Iridium Communications Inc.: A Growing Business With Economic Moat

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About: Iridium Communications Inc. (IRDM)
by: Cassiopeia Value Investing
Summary

Iridium Communications operates in the satellite business.

The business is different to other satellite companies due to niche markets and has high entry barriers for potential competitors.

Growth perspectives for the next decade and better margins and cashflows on the one hand and a high stock price on the other hand are a difficult combination for investors.

1. Business model

Iridium Communications is a company, based in McLean, Virginia, which was founded in 1991. The company offers worldwide broadband and narrowband communication via satellite and its customers are active in the maritime, aviation and transportation sector. The company's services cover 100% of the world and were needed in nearly all regions in February 2019 apart from the Antarctic, parts of Africa, Russia and Greenland. Plot of Iridium Service Usage (Origination Points): February 7, 2019 –February 13, 2019 source: http://investor.iridium.com/download/Investor+Day+2019_Slides+%283_7_19%29.pdf

2019 will be a year of innovations and transition for Iridium as it launches not only new products (Iridium Certus) and the Global Maritime Distress and Safety System (GMDSS) but also a new generation of satellites which have an expected life span of twelve years at least (1. generation: 5-7 years), offer more connections and show a better performance. The total fleet consists of 66 active satellites and 15 spare satellites (6 on the ground) which can be activated if needed. The company has 1.12 million subscribers for its services in 2018 (up nearly 15% from around 0.98 million in 2017). Hence, Iridium's business model is healthy and growing. The following section will analyse Iridium's growth opportunities and the role of IoT (Internet of Things).

2. IoT: the key driver for revenue growth

Iridium expects growth from the Industry 4.0, the Internet of Things:Satellite IoT Market 2027 Global revenue for all companies is expected to increase 65.6% (or 6.5 % p.a.) from $1.5 bn to $2.49 bn . Key growth markets for Iridium will be UAVs (unpiloted aerial vehicles), connected ships and trucks, connected farming and agricultural machinery and 5G. (source: Investor day slides 2019, p. 24)

Iridium is convinced of its strengths and satellite technology and it is prepared for the future because it completed its so-called 3 billion Iridium NEXT investment since 2007 for new products and a new generation of satellites. The company reduces its CapEx in 2019 below $100 million and starts a 10-year "CapEx holiday" with annual investments below $50 million. The CapEx holiday is possible because it introduces a faster generation of broadband transmitters, the Iridium Certus Broadband, which are up to ten times faster than the old generation. The Iridium Certus narrowband, which is used for voice & data transmission and for IoT, will be introduced next year. As a result, the company can reduce investmests in the next decade, supported by an extended life span of its new satellites, and can offer services for growing multi-billion dollar markets. Finally, Iridium will improve free cashflow and shareholder returns with a planned capital return of $2 bn through 2025. Furthermore, Iridium aims at debt reduction to deleverage the balance sheet. All in all, the company provides a good outlook for the next decade but is an investment in Iridium worth considering? Section 3 investigates Iridium's current valuation and balance sheet.

3. Valuation and balance sheet

Iridium's market capitalization is divided into 112.2 million common shares and 1.5 million preferred shares and amounts to $3.06 bn US as of 3/11/2019.

In 2018, total revenue was $523 million which results in a Price-to-Sales ratio of a whopping 5.85 which is much higher than the PS-ratios for competitors like SES (2.7) and Eutelsat (2.6). The company argues that its services cover a niche market and there are high barriers to entry this market which results in growing margins while SES' and Eutelsat's businesses face competition from terrestrial providers and commodity bandwidth pricing pressure. Nevertheless, Iridium's stock price shows a lot of optimism about the future.

The PE ratio is negative for 2018 because of a significantly lower tax benefit of just $7 million compared to $114 million in 2017. The net loss was also caused by a $67 million increase in interest expenses. From 2012 to 2018, Iridium Communications earned $0.88 per share on average. The share price as of 3/11/2019 was $22.6 (PE7= 25.7). A PE of over 20 is not cheap and also reflects great optimism among investors. Eutelsat's PE10 is below 13 and SES's PE10 below 10.

For 2019, Iridium expects a Leveraged Free Cashflow of $167 million (LFCF yield= 5.5%) which results in a Price to Free Cashflow ratio of 18.3. Again, the stock is not cheap at all even if investors can expect single-digit revenue growth annualy.

The balance sheet is the bright spot with an equity ratio of 40%, $272 million cash on hand and $130 million more current assets than current liabilities.

The book value per share is a fair 1.9 but compared to the competitors (Eutelsat PB= 1.3; SES= 0.9), Iridium seems to be overvalued.

The company does not pay any dividend but it intends to start paying a dividend or buying back shares in the near future.

4. Conclusion

Iridium Communications Inc. is a healthy company with a strong balance sheet and a good economic moat. The future prospects are promising and the company is well-positioned after its investment programm in new technologies and products. However, investors have to pay too much for the stock at current price levels comparing Iridium's valuation with its peers. A fair price and interesting entry point for investors can be seen in the range between $12-$15 per share.

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.