenue grew at just 0.7% in 2015 and at a 1.7% CAGR over the preceding 4 years). Such a lofty growth forecast is a necessary requirement in order to project the payment of the capex and debt obligations for the $3.0 billion NEXT project. Even though the Company's current annual revenue growth rate is less than 1% in a declining satellite phone market, Management attempts to distract investors with "long-term guidance" through 2018, over which time the Company is expected to grow service revenue at an accelerated rate even though there is no basis for such an assumption.
Iridium also appears to be ignoring the threat from the DoD's MUOS system, which will be entering service this summer. After the U.S. DoD (Iridium's largest customer) spent $7.7 billion on this project, Iridium's DoD contract expiring in 2018 is at risk. MUOS uses a high capacity UHF system which provides superior service to Iridium's L-band services as it does not require direct line of sight to complete a satellite connection and can better penetrate vegetation and foliage. Built by Lockheed Martin, MUOS provides the military with its own mobile satellite network with expanded communication capabilities including simultaneous voice, video and data. Iridium's current DoD contract provides the Company at least $88 million per year or approximately 20% of the Company's annual revenue (and reasonably contributes in excess of 30% of EBITDA). In 2010, Scott Scheimreif, Iridium's Vice President, Government Programs, acknowledged the risk to Iridium's government business when the MUOS constellation is in service. "Does Netted Iridium go away once MUOS becomes operational? No. Eighty percent of DOD satcom use comes from commercial satellite providers. Whether it remains 80/20 or moves to 70/30 or 50/50 will be seen over time." However, it has been 6 years since we have seen the Company's Management disclose MUOS as a risk.
Because Iridium has no reasonable growth prospects in its core business, Management has been pressured to develop a series of programs outside of the Company's core satellite service offerings that are now included in guidance and projected to bring in hundreds of millions of dollars - not today or any time soon but in the future. Although the probability of success in these new businesses is very low, with little traction over many years, Management continues to aggressively advocate to the market that these opportunities are solid and will allow the Company to grow in order to meet its massive funding obligations. Management's current financial guidance is based on the below set of operational and financial assumptions:
As we explore below, the above launch schedule is not grounded in a realistic schedule for satellite construction and launches. We believe that clear, independent evidence leads to the conclusion that the Company will miss the in-service date for NEXT not by months but by years. Even under the fantasy scenario whereby Iridium is able to perfectly meet the launch schedule above, the Company has a massive undisclosed funding gap discussed below. Given this funding gap, the most important metric regarding future performance is operating cash flow (not Management's preferred "OEBITDA", a heavily engineered and largely irrelevant, made-up metric that does not serve as a good proxy for cash flow). Operating cash flow grew to only $217 million from $214 million, or 1.2% over the past year. Additionally, according to the Company's own disclosures, this mild growth was driven not by the Company's core revenue growth but by "changes in working capital requirements compared to the prior year".
The Company wants the market to believe that "paper commitment" payments from Aireon are secured. We explain below why assuming Iridium will receive hundreds of millions of dollars from Aireon is unfounded. In reality, we believe the Company's current growth rate is a fair approximation for future growth. Additionally, guidance has not only been massively aggressive over time but also vague and misunderstood even by the equity analysts who supposedly know the Company well. The fact that Management's guidance to grow at an accelerated pace through 2018 was not coming from its core business but takes into account speculative payments received by Aireon was a surprise to at least two equity analysts who asked for additional clarity on this point during the Q4 2015 earnings call. The Company's CFO, Thomas Fitzpatrick, had to clarify that Management actually is not "calling for a massive turnaround here" while CEO Matt Desch hinted that there may be more opportunities by adding "We're not projecting exactly what we'll be doing".
The assumptions underpinning Management's growth estimates are beyond aggressive. Even though Management has known or should have known the realistic timing for launching its NEXT constellation and could have offered more reasonable guidance, the Management team has preferred a communications strategy of providing only incremental bad news over extended periods of time regarding its satellite construction, launch timing and funding situation. When we analyze the evidence (separate from Management's guidance) underpinning what will most likely happen over the coming years, we believe the launch of NEXT will suffer further material delays. Even though the launches have been delayed multiple times including three delays over just the past year, Management has communicated frequently that it will complete all launches and replenish its constellation by the end of 2017. Although this guidance is completely unreasonable given the state of the Company's satellite construction and launch process (both discussed in this report), we believe Management has a strong incentive to mislead as its current satellite network can only be in operation until January 31, 2018.
NEXT Launch Schedule
Iridium plans to launch a total of 72 satellites on 8 launches through the end of next year. 7 launches of 10 satellites are planned to be launched using SpaceX and 1 launch of 2 satellites is expected to take place on Dnepr, a Russian-Ukrainian launch vehicle.
In our July 2015 report, we highlighted that delays regarding the launch of NEXT were "nearly certain" given the history of manufacturing problems with the Iridium project, the well-known geopolitical situation affecting the Russian launch vehicle and Ukrainian launch site selected for the Dnepr first launch, and the history of delays affecting similar projects including those launched by competitors Globalstar, Inc., Inmarsat Plc and O3b Networks. Nevertheless, Management remained outwardly confident that the first launch of NEXT would occur first by October 2015, then later revised its guidance to the end of 2015, then April 2016 and finally indefinitely postponed. In our July report, we expressed our strong belief that any 2015 launches were unlikely and predicted substantial further delays.
Iridium has repeatedly failed to meet its ever changing launch schedule. In 2014, the Company stated that they would begin launching NEXT in early 2015. Just one year ago, Management communicated that its first launch of Iridium NEXT would be in October 2015 aboard a Dnepr rocket, followed by a 4-month in-orbit test period to determine the efficacy of the new satellites. With this launch timing, Management claimed that the NEXT constellation would be fully operational by the end of 2017. The timing of the first launch on Dnepr was later delayed to December 2015 and then again to April 2016 and then abruptly and indefinitely suspended. Despite public reports that the Dnper program was suspended by the Russian President in April 2015, Management stated repeatedly that the Company's inaugural NEXT launch would be aboard the Dnepr up until February 2016 when the Company finally announced that the Dnepr launch could not take place. Just as abruptly, Management has now pivoted to a plan to conduct its first launch aboard SpaceX in July 2016 (16 months later than the original plan), followed by a second launch in October 2016. Launches are then to follow every two months thereafter and Management somehow still remains publicly confident that it will complete launching NEXT in 2017 "as scheduled".
We believe it is unrealistic to delay the front end of the launches by 16 months yet not change the back end of 2017. Further, the "new" launch schedule no longer provides 4 months of in-orbit testing after the initial launch. On top of this, we know that not one satellite has yet to even complete construction and qualification testing for launch after the program has experienced significant construction delays and technical problems. We also know that the program is dependent on SpaceX, which has a large backlog for government and commercial customers. Our view is that Management has stuck with their 2017 guidance in the face of these program issues because they are pressured to comfort the market that they will meet the requirement to complete NEXT before the January 31, 2018, license deadline. The satellites need to be deorbited in time for there to be enough on-board fuel remaining to be physically able to be deorbited in line with the FCC mandated deorbit plan.
Because Management has been so consistently unreliable with its launch timing plans, we analyze objective data and information to determine a more realistic schedule. In order to complete launches successfully, two obvious milestones need to be completed. First, the satellites need to be fully constructed, tested and delivered to the launch facility. Second, the launch provider needs to be prepared to launch the payload. Iridium has contracted with Thales Alenia Space to construct 81 NEXT satellites and with Orbital ATK to complete the final assembly, integration and testing of the satellites. Thales has a long history of prolonged manufacturing delays and technical problems, including problems only appearing while in orbit for satellite constellations provided to Globalstar and O3b. Both programs were delayed by many years and experienced technical issues after launch. Iridium is not immune to similar risks including last year's disclosure that satellite manufacturing would be delayed due to issues with their "Ka-band modules". Nevertheless, Iridium now says Thales Alenia "has remained on schedule with the plan we communicated during the third quarter call" with the first two satellites to be completed, fully tested and ready to be shipped in March 2016. As of this writing in early April, Iridium has not yet announced the completion of verification testing which, given the Company's penchant for issuing press releases on far more trivial matters, indicates to us that Thales Alenia is behind its revised schedule.
We remain dubious that the Company will hit either its near-term or long-term launch guidance. Management has a strong incentive to assure its investors that the program's technical issues have been fixed and now says that these issues "appear to be resolved". Since the first two satellites have not even completed the manufacturing process only one month prior to their previous planned launch date, it calls into question whether Thales Alenia has truly remained on schedule. Going forward, although Iridium is 6 years into its Thales contract and only has "12 vehicles in various stages [of production]", the Company has communicated a plan to somehow "produce 6 satellites per month by July". However, while Management is saying that everything is on schedule and all of the technical issues have been fixed, the evidence regarding the manufacturing schedule calls this assertion into question. For example, according to the 2014 10-K, Iridium planned for $554 million of payments to Thales Alenia tied to certain 2015 program milestones. Given that Thales Alenia completes the core work on the satellites before Orbital ATK completes final assembly and testing, if the program was going well and even close to schedule, the 2015 capital spend should have been close to this projected amount. Analyzing the 2015 10-K, total payments to Thales Alenia in the year 2015 were just $229 million (including amounts in accounts payable of $23 million), or only 41% of the planned payments during that year. Under the assumption that payment timing is a proper indication of milestone completeness, this is indicative of the fact that Thales Alenia is materially behind schedule which will likely lead to further delays despite Management's many statements over time to the contrary:
Going forward, Management expects to launch aboard SpaceX in July followed by a second launch in October and then five more SpaceX launches, one every 60 days thereafter. Even assuming Thales Alenia and Orbital ATK can somehow turn around the program and produce satellites to meet this schedule, the evidence regarding SpaceX's ability to launch such an aggressive schedule needs to be analyzed. While SpaceX is an innovative company disrupting an industry long dominated by government-subsidized entities, launching satellites is very difficult and delays and failures are commonplace in the industry. To date, SpaceX has had to face numerous failures and delays. Since the introduction of its Falcon 9 vehicle in 2010, from 2010 through 2013, SpaceX launched only 7 rockets, one of which failed to deliver its payload. In 2014, the Company successfully completed only 6 launches. In 2015, 7 were launched with one failure, resulting in a cessation of launches and a 6-month delay before resuming activities.
SpaceX currently has a backlog of 44 launches, 7 of which are for Iridium, 20 are government and 17 for other commercial customers. Thus, Iridium only makes up 16% (less than 1/6th) of SpaceX's backlog. Iridium's timing guidance requires SpaceX to complete 7 launches by the end of next year for Iridium alone, and this is simply not possible given SpaceX's current launch pace and backlog. Other programs would need to be delayed in order to make room for Iridium to complete its launches next year. Why would NASA, which needs to supply the International Space Station, move out of the way to accommodate Iridium? Why would commercial customers with completed satellites, who have in some cases been waiting years to launch, move out of the way? Iridium will be competing with at least 37 other SpaceX launches and will have to wait in line like everyone else. Even assuming SpaceX's cadence increases over time as the launch company accelerates its learning curve, it is more realistic to assume Iridium's launches can be completed around 2020 given actual timing and capacity constraints for SpaceX.
Management has countered this basic logic with the fact that they will be launching from the "less busy" Vandenberg, California, launch site and that only the Cape Canaveral site will be backlogged. This argument has no basis. For example, SpaceX was capable of launching from either site in 2014 and 2015, yet completed only 6 and 7 launches, respectively, in those years. The limitation does not only exist at the launch site but rather is capped at SpaceX's total resources (constructing rockets, control systems, engineering manpower, etc.) to launch at any site.
The Management team has a long history of communicating to the market that the Company is "fully funded" only to shortly thereafter raise hundreds of millions of dollars of dilutive capital. This happened first in 2012 and then again in 2014. Shockingly, in August 2012, the Company communicated that it was fully funded but just two months later, raised $96 million in a dilutive preferred stock financing. During 2013, Management communicated repeatedly that it was "fully funded" only to raise $220 million in the first half of 2014 at a below-market price. Management attempted to provide cover by saying that their lending group required the financings. While we do assume the lenders required Iridium to raise capital, that's not the complete story - the banks required the capital because Iridium did not have the capital resources to meet its near-term and long-term obligations.
Today, the Management team once again claims to be fully funded. On the contrary, we believe that a proper analysis of the Company concludes that a half billion dollars will be required over the next several years, approximately $200 million of which is needed during the next 18 months alone. The historical raises and current funding shortfall are material, especially given Iridium's approximate $800 million market capitalization.
Given that Management's guidance has been proven unreliable, we look at independent data that provides a realistic look at the Company's prospects, risks and future performance. Iridium faces capital requirements of $742, $485, $275, $320 and $393 million over the next five years. Even assuming the Company proceeds with 8 perfectly executed launches (including a rescheduled Dnepr launch in 2016) through 2017 and even assuming that the Company can accelerate operating cash flow growth, given the Company's massive capital obligations, Iridium faces large funding shortfalls as illustrated in the schedule below. Without these aggressively favorable assumptions, the funding gap is far greater.
Aireon's Funding Gap Impact
How does Management get away with saying the Company is fully funded? The answer is based on "anticipated" payments from its own subsidiary Aireon, a start-up company internally established to one day provide satellite-based air traffic control and tracking services. Located in McLean, Virginia, Aireon plans to provide the world's air navigation service providers (ANSPs) and airlines a satellite-based tracking solution for planes when over oceans or out of reach of terrestrial tracking coverage. This idea is totally unproven technically as well as commercially and yet Iridium says it will accomplish this by renting out capacity on its satellites using dedicated "hosted payload" equipment. Iridium boasts that Aireon is contractually obligated to fund a one-time "hosted payload" fee to Iridium in "2H 2016 or 1H 2017" in the amount of $234 million. This amount is expected to bridge the Company's shortfall next year followed by a planned $120 million "redemption" payable to Iridium in 2018. In our July 2015 report, we highlighted our strong skepticism regarding Iridium's plans for Aireon. Since then, Aireon has failed to secure the FAA as a partner (which the Company first disclosed in its Q3 2015 10-Q to be essential to Iridium receiving full payment from Aireon), and just recently Iridium admitted that in order to provide funds back to Iridium, Aireon must also execute an unlikely debt capital raise from capital sources yet to be identified. Obviously Aireon can't provide service and generate revenue until the constellation is completed, but in order to complete the constellation, Iridium must receive these funds from Aireon, so the problem is circular. What lending source for Aireon is going to allow hundreds of millions of dollars to leave Aireon to pay Iridium before NEXT is fully in place, technical efficacy established and long-term service quality and revenue are secured?
On the Q4 earnings call in February 2016, CFO Tom Fitzpatrick said that "Aireon has said that they intend to get an FAA contract kind of in the latter part of this year..". Iridium represents that simply having an FAA contract will then allow Aireon to fund the amounts due on paper to Iridium. But there are certainly many milestones that need to be reached in order for the venture's existing investors to fund additional capital into Aireon let alone to allow Aireon to raise outside capital and have enough commercial success to fund hundreds of millions of dollars back to Iridium and to become the growth engine to meet lofty revenue guidance. Iridium discloses that "Each tranche, however, is subject to the satisfaction of various operational, commercial, regulatory and financial conditions, some of which will be out of our control, and the investors have significant discretion in the determination of whether those conditions have been met." While Iridium fails to disclose what these milestones are, it would be reasonable to assume that an important operational milestone is Iridium's completion of NEXT which we believe will prove challenging, and therefore it will be difficult over time to keep Aireon's partners continually engaged.
Yet, as much as Iridium likes to portray Aireon as a separate company using the term "they" at every mention of the venture, Aireon is actually structured as a subsidiary of Iridium. In fact, Aireon coincidentally shares the same headquarters building of 1750 Tysons Blvd, McLean, Virginia. Analyzing Iridium and Aireon's history provides some context for how Aireon came to be. In order to justify a $3.0 billion capital project, in the early stages of planning for NEXT, Iridium needed to develop other business plans outside of the traditional slow-growth satellite service industry. Thus, Iridium developed a plan to allocate capacity on its new NEXT satellites to provide potential partners with the opportunity to lease a portion of the satellite's space and power, allowing partners to avoid building and launching their own satellites. This is referred to as "hosted payloads"; Management originally claimed that this strategy would yield $1 billion to Iridium. When you combined $1 billion of hosted payload cash flow with the Company's core operations, the capital obligations of Iridium NEXT could possibly be satisfied.
However, even though the Company boasted of 15-20 potential hosted payload projects, Iridium was not able to secure a single one. Running out of time before the completion of the NEXT design process, Iridium dreamed up and created Aireon. Iridium next structured a contractual arrangement with Aireon such that the venture was to owe Iridium non-recurring and recurring fees, with Iridium retaining a 24.5% long-term equity position in the venture. On paper, this could help the task of justifying a $3 billion spend on a new network that the core business alone could not support.
Despite Management's portrayal of Aireon, it is not actually a separate company with low-risk funding obligations to Iridium. The Aireon CEO, Don Thoma, previously served as the Executive Vice President of Marketing at Iridium and still shows up in Iridium's proxy statements as an Iridium executive officer. Aireon was formed by Iridium, is run by Iridium and only has a contractual obligation on paper that has no reasonable likelihood of actually being met. Iridium has provided guidance to the market that Aireon will fund a total of $350 million to the Company through 2018. However, the sources of the funds for Aireon to meet its commitment are currently non-existent. Before the Q4 2015 earnings call, investors assumed that Aireon's partners including FAA-like organizations around the world, would contribute the funds. These funds would then simply be provided to Iridium to meet Aireon's obligations. However, on the Q4 earnings call, equity analysts partially drilled down on this issue for the first time. Iridium's Fitzpatrick responded that only after the FAA is secured as a partner, Aireon will "go to market and raise capital and that's how they'll pay us in late 2016 or 2017." Thus, Aireon needs to secure 3rd party debt capital to fund its obligations to Iridium. How do you get the FAA to commit in advance (more than just another toothless Memorandum of Understanding as has been secured with other ANSPs around the world) when Iridium has such a large funding gap and an uncertain date for completion of NEXT?
The chances of a start-up entity raising hundreds of millions of debt capital to then turn around and remit 100% of these funds to pay its founder is, to put it mildly, challenging. Prior to Q4, we could not find any mention of Management disclosing such an external funding plan publicly and the details around their plan today remain incredibly thin. Further, when pressed if there is a precise deadline date for Aireon to pay Iridium its fee, the CFO responded "I don't know that we have disclosed the exact terms of the agreement between Aireon and I really would have to check that..". However, he then went on to reiterate how confident he is in collecting the initial $234 million and described the accounting treatment for the payment. It is at least mildly suspicious for a public company CFO to not know whether the terms of the most material capital source for the Company's near-term cash shortfall have been disclosed. If not disclosed, why not? We believe the Company's disclosures on this front have been consistently limited and remain far from complete. Now at least it is clear that a significant portion of the near-term funding gap is based on its own start-up company securing hundreds of millions of debt capital in the near term. We view this with appropriate skepticism.
After failing for the last several years to secure an insurance program for NEXT due to prohibitive costs, Iridium has announced a new insurance concept for its set of 8 launches that exposes the Company to material harm if any of its satellite launches or satellite in-orbit performance is not successful. Meanwhile, Iridium still has not been able to bind its insurance due to what Management claims to be "changes in the insurance market." Before the latest launch schedule was announced, Management had reassured investors that only 2 satellites would be launched on the first launch which could be treated as an in-orbit test scenario, reducing the program's overall risk. If there were issues with these satellites, the losses would be manageable and the remaining satellites on the ground could be fixed to account for any identified problem. However, Management's latest plan is to now launch a full set of 10 satellites on the initial launch, and then shortly thereafter launch another 10 satellites before any problems in space might be fully known; this materially increases the program's risk and increases the cost for any final insurance package.
Further, it is important to assess the detrimental financial impact on Iridium in the event that one or more of these SpaceX launches fail. Launching satellites is inherently risky and companies typically insure each launch to allow them to buy additional satellites and launches in the event of a failure(s). Iridium has a very different, riskier plan. Although Management tries to reassure the market that "our placement of launch insurance continues to proceed smoothly," Management had previously planned to purchase 100% of the launch insurance before the first launch. To date, it has yet to secure insurance, will purchase insurance in multiple stages including after the first launch and now expects total insurance costs to exceed the high end of Management's estimate of $125 million. The problems securing insurance were likely heightened following SpaceX's June 2015 launch failure, perhaps representing the referenced "changes in the insurance market."
Since 2010, there have been a total of 23 SpaceX Falcon 9 launches and 2 instances where SpaceX failed to deliver its payload. This equates to a 91.3% success rate. Going forward, assuming this past rate is applicable to future risk, assuming 7 sequential launches each with a 91.3% success rate, there is only a 53% (91.3% ^ 7) chance that all 7 will be successful. With this 50/50 risk profile very well known to insurance providers, a $125 million insurance program to cover $3.0 billion of exposure seems difficult. In a process ongoing for several years, Iridium has had a difficult time securing such an aggressive package. Given the failure to launch 2 initial satellites on Dnepr and the recent SpaceX launch failure, the Company has been forced by the insurance market to adjust its original insurance structure and now has to go forward with a material amount of "self-insurance and deductibles, providing reimbursement only after a specified number of satellite failures." The Company will now harbor much of the risk in the event that a failure occurs. When replacement satellites from any failure need to be constructed and launched, this now won't solely come from insurance proceeds but from Iridium's limited liquidity resources which would lead to materially increased total project costs. If Iridium must directly replace only 10 satellites that are not insured, we estimate that this would cost the Company between $250-$350 million.
In summary, Iridium's insurance program has taken longer, will be more expensive (we estimate at least $180 million not $125 million) and exposes the Company to materially increased risk, much greater than historically communicated. We are unable to understand how Management could say that the process continues to "proceed smoothly."
Because Iridium was not able to contract for any real, 3rd party hosted payloads which Management had previously guided as bringing in approximately $1 billion of cash proceeds, the Company announced another new program called Iridium Prime, a bold vision "which will allow customers to host payloads on stand-alone satellites integrated into the Iridium NEXT constellation..." The idea is that after NEXT is fully launched, customers will supposedly be able to take advantage of the efficiencies of Iridium's NEXT manufacturing line to launch stand-alone new satellites and integrate them into Iridium's NEXT constellation and somehow pay Iridium in the process. In the past, Iridium Prime was a major focus for the Company and discussed as a material future growth opportunity. Even as late as March 2015, Iridium disclosed that there was "strong early interest" and a "funnel of about three dozen potential customers". However, the Company has not even mentioned the program on its last set of earnings calls and has made no material Prime announcement. This is in spite of including Prime in a short list of 5 total sources of capital for the Company in its SEC filings.
We believe Management is pressured to keep hope alive regarding its previous hosted payload guidance and is being quite loose with the application of the term "hosted payload" as it relates to Iridium Prime. We believe this is nothing more than throwing out another business plan for investors while only being able to offer vague details in an attempt to distract from the Company's failure to secure real external hosted payload opportunities. Given Management's history of being aggressive with potential growth opportunities, the failure to even mention this on the scripted or Q&A portion of earnings calls is likely quite telling of the real reception of this program by potential customers over the past year. We believe this is simply another example of why investors need to remain cautious when determining the reasonableness of Management's guidance.
NEXT Cost Increases
Management has also not disclosed the reasons for material increases in the total costs for NEXT over time. According to Iridium's initial plans, the project's total cost was to be $2.7 billion. Then, the contract with Thales was quietly altered from a "fixed-price" contract to a "primarily fixed-price" contract without any mention of this change on Iridium's earnings calls: rather it was buried and almost indecipherable in Iridium SEC filings. The principal driver of this increase was a $200 million price increase from Thales for reasons not provided. That is $200 million for a $800 million market cap company. Even today, costs are only continuing to increase with payments to SpaceX increasing $15 million in just the latest SEC filing. The program's costs have increased $300 million in total over the past six years even though the first satellite has not yet been completed.
Additionally, Management has added a curious change to its OEBITDA footnote in the Q4 2015 earnings release disclosing, for the first time and with no elaboration, that certain NEXT payments expensed but not capitalized are "not part of the approximately $3 billion construction cost of Iridium NEXT." This footnote had previously remained consistent and unaltered quarter after quarter without this new insertion. Why the additional language now? Have total NEXT expenses exceeded $3 billion or are they now expected to including these other expenses? If so, we believe it would be appropriate for Management to clearly disclose this. Could this total continue to increase if program delays continue? While small increases individually may not be significant, if they recur over a period of time, they can certainly become material when added together and we believe Management should be forthcoming about this.
Why has the Company decided that it's best to maintain a set of impossibly aggressive financial and operating milestones? Don't they know that this only sets them up for failure in the future? We believe the answer is simple: survival. If the Company is forthcoming about a realistic launch schedule or the need to raise additional capital, Iridium will not be supported by equity investors, potential Aireon partners including the FAA and other ANSPs, its dealer network and lending group. The Company likely also fears that communicating anything but an impossibly aggressive schedule may result in a slowdown by construction and launch partners and cause its customers, including the US Government which accounts for 20% of revenue, to question Iridium's service sustainability. If they admit that launches will be further delayed and the payments from Aireon are suspect, the Company's lenders would likely force a material equity raise. The FAA would certainly get spooked as would any potential debt providers for Aireon. If guidance was updated with a more realistic growth rate not of 10-14% per year but rather 1-3%, investors would not be able to see enough equity value to cover a $2.0 billion debt and preferred stock load for a company only producing $217 million of operating cash flow. Disclosing the reality of their situation would mean a complete collapse of the house of cards that has been built. Instead, Management communicates an unrealistic plan that shields bad information until the latest possible moment. In the meantime, the Company works to get capital and partners secured based on a set of impossible assumptions. They need investors to think about "long-term" growth opportunities (as unlikely as they are) and to believe that speculative payments are in hand just because there is a contractual obligation from an "outside" entity to pay the Company hundreds of millions of dollars.
We have now seen this play out over many years, multiple capital raises and with new launch delays announced almost every quarter. The Company has preferred to only deliver pieces of bad news over time in order to be able to raise enough money along the way and build a stakeholder base of lenders, investors, ANSP partners, insurers, vendors, etc. such that everyone will be forced to work out Iridium's future problems together. Given the inevitability of additional capital raises and certain launch schedule delays that will need to be disclosed in the near term, long investors should be wary and short investors have an opportunity to take advantage of this unsustainable reality.
Further, Management has been very focused on completing the launch of NEXT by the end of 2017. As we have analyzed above, without having completed the manufacturing and final test of a single satellite to date and with 72 satellites to launch over 8 launches, the plan to have all satellites in operation by the end of next year is beyond dubious. We believe that, as disclosed by the Company in its 10-K, Management is being pressured to keep to this date as its first-generation satellites are licensed to operate only until January 31, 2018 at which time the current satellites must be deorbited.
We believe the next few years will be very difficult for Iridium and will prove that a $3.0 billion capital spend, with $2.0 billion sitting above the common equity, is far too extreme for a Company with the limited growth opportunities provided by Iridium. Iridium's funding gap is simply too large to be financed by the equity markets and, without this funding, Iridium will not be able to complete NEXT and support the growth needed to handle its debt load. With 2018 leverage (including preferred stock assumed raised to satisfy the funding shortfall) in excess of 9x and minimal underlying growth, attributing any equity value to the Company is a miscalculation. In fact, it is likely that even the debt amount will need to be compromised either inside or outside of Chapter 11. We believe the next few years will be a total loss for long investors and that the below chart will prove true:
We are well aware that just about any Management team's guidance has some degree of error and can, in retrospect, be attacked easily from the sidelines. But most Management teams make reasonable estimates based on information that is available to them at the time and fully and fairly disclose an appropriate range of outcomes and risks. The difference with Iridium's Management team is that we believe there is no reasonable basis for their financial and operational guidance. In mid-2012, they could have easily projected and then communicated a near-term liquidity shortfall but instead decided to communicate to the public that they were "fully funded" just months before executing a substantial capital raise. The same occurred again prior to the 2014 capital raise. We believe this same pattern is playing out again now.
Today, the Company must rely upon somehow flawlessly executing the following items: completing the satellites on time, launching on time, not experiencing any material technical issues, securing hundreds of millions in payments from Aireon and materially growing the core MSS business. Because Management has been so unreliable with disclosing negative news as it becomes known, we have put together the below table of announcements to follow in order to track Iridium's progress (investors should also monitor quarterly capex spend relative to the amounts laid out in the Commitments and Contingencies section of Iridium's 2015 10-K):
For the reasons discussed in this report, we believe there is no chance of executing this strategy. We encourage readers to diligence these issues for themselves and no longer simply take for granted that Iridium Management is providing estimates in good faith - the consequences of the guidance being wrong are too dire to do otherwise.
Appendix: Historical Consensus EBITDA Estimates from Initiation to Reported
Forward sell-side EBITDA estimates have come down dramatically each year following initial publication (per Bloomberg);
- 2013: first estimate in October 2009 was $263 million of 2013 EBITDA; ultimately reported $201 million (23.6% decline)
- 2014: first estimate in October 2009 was $294 million of 2014 EBITDA; ultimately reported $217 million (26.2% decline)
- 2015: first estimate in August 2011 was $337 million of 2015 EBITDA; ultimately reported $234 million (30.6% decline)
- 2016: first estimate in March 2012 was $356 million of 2016 EBITDA; current consensus at $248 million (30.4% decline so far…)
- 2017: first estimate in August 2013 was $337 million of 2017 EBITDA; current consensus at $268 million (20.5% decline so far…)
 Per the article "Iridium: 7 Years Out Of Bankruptcy, Satellite Communications Player Eyes A 2009 IPO" published on February 22, 2008.
 Per Iridium Investor Presentation / 8-K published on December 16, 2010.
 Per fourth quarter 2015 earnings call transcript published on February 25, 2016.
 Per 2015 10-K filed on February 25, 2016.
 Per Iridium Investor Presentation / 8-K published on March 3, 2015.
 Per 424B5 filing on June 25, 2009.
 Prior to Q2 2010 10-Q filed on August 9, 2010, Iridium used the Thales Alenia contract was described as "fixed price". In all future filings, the Thales Alenia agreement was changed to "a primarily fixed price full scale development contract".
 Per launch manifest published at spacex.com.
 Per 2015 10-K filed on February 25, 2016.
 Per article "Moscow Confirms Suspension of Russian-Ukrainian 'Dnepr Rocket Launches" published on December 17, 2015 in Space Daily.
 Per second quarter 2015 earnings release published on July 30, 2015.
 Per fourth quarter 2015 earnings call transcript published on February 25, 2016.
 Per fourth quarter 2015 earnings call transcript published on February 25, 2016.
 Per article "Netted Iridium 'Radios' Prove Indispensable in Battlefield Test" published on January 21, 2010 in Defense Systems.
 Per 2015 10-K filed on February 25, 2016. Includes $234 million Aireon hosted payload fee and $120 million payment to redeem a portion of Iridium's ownership in Aireon. Excludes Aireon data service fees "of up to approximately $20 million per year once the system is fully operational".
 Per 2015 10-K filed on February 25, 2016.
 Midpoint of Management's 2018 service revenue guidance ($442.5 million) plus $100 million of equipment and engineering revenue, all at management's 60% OEBITDA target, less $90 million of annual interest and $30 million of annual maintenance capex.
Disclosure: I am/we are short IRDM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.