On Friday, January 3, Globalstar (NASDAQ:GSAT) was the subject of a bearish article which provided a review of the company's onerous capital structure. Anyone involved with GSAT can benefit from understanding the risks involved if the FCC fails to approve GSAT's spectrum for terrestrial use. However, the article was only a half-truth. It failed to present the upside…the potential reward, which offsets the risks inherent in GSAT's capital structure.
I quickly drafted a rebuttal, which was sent exclusively to my subscribers at PTT Research.
Those issues have since been corrected and the article was re-released. The response was quite bullish. After the original article sent the stock as low as $1.63, my rebuttal (and the corrected article) sent the stock up to $1.90 (as I type this) -- a 15% return in 7 trading days!
In the end, it all went to prove two things:
1) Always be aware of whose analysis you are reading. In this case, I believe the author in question has a promising career ahead of him. He demonstrated some good skill in analyzing GSAT's capital structure. However, his lack of experience and bravado proved to be a lesson in the young man's development. I have no doubt that he'll bounce back. His corrected article was very well done.
2) In order to appropriately evaluate any stock, an analyst must research its risks and its rewards. This is exactly how my staff at PTT Research approached GSAT, just before I predicted the stock would triple.
It took less than four months for that prediction to come true. I discussed this and my other picks to triple in a follow-up contribution to Seeking Alpha.
The reason for my prediction was simple. After Amazon Tested GSAT's Satellite Network, our analysis determined that GSAT's business and spectrum assets might be worth approximately $4 per share if the FCC approves a measure to expand the ways its spectrum can be utilized to include terrestrial Wi-Fi. Our analysis was validated by the work of Seeking Alpha contributor Paulo Santos:
"GSAT's spectrum will cover the entire U.S. and be equivalent to around 7 billion MHz-Pop. This will be high-quality spectrum presently free of interference and potentially requiring only firmware/software upgrades to be used by existing devices (if configured as an additional Wi-Fi channel) (Source: GSAT "Understanding the Terrestrial Low Power Service." presentation)
If we value this spectrum at a multiple comparable to Clearwire's, $0.325 per MHz-Pop, this gives us an indicative value - just for the spectrum - of $2.275 billion. Removing the $668.3 million in net debt, means that GSAT's equity might be worth as much as $1.6 billion, or $3.24 per share, a 405% upside from its present quote."
This was an excellent assessment by Santos. For investors, this represented GSAT's potential reward.
Our analysis was further validated when institutional buyers piled into GSAT on the news that LightSquared attracted an offer from Harbinger Capital Partners to buy the company out of bankruptcy for $3.3 billion in cash and $1.7 billion in debt. In other words, the demand for wireless and public Wi-Fi bandwidth is at an all-time high, leading to higher valuations for spectrum assets.
Friday's bearish article completely ignored this data, rendering the rest of his argument moot.
The author also presented an outright falsehood by assuming that retail investors were the main reason that GSAT's market value had increased by $1 billion. A move of that magnitude can rarely occur without institutional support. At worst, institutional short-sellers would stymie the move. As a consultant to institutions with ownership in GSAT, I can personally confirm that the author's claims were false. If you have a relationship with any institutional traders, they might provide you with similar confirmation.
As experienced stock analysts, Paulo and I both know that reward is only half of the equation. Accordingly, we both discussed GSAT's downside risk. Specific to my perspective, the core business (assuming failure to receive FCC approval) is worth a fraction of the potential value of its spectrum assets. That being said, that core business was (and still is) improving. 2014 estimates were creeping upward and its book value was $400 million.
In my opinion, the risk was that the stock was only worth 89-cents, fairly close to the 68-cent estimate cited in the bearish article. In other words, I agree with the author…on half of the risk/reward assessment.
However, the author's failure to discuss (or even acknowledge) the potential reward made it impossible for him (or investors) to determine the risk-weighted value of GSAT's shares. In this case, that potential reward was/is likely between $2-5. If we simply take the midpoint of that range we derive an upside target of $3.50. Then, if we use the bearish author's downside target of 68-cents, we can calculate a coin-flip valuation in excess of $2 (($3.50 + $0.68) / 2 = $2.09).
This is why I correctly predicted GSAT's 200% move in late-August.
In fact, the shares reached $2.06 last month (by no coincidence in my opinion). Rather, it was simple math -- a matter of weighing the risks and rewards.
Based on my company's winning low-risk / high-reward methodology (we've picked 10 triples), GSAT has graduated from our model portfolio. However, investors are still free to play the stock based on its current and ever-changing risk/reward profile.
Based on the calculations presented above, shares of GSAT are undervalued by about 20%. Because of this, I still hold a modest stake in the company, mindful that GSAT's ultimate valuation will be largely determined by the FCC in the coming months. Bad news on that front will justifiably trigger a sell-off in the shares, leaving it significantly below current levels. Similarly, good news from the FCC should spark a rally that could potentially lead to a $5 valuation, which would make it a triple from current levels.
In short (no pun intended), the bear case presented on Friday made a critical error. By ignoring the potential reward, the author mistook a great short for a stock with a wide range of potential outcomes - high risk / high reward. A mistake like that can still pay off (if the coin lands on tails). However, half of the time, this won't be the case, leading to subpar investment results for investors who fail to examine both sides of the equation…the risks and the reward.
Disclosure: I am long GSAT, .