Iridium Communications: Unparalleled NEXT Capabilities To Drive Cash Flows, Clean Balance Sheet And Return Capital To Shareholders

Summary

• The strong IoT momentum is set to resume as social distancing measures ease - reacceleration in subscribers growth and rollout of Certus midband device.
• The evolving financial profile and value of Aireon stake with prevailing long-term tailwinds to air traffic and tighter GADSS measures set for 2021.
• Catalysts: 2H20 reopening of the global economy.

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For the reasons mentioned in the summary, I issue an outperform rating and a $26.45 price target for Iridium Communications (NASDAQ: IRDM) derived from an average of the low-end estimate prices in Exhibit 8's football field range.

Financial Summary

1Q20 marked the first full year of Iridium NEXT service. Continued FY19 commercial momentum primarily stemmed from industry adoption of Certus broadband's unparalleled speeds/capabilities in addition to an Aireon contractual fee steps up. Q1 commercial services revenue was up 7% with commercial subscribers (~90% of total subscribers) up 12% YoY. This was partially offset by a COVID-19-led global slowdown in client demand particularly in aviation (less flight tracking), maritime (social distancing preventing the OpenPort terminal installation/activations) and oil and gas (lower oil consumption) verticals. Elsewhere, Iridium strengthened their US government relationship through 2019 EMSS and IDIQ contracts and saw trailing twelve government revenues (services and equipment/support services) and subscribers up 19% and 22% YoY, respectively.

In terms of margins, Q1's gross margins grew 2.5% YoY primarily from a discontinued in-orbit insurance policy while EBIT margins benefited from lower post-NEXT R&D and management comp/SAR expenses, partially offset by increased depreciation on the new constellation. Iridium's Q1 $145.3m revenue beat street estimates by $3.8m and the $0.01 EPS, excluding the $30m loss recognized for the early extinguishment of debt, beat street estimates by 12 cents.

4Q19 saw Iridium refinance their legacy BPIAE loan facility with a $1.45bn (LIBOR+3.75%) term loan providing shareholder-friendly terms accommodative to future buybacks, dividends and M&A activity. The firm immediately hedged a portion ($1bn) of this variable interest rate risk with a 1.565% fixed rate Swap and later extended the issuance by $200m in Q1 to address any near-term liquidity issues. Iridium's strong earnings and growing free cash flow (positive for the fourth consecutive quarter time on a trailing twelve basis) are supportive of the added debt with the 4.5x net leverage ratio down 0.3x YoY and 0.1x QoQ - on the path for the FY20 target 4.3x.

Rationale

Since the beginning of the 21st century, a concerted regulatory push has forced geostationary satellites (GSOs) to share the use of C-, Ku-, Ka- bands (now Q- and V-band frequencies), thus their hold of the global communication ecosystem with non-GSOs such as Iridium. Non-GSOs operate closer to the earth so require less terminal power to transmit while experiencing less interference between satellites and systems. As businesses and governments continue to digitize processes and expand their geographic footprint, the commercial drive for cost-efficient, truly global and always-on connectivity has increased the value proposition of IoT, particularly in non-GSO constellations.

M&M research points to a $95.1bn global wireless connectivity market in 2023 - 13.4% CAGR. According to SIA, the US holds, on average, a 44% share of global satellite industry revenue with mobile satellite (i.e. maritime, aviation, etc.) and earth observation services being the fastest-growing segments of the largest share of within these global revenues. Iridium NEXT's unrivaled reach and speeds combined with an AWS-powered CloudConnect position their value-added partners and end-users to address their big data needs. It is with these points and the below theses that I see further upside to profitability, cash flows and share price:

1. Over half of the world remains disconnected and this represents billions of people and devices for Iridium's thriving IoT business to capitalize on. IoT represented 27% of commercial revenues in FY19 with subscriber growth topping 25%, CAGR, in the trailing 10 years. Iridium's broad 450+ partner ecosystem has been a large driver for this growth and with Certus' industry-leading speeds/coverage, the firm's value proposition is reaffirmed leaving ample growth opportunities for the firm and partners to exploit NEXT constellation's true capabilities. Notably with the 2H20 rollout of midband devices providing rich imagery and video capabilities to tap into a $52bn UAV market; and the new maritime business opportunities spilling over from the GMDSS approval ending Inmarsat's monopoly on the provision of the satellite-based portion of maritime distress services. Over 20 new IoT partners were added in 2019 alone which is the momentum that will continue on the other side of a COVID-19 vaccine, with a catch up on delayed/new network activations providing upside for ARPU.
2. Air traffic growth has consistently defied economic recessionary cycles, expanding two-fold every fifteen years over the last 45 years, and directly/indirectly contributed $2.7+ trillion to global GDP in 2018. Since the NEXT constellation launch completed, Aireon has seemingly delivered on its promise to address the inefficiencies within air traffic control with strong momentum in-service tests completions, ADS-B deployment and new partnerships - see Exhibit 11. As GADSS increase their safety requirements to minute-by-minute updates for aircraft in distress in 2021, the value of Aireon services grows. Aireon's access to a $200m credit line positions them well to address near-term liquidity risk from the COVID-10-sparked halt in air traffic. Longer term, the firm's continued milestones point to strength in their ability to exceed GADSS safety requirements, pay their remaining $146m debt to Iridium by 2021 and begin to deliver a meaningful return to Iridium shareholders.

My $26.45 price target implies a 14% upside and rich premiums on both a trailing EV/Sales, P/Sales, and EV/EBITDA multiples - see Exhibit 7. Iridium's unparalleled coverage, broad and expanding partnerships in key verticals, within a high margin business model positions them well to grow cash flow and return to profitability in the upcoming CapEx holiday. This financial profile allows the firm to weather the severe macro headwinds better than their traditional satellite peers; as seen by the recent Speedcast, Intelsat and OneWeb bankruptcies; justifying their loftier multiples. The price target's implied 14x FY21 EV/EBITDA is nearer to that of the Fiber industry as a result. My conservative WACC of 6.21% factors in the target FY20 4.4x net leverage in addition to a continued shift to a recurring service revenue model as the momentum of NEXT's adoption resumes in FY21.

Risk Factor(s)

The pace of the COVID-19 outbreak combined with the strong social distance measures saw the pace of subscriber additions reduce in March according to CEO Matt Desch - particularly with the abrupt halt of air traffic and oil demand/prices collapsed. Further extensions to preventative measures of the COVID-19 outbreak taken by governments and nations in the reopening of businesses are likely to further extend the recovery of the global economy. This will delay the rollout of key industry technologies (i.e. 5G), see growth opportunities for Iridium's products and services missed, leading to softer subscriber growth and ARPU.

Catalyst(s)

Near term, investors should look out for the continued easing of social distancing measures and the gradual restart of the global economy as Iridium's products/services, partners and coverage span globally. The expected rebound in the revenues and budgets of partners and end-users in 2H20 should accompany a reacceleration in Iridium sales and subscriber growth as normal usage levels and physical installations of terminals are safely resumed.

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Analyst’s 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.