Will Niche Companies Spur Industry Growth?

By J. Armand Musey

The dominant sectors in the satellite industry, fixed satellite services (FSS) and direct-broadcast-satellite (DBS) services, are entering a mature growth phase. The level of growth is in the low to mid-single digits annually. Other major sectors, including manufacturing, launch services and insurance, actually are in a decline versus historical norms.

Moreover, large private-equity firms now control much of the FSS industry, and most observers expect they will run them conservatively by focusing on improving operating performance without aggressive expansion.

While growth may be constrained at the larger firms, there are opportunities for smaller players and new entrants. As the satellite industry adjusts to these new realities, growth in the near term will come primarily from small, niche firms. Investors may find some real gems.

The general growth outlook for most sectors of the industry is weak. There is low demand and moderate overcapacity in the FSS sector. DBS growth, particularly in developed countries, is slowing. In the United States, for example, more than 95 percent of U.S. homes have DBS or cable, including homes engaging in piracy. These trends, of course, also have downstream effects on satellite manufacturing and launch services. For the next five years, fewer than 20 satellite orders a year would be needed as replacements for aging in-orbit spacecraft. Ground-segment providers also would be affected.

These trends will cause heightened focus on operational improvements through downsizing, internal rationalization and general “belt-tightening.” Companies will revisit their overall structures, and they will question whether they are best designed for a slow-growth market. Joint ventures, increased outsourcing and swapping assets as well as other types of creative transactions could help to rationalize assets between companies.

Outsourcing Will Begin

The FSS industry likely will begin to outsource its satellite operations and telemetry, tracking and control (TT&C) functions. There is significant overcapacity, and few operators see TT&C as a core competency. There is little reason why an outsourced service provider could not be used to fly the satellites of several operators to achieve large economies of scale. It is unlikely that many operators would want a competitor to fly its satellites, so we expect that third parties will emerge to own these assets and to fly the satellites of multiple operators, much in the manner in which the communications-tower industry has evolved in the United States. In fact, Universal Space Networks is seeking to do just that with the backing a major private-equity shop, Warburg Pincus, which is its majority shareholder. On the manufacturing side, ComDev has been buying assets to help satellite manufacturers outsource some of their processes so the manufacturers can rationalize and become more profitable on a smaller number of orders.

On the ground-segment side, there will be more consolidation in satellite communications equipment, teleports, network design and antennas. Established companies with solid management — and appropriate balance sheets — are likely to acquire some of these smaller companies. These sectors of the satellite industry are highly fragmented, and some companies are akin to “hobby shops” run by a few brilliant engineers. Overcapacity and redundancy is huge. Expect the U.S. government’s increasing use of satellite communications to serve as a catalyst to drive much needed consolidation in these sectors as companies position themselves to compete for sizable and long-term contracts.

On the DBS side, we are seeing EchoStar Communications [DISH] gradually outsource its satellite fleet to SES Americom to save operating costs. We also are seeing an increased focus on identifying niche markets and niche content. Small startups are bringing new technologies and business models to the multiple-dwelling- unit market that includes college dormitories. A customer base with low monthly revenue and high churn rates might be served profitably with new video technology.

On the financial front, long-awaited initial public offerings appear to be off the table until the private-equity firms decide to sell. Those sales are not likely to occur for another three to five years.

Large investment banks increasingly will be hard-pressed to keep dedicated satellite bankers on staff. Coverage of the industry likely will shift to private-equity-coverage groups, the mergers-and-acquisitions (M&A) groups or the high-yield desks as transactions are needed. With a few exceptions, expect a significant decline in the focus, effort and creativity from Wall Street, especially for the small and mid-sized firms. The creation of boutique investment firm Near Earth LLC is an example of a niche firm that emerged to fill such an industry void. Other entrepreneurial startups also should be expected.

Relatively small companies pursuing niche opportunities likely will spur the next phase of industry growth. Investors will need to sharpen their focus and look below the industry’s surface to find them. This effort will require identifying private companies that are not required to disclose extensive financial information the way public companies must do. However, the effort could be well worthwhile.

J. Armand Musey, CFA, is president of Near Earth LLC, a boutique satellite-investment bank; he can be reached at [email protected]. The views in this article reflect those of the author and are for informational purposes only. They do not constitute an investment recommendation of any type. Universal Space Networks, mentioned in this analysis, is a client of Near Earth.