Iridium Communications (NASDAQ:IRDM) is the company that offers telecommunications products and services powered by satellite. The corporation claims to be "the second largest provider by revenue of mobile voice and data communications services" and currently possesses more than 60 operational satellites that facilitate global coverage.
Iridium has been quite successful in the last five years with its existing satellite base and offered its services to both commercial and governmental institutions. Thus, the corporation generated 25% of revenue from the U.S government for the year ended December 31, 2016, with the Department of Defense (DOD) being the primary customer. The list of commercial clients includes companies from a broad range of industries, including aviation, utilities, mining, construction, and transportation.
The main advantage of such a business is the fact that relationships with the customers are likely to be long-term, which enables steady growth over a long period of time. Additionally, the entry barriers (financial, regulatory, and technological) are significant, making the competition inside the industry rather predictable.
Moreover, the current trends in global technology development seem to be beneficial for the type of business operated by Iridium. For instance, the company emphasized in the annual report its ability to profit from the advancement of Internet of Things (IOT) which requires significant machine-to-machine (M2M) data communication. Therefore, the services offered by the company could be in demand by the industries involved in the smart city development or, especially, by the companies developing a self-driving technology. These include such giants as Tesla (NASDAQ:TSLA), Intel (NASDAQ:INTC) after acquiring Mobileye (NYSE:MBLY), Delphi Automotive (NYSE:DLPH), and other big corporations that need global data communication to make connected cars possible.
Iridium already emphasized in its 2016 annual report the importance of M2M services for the company's future growth. Even now, Iridium provides its M2M communications services to global heavy equipment manufacturers like Caterpillar (NYSE:CAT), making it possible to monitor all kinds of machines in the construction, mining, and other markets. Other activities facilitated by M2M services include fleet management, asset tracking, resource management in the fishing industry, and scientific data monitoring. Therefore, it is evident Iridium's products and services can be applied in a broad range of businesses, enabling the company to build a diversified growth strategy.
Additionally to the communications services, the corporation offers a range of products to its customers. For instance, Iridium provides personal mobile satellite communication through the Iridium GO device, which enables satellite connection from smartphones, tablets, or laptops. It is stated by the company in the annual report the development of personal communications technology is a part of Iridium's long-term growth strategy.
The main big thing which will define Iridium's success in the coming years is its Iridium NEXT constellation project. The project aims to replace the existing satellites network by the new constellation of the NEXT satellites to advance communications capability. It is stated that "once complete, the satellites will provide speeds of up to 1.4 Mbps and will be able to support mission-critical communications and machine-to-machine connections," enhancing further support of Internet of things along with other new products and services.
This was confirmed during the last conference call. The technology responsible for the future M2M communications growth and the IoT development is Certus, which will be available once the NEXT constellation is deployed:
Certus technology kind of turbo charges our machine-to-machine offerings as well, our IOT offerings in the coming years as we build new devices and we put other new capabilities at the satellites entail.
Additionally, an important note was made on Certus regarding the services provided to the US government:
We have never really had any broadband business with the US government, but Iridium Certus has a whole lot of advantages for the government in terms of being a secure private, almost broadband L Band service that has higher speeds and things that they are currently deploying today.
The first 10 satellites have been successfully launched by SpaceX in January 2017. Iridium claims that "on February 16, 2017, the first Iridium NEXT satellite was inserted into the constellation," and three days later switched on. The remaining satellites are expected to be deployed by 2018.
If the corporation can keep to the schedule, the new constellation will undoubtedly drive its profits from 2018, since the possible market opportunities will increase significantly. This is because higher data speed and improved coverage will attract more customers from a broad range of industries. Therefore, I believe that in the next five years the average revenue growth will be at least 10%, making Iridium attractive for investment.
The main competitive advantage of Iridium against Inmarsat is the type of used constellation. The thing is Inmarsat uses satellites which are placed in geostationary Earth orbit (GEO), which leads to the extensive reliability on ground stations, more expensive antennas, and higher delay. At the same time, Iridium's satellites are placed in low Earth orbit (LEO), which is closer to the Earth equator. It is stated by Harris CapRock:
This type of orbit allows them to provide constant coverage through a constellation of several satellites that are closer to Earth, offering a significant performance advantage with low latency.
Iridium exploits the benefits of LEO by a sophisticated network of 66 satellites, making sure at least one satellite is always reachable from any point on Earth.
Regarding Globalstar and ORBCOMM, the two corporations use the same type of LEO satellites. However, both companies use so-called "bent pipe" architecture, which requires the signal to be routed to a nearby ground station to keep the connection. As a result, only Iridium with its satellite network is able to provide "true global coverage," making the company a unique player in the market. Moreover, the coverage will be further enhanced when the Iridium NEXT constellation is deployed, and all the satellites are in service. As a result, I expect more customers, especially governmental entities, will consider Iridium as a provider of services in the coming years.
From a financial standpoint, Iridium Communications also looks more stable. First of all, it is the only publicly traded company that has shown positive operating income and growing revenue through the period from 2012 to 2016. For instance, ORBCOMM's operating income has been negative since 2014, while Globalstar's operating results have been negative over the whole period.
This leads to the problem of funding. Thus, Globalstar had only $10 million of cash in 2016 against near $500 million of debt. The numbers for ORBCOMM are $25 million of cash to about $150 million of debt. In contrast, Iridium possessed more than $410 million of cash to about $1600 million of debt. Moreover, the business of Iridium remains profitable, making the debt burden less threatening. As a result, Globalstar and ORBCOMM will rely more heavily on refinancing options, which may adversely influence their business decisions.
In addition, it should be noted Iridium's current ratio is 6.21, which significantly reduces the probability of having any troubles in the foreseeable future. In contrast, ORBCOMM has a current ratio of 1.75, while Globalstar's number is even lower - 0.22.
The average revenue growth from 2012 to 2016 was 3%, with average EBITDA growth of 12% for the same period. The company has been able to increase its margins due to a growing number of subscribers (850000 in 2016, with 9% YoY increase) and increasing revenue from M2M services. Thus, commercial M2M data services revenue increased from $61.3 million in 2015 to $66.3 million in 2016, representing more than 8% rise. Iridium's management expects the operational EBITDA margin to grow to 60% by 2019.
The R&D spending has been stable over the last five years, which is likely to remain, since the new constellation is already being deployed.
Iridium consistently increased the amount of debt in its capital to make the NEXT project possible. Thus, long-term debt grew from $752 million in 2012 to $1657 million in 2016. However, the debt burden seems reasonable if we take into account the fact that company is profitable and possesses a significant amount of cash. It can be expected that once NEXT project is completed, Iridium will start paying off a certain amount of borrowings, decreasing leverage.
Valuation multiples are attractive. P/E ratio of Iridium Communications is 11.2, which is way below the industry average. Both ROA and ROE are lower than those of competitors. However, this can be explained by the retirement of the current satellites network. The transition to NEXT satellites is likely to change the situation. EV/EBITDA multiple is reasonable 10.9, according to the Seeking Alpha data.
I use discount cash flow analysis to identify the intrinsic value of the corporation. The model shows that under the base scenario (9.5x EBITDA terminal value multiple) the fair stock price is 11% higher ($11.1) than the current price of Iridium shares ($10 as of April 14). Under the optimistic scenario (10.5x EBITDA terminal value), which assumes the company will be successful with all the launches of the NEXT satellites, the upside potential is hefty 32%.
My key assumptions for the model:
1. The average annual revenue growth over the horizon period of 5 years is estimated to be around 10%, with 3% increase in 2017 and 14% increase in 2019. This will be achieved by a higher number of products and services in the portfolio, made possible by NEXT constellation.
2. EBITDA margin will increase to 50% in 2019 due to the same reasons mentioned earlier. Notably, Iridium's management expects operational EBITDA margin to be 60% in 2019.
3. Capex will amount for $450 million in 2017 and then will decrease in 2019 to approximately $35 million, which complies with the management's expectations.
4. The after-tax cost of debt is 3.2%. The cost of equity capital (24.9%) is calculated using CAPM, with 1.62 beta, 2.3% risk-free rate, and 14% market premium. The WACC is, therefore, estimated to be 12.42%.
As a result, the model shows $1082 million equity value under the base scenario, which assumes EV/EBITDA multiple will decrease to 9.5x by the end of the horizon period (2021). In this case, the value per share is $11.1.
At the same time, if the launches made by SpaceX continue to go smoothly, the optimistic scenario will be exercised, resulting in more than 30% upside potential. Therefore, the suitable price range for the stock is $11-13, representing 10%-30% potential.
However, the risks of this investment should be taken into account before making a decision.
The risk factors associated with the investment in Iridium are quite significant.
The main challenge is the launches of the NEXT satellites being performed by SpaceX. While Iridium expects the project to be completed by 2018, any disruption of SpaceX's operations can be devastating to the satellite corporation, since it can increase the reliance on their old constellation and degrade the quality of services. However, the first launch of 10 satellites has already been successfully performed, and the first satellites inserted into the network. This gives a certain hope the schedule will be kept.
Another risk factor is the financing of operations. Iridium has a high amount of debt on its balance sheet, and it seems the corporation relies significantly on the future growth of revenue. This growth can only be achieved if Iridium will be able to replace the existing satellite network with the NEXT satellites on time. Once the NEXT project is completed, Iridium will have the basis to expand its operations and extend the list of products and services.
Finally, Iridium heavily relies on its relationship with the government and provisions from the company's subsidiary - Aireon. If Iridium is not able to keep providing its services to governmental entities, or if Aireon is not able to maintain its operations, the corporation will lose a substantial share of revenues.
Overall, Iridium Communications seems to be attractive for investment now, since the constellation of satellites will enhance the company's communications services and will provide an ability to scale the operations. While certain risks exist, the company has shown that it is able to surprise pessimists and keep performance sound.
A comparative analysis shows Iridium's stock is undervalued. Thus, a P/E ratio of 11.2 is much lower than this of competitors, while the company's past performance is better and future opportunities are promising. Therefore, a buy recommendation can be given with a suitable price range of $11-$13, representing 10%-30% upside potential.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IRDM 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.