The next space race is (likely) here. Launch costs are down, technology is advancing leaps and bounds, and the public sector is more interested in exploring the final frontier perhaps more than any generation before it. Unlike in the past, SpaceX and other privately-held firms are leading the charge forward. While speculation in actual outer space assets could be profitable there is also perhaps a case to be made for low earth orbit (“LEO”) investment. With budgets growing and greater interest, there is a solid path forward for stable growth – so long as firms are in the right positions and can bear the high costs.
For Maxar Technologies (MAXR), the problem is that it has problems with both of those themes. The legacy GEO Comsat business is shrinking at a brisk rate with no signs of a bottom. Meanwhile, an overlevered balance sheet has created substantial credit concerns just as the firm needs to spend hundreds of millions to finish a new asset; shares are down more than 90% from highs. While management has avoided some pitfalls and created some wiggle room, there are several more bridges to cross: a (very) necessary dividend cut, substantial refinancing risk, and the potential sale of the GEO Comsat business. My gut here is that things do get worse before they get better. However, a year or two down the line this could be an interesting play if the new CEO is nimble enough. Nonetheless, the deep value here does lend itself towards being an intriguing watchlist target.
Business Overview, Market Concerns
Maxar Technologies describes itself as a leading global provider of advanced space technology solutions for commercial and government customers. Formed by the merger of MacDonald Dettwiler & Associates and DigitalGlobe in 2017, the firm now has four distinctive operations (SSL, MDA, DigitalGlobe, Radiant Solutions) offering satellites, earth imagery solutions, geospatial data, and other various services like surveillance to some high profile customers including NASA, various military branches, Alphabet (GOOGL), and Boeing (BA). The goal here is to be a “catch all” business provider that can offer multiple solutions tailored to customers. When the competition includes some of the firm’s very own customers then you do have to have a broad product offering.
While my own knowledge of space-related businesses is admittedly low, I do like that the company focuses on LEO products using battle-tested technology. This isn’t some speculatory firm reliant on cutting edge advancement with payoff many years down the line: multi-year investment at Maxar generally leads to clear cash flow. While LEO is still incredibly capital-intensive, costs are also low enough that a blunder or two do not risk upending the entire business.
*Maxar Technologies, November 2018 Investor Presentation, Slide 6
However, there are some underlying concerns. The market for geostationary orbit satellites – operated under the Space System Loral (“SSL”) moniker - has declined considerably over the past several years. This can be seen in the above slide through the declines in revenue for “GEO Comsat” revenue. Once a core mainstay of launch providers, demand has fallen given concerns over what eventual market impact low earth constellations – made up of many small satellites in geosynchronous orbit – will have on overall demand. Small satellites are booming and industry consensus is largely that these launches do not return to prior levels. In any case, a reversion isn’t in the cards for several years: there is generally a year or two of lead time between a contract award and delivery. While perhaps there is an argument to be made that this is cyclical and the SSL business might return to its former glory, I do not think any reasonable expectation has this business seeing any major bounce off the lows in demand until early 2022.
Impacts from this are already being felt. Weakness led to a $384mm non-cash impairment and inventory obsolescence charge during Q3. Alongside those charges, management announced that the firm is looking at strategic alternatives (read: a sale) for the business. I think the company has gotten away with taking the true balance sheet hit. There would likely be more charges taken (e.g., goodwill impairment) if the firm did not test for goodwill on a segment basis (these assets are held in the Space Systems segment which includes the growing smallsat and MDA businesses).
With the midpoint of GEO Comsat 2018 EBITDA expected to be $33mm, it’s a small piece of the pie for Maxar but it does generate a massive chunk of revenue. A sale at any attractive EBITDA multiple would go a long way towards addressing debt concerns that I will highlight later on as well as improving market perception (higher margin consolidated business). Given SSL has long been a market leader – predecessor entities paid $1,100mm for SSL in 2012 after all – there is some embedded value here just from the name alone and the talent held there. But the reality is that free cash flow generation has always been poor in Geo Comsat due to high capital expenditure needs. With Maxar looking to delever, it isn’t a surprise to see management looking for a sale, citing “multiple interested parties” during the Q3 2018 conference call. My only question here is whether there are potential pitfalls in a sale in regards to intersegment asset sharing like employee talent.
What happens in a sale? I think the EBITDA in the remaining Space Systems segment business can likely support substantially all of the goodwill on the books ($774mm in goodwill, my estimate of $350mm in legacy business intangible assets). Contrary to Spruce Point, I would not expect a major impairment charge to accompany that divestiture and think calling for this company to write down billions is hyperbole. However, SSL was a business that was acquired at 2012 at a market top; competitive concerns were well understood at the time. In my view, prior management rushed into what they felt was the best deal after more than a year of searching after they raised cash following the sale of the real estate assessment business for $850mm to shift back into a pure play within its military/defense technology roots.
WorldView-4 Satellite, Impact On Financial Covenants
When it rains, it pours. Adding to pain in early January, Maxar announced that its WorldView-4 satellite had malfunctioned due to a failure of the control movement gyros. An imagery satellite that cannot move is, of course, rather useless and management believes the satellite will not be recoverable. Lockheed Martin built the satellite and Honeywell built the gyros so this appears to be external issues. And perhaps all is not lost as the company carries insurance on the satellite valued at $183mm which it intends to recover.
Does this make it a moot point? Not at all. The company tried to spin this failure by pointing out the satellite only generated $85mm of 2018 revenue or incrementally more than 4%. However, we’ve already established that much of company revenue is in the high revenue, low margin Geocom Sat business. Imagery generated 64% EBITDA margins in 2018; the loss of this asset could be a substantial driver of EBITDA contraction. While I believe EBITDA in the segment is overstated (non-cash imputed interest that will relax post 2020), at 50% EBITDA margin this satellite was going to generate $400mm in EBITDA over its life, potentially more if it stayed in service beyond its expected term.
*Maxar Technologies, November 2018 Investor Presentation, Slide 21
As shown above, Worldview-4 was not slated to be replaced until 2027. With most of the operational cost bore upfront, this satellite would have thrown off gobs of free cash flow over the next eight years. Replacement value is near $600mm, at least based off the cost of WorldView Legion 2. Insurance does very little to offset this loss in my view; I think the net present value of the asset is at least $500mm. The insurance recovery – if it occurs – covers less than half of the lost value. It’s a major hit to Maxar Technologies.
I think the view from bulls following the company is that since the asset is insured the loss doesn’t matter and that the market is being irrational in the sell-off. This is a misunderstanding on just how important WorldView-4 was as far as free cash flow generation, particularly given debt covenants. This factor is something that ratings agency Moody’s reiterated in shifting its outlook to negative while (for now) leaving the credit rating intact:
The Maxar group of companies ratings are unchanged because we think that the group's credit profile is unaffected by the U.S. domestication, and presuming a comprehensive suite of compensatory actions, can largely be maintained subsequent to the recently announced loss of cash flow from its WorldView-4 satellite. However, the outlook is negative because the company's ability to de-lever has potentially been adversely affected by the WorldView-4 loss and related remedial actions consume most of the company's flexibility, reducing Maxar's ability to absorb additional unexpected setbacks.
While the company amended its credit agreement in December – allowed leverage is now 5.5x in Q4 2020 and thereafter – I think the company has a risk of tripping those covenants. Sell-side EBITDA estimates are now at $609mm for 2020; net debt was $3,196mm at the end of Q3. That points to 5.2x leverage. However, if they sell SSL those ratios fall:
the Consolidated Debt Leverage Ratio to exceed (I) 5.50:1.00 as at the end of each Financial Quarter ending up to and including December 31, 2018, (II) 6.00:1.00 as at the end of each Financial Quarter ending on or after March 31, 2019 and up to and including September 30, 2020, and (III) 5.50:1.00 as at the end of each Financial Quarter ending on or after December 31, 2020; provided that immediately following any disposition by the Borrower or its Affiliates of SS/L, each such ratio for all subsequent Financial Quarters shall be automatically reduced by 0.75:1.00;
This ensures that all of the proceeds from SSL, if sold, is likely to go towards debt reduction. If not, credit restrictions tighten further. I think this is pretty important given the steps the company has already taken to shore up its balance sheet and the capital outlay it has yet to make (more than $600mm in spending on the way in 2019 and 2020 for Legion). While the firm has done a few things to shore up its balance sheet prior to this, including:
- Renegotiating its bank covenants to provide some room.
- Extending its largest Imagery contract (NGA EnhanceView) to 2023.
- Selling part of its Palo Alto campus for $70mm in cash.
There remains much work to be done. However, I think it was an extreme positive to see the firm extend the EnhanceView contract. In my view, contract rollover risk for the NGA Enhance View contract – a substantial portion of Imagery revenue – was a primary risk. This was, in my opinion, the largest risk cited by Spuce Point in its mid 2018 short report on the firm (alongside :
DigitalGlobe A Ticking Time Bomb, Bull Case Likely To Disappoint: Maxar’s bull case for DigitalGlobe is predicated on two pillars: 1) Its contract with the National Geospace Agency (NGA) is priced too cheaply and is due for a price increase, and 2) There’s a huge opportunity for DGI outside of the U.S. government. Our work completed to date suggests both pillars seem unrealistic: it appears that DigitalGlobe is more likely to see prices decreases on the NGA contract and opportunities outside of the U.S. government seem limited, and have never lived up to expectations dating back to DigitalGlobe’s IPO.
Prior to the failure of WorldView-4, extending NGA EnhanceView through 2023 versus the prior 2020 expiration bolsters the view that there will be a period of delevering once Legion spending is done. However, the failure of Worldview-4 puts pressure on the firm to get Legion 2 finished quickly to transition key capital projects into being revenue generating. A project that was once slated to be undertaken between 2024 through 2026 may need to be bumped up. 2021-2023, once expected to be capital spending light, may not be so.
Additionally, I think the resignation of former CEO Howard Lance – an iffy appoint and appointment of Daniel Jablonsky, who came with DigitalGlobe during the 2017 acquisition, should ease some of the concerns on management quality. It also shows the Board of Directors recognized the need to take some action – whether that be too late or not – to address what it feels are misdirection in how the firm has been led. I think by any measure, the DigitalGlobe business has been the healthier side of the business. The Imagery segment, which is substantially made up of DIgitalGlobe assets other than the legacy geospatial services operations, generates more than three quarters of trailing EBITDA.
There are a couple of hard choices that the company has to make to ensure the company survives:
- Cut the dividend to zero. This saves $68mm/year to be used to fund necessary capex and/or debt reduction.
- Find a buyer for the SSL business, ideally for above $500mm. Could be a tough sell in this market.
- Continue to see EBITDA growth in the remaining businesses, pro forma for the impact of WorldView-4.
Addressing Spruce Point Concerns on EBITDA Quality
*Spruce Point, Maxar Technologies Short Presentation, Slide 11
Ben Axler at Spruce Point and I usually are not on the same page, however I do buy into the overcapitalization arguments. Maxar Technologies has historically rolled its technology spending into intangibles at a rate in excess of 50% per year, well above that of peers of similar size. Such activity (capitalize versus expense) inflates earnings in the immediate term. The impact of that – like the non cash charge taken in Q3 – is the potential result of that which the firm can spin as a one-off charge. Likewise, the impairment of property, plant, and equipment (“PP&E”) and equal/offsetting move to intangibles ( Slide 48) looks fishy to me given how earnings per share is calculated. As a cash-flow centric investor, earnings per share inflation allegations do not bother me as much; the same with the imputed interest issue.
*Source: Author calculations.
But as can be seen above, there is no free cash flow to pay the dividend and fund Worldview Legion. I think there were some crazy free cash flow implications in 2021-2023 but I’m not sure how much of that exists today. As mentioned, before Legion 2 could have slowed down and the company could have done some passive debt paydown. With the loss of WorldView 4, DigitalGlobe has little ability to compete for additional market demand until 2021 when Legion 1 is launched. Launching that satellite on time and on budget has become incredibly crucial. Liquidity access is not a problem given the access that exists still on the revolver and relaxed covenant schedule gives some leeway.
Sentiment is extremely poor but there are a lot of moving pieces here. I’d like to see some of the bad news out of the way (primarily the dividend cut) in order to take a stake here. Once that is done, there are quite a few catalysts:
- Collection of the insurance policy on WorldView.
- Sale of the SSL business at an attractive price.
- Potential growth through the Radarsat constellation and the GBDX platform.
I’m incredibly tempted here given a fresh face in the CEO seat and the market collapse. However, I think a few more tough decisions have to be absorbed by the market but this could make for an excellent risk/reward play heading into the launch of Legion and the ensuing free cash flow fiesta if all goes to plan. Buying is a little early in my opinion but this deserves a slot on a watchlist.
Note: Members of the Industrial Insights community receive access to actionable research ideas like this often. This isn't your average investing resource. Receive deep dive insight into companies that include facility tours, management interviews, and in-person conference coverage. This type of coverage is not publicly available.
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.