Dollars And Sense: Cycle Of Consolidation Rolls On
by Armand Musey
Consolidation pressures in the satellite manufacturing business have increased, given the continued deterioration in the industry’s outlook for 2002 and beyond. In June, press reports indicated Loral and Lockheed Martin were contemplating a combination of their satellite manufacturing businesses. The proposed transaction would create a company with annual revenues in excess of $1 billion and a commercial backlog of approximately $1.8 billion. More recently, press reports have indicated that EADS has proposed combining its Astrium business with Alcatel’s satellite manufacturing business in a move to create a single large European satellite manufacturer.
Our view is that both transactions would bring about a desperately needed rationalization of capacity. By our estimates, the industry has an enormous amount of excess capacity based on existing manufacturing lines. Total capacity is close to 50 new satellites a year, yet we know of only seven new orders so far this year including two to Israeli Aircraft Industries, two to Lockheed Martin and one each to Boeing, Astrium and the Chinese Academy of Space Technology. The annual number of commercial satellite orders declined steadily from 30-40 in the mid- to late-1990s to less than 28 last year. We expect demand for large GEO satellites to equal around 20 per year through 2007 based on known projects. Demand for smaller LEO satellites is not expected to be much better, with most known orders coming from government and scientific projects.
Several factors are making the outlook for new satellite orders challenging. These include shorter manufacturing cycle times, the cancellation or scaling back of several proposed satellite broadband projects, and the fact that new satellites are typically far more powerful and expected to last much longer than those they are replacing. We would also note that near-term trends are exacerbated because several of the largest FSS operators have completed, or are in the process of completing, fleet replacement programs, including Intelsat, Eutelsat, Panamsat and SES Global.
If the satellite manufacturing industry were to go through a cycle of consolidation, the resulting improvement in efficiency could lead to a healthier pricing environment for customers and stronger financial performance from the surviving suppliers. Along with major cost-savings, we believe satellite manufacturers may also gain the following through consolidation efforts: increased efficiencies in research and development; rationalization of manufacturing lines; reduced sales and marketing expenses; and the opportunities for synergies to be recognized through vertical integration.
If this much-needed consolidation in commercial satellite manufacturing were to occur, we believe a triumvirate of commercial manufacturers would emerge: Boeing Satellite Systems, Lockheed Martin/Loral, and EADS/Alcatel, while a combined Northrop Grumman/TRW would likely emerge as a major competitor to Boeing and Lockheed on the defense side. We think these combinations would create companies with stronger balance sheets. With only 15 to 20 new satellite orders expected per year, however, this would translate into only five to seven satellites per manufacturer each year, well below the ’90s levels.
Another intriguing opportunity for consolidation would involve further vertical integration between the satellite manufacturing and the launch service businesses. We note that significant overlap already exists between the satellite manufacturing and the launcher segments with three operators dominating: Boeing, Lockheed Martin and EADS. These same three also provide satellite launch services through affiliated entities: Lockheed Martin through its International Launch Services partnership; Boeing through its Sea Launch venture; and EADS through its share in Arianespace.
We believe further integration of the satellite manufacturing and launch business would not only improve the outlook for suppliers by creating companies with stronger balance sheets and improved cost structures, but improved efficiencies could also be passed on to customers in the form of lower overall prices, particularly if manufacturing and launch services were to be delivered as an integrated package. Naturally, just because this makes economic sense does not necessarily mean it will happen. For one, regulatory restrictions and national pride could curtail many deals. Some companies (such as Alcatel) may also be resistant to merge with former rivals. However, it is clear that rationalization of capacity would likely benefit the industry as a whole.
Armand Musey is a satellite communications analyst at Salomon Smith Barney (SSB). Part of the information provided herein includes excerpts, abstracts, and other summary material derived from research reports or notes published by Armand Musey as a member of the Firm’s Global Equity Research Department. For a copy of the full research reports or notes or to view the research-report disclosure required by the NYSE and NASD rules relating to analyst independence and conflicts of interests, please visit http://www.ssbaccess.com or contact a SSB Financial Consultant. Valuation methodologies and associated risks pertaining to price targets, as well as other important disclosures, are contained in research reports and notes published on or after July 8, 2002