Dollars And Sense: Satellite Stocks–Who Is Leading The Pack?
by Armand Musey
Our research team found a new home at Salomon Smith Barney. This changing of firms required us to reinitiate coverage of the group, which gave us the opportunity to review many of the fundamental premises underlying our stock ratings and 12 month price targets. This review led us to our second major downward revision in forecasts for the group in three months. Salomon Smith Barney’s ratings follow a scale from “1” to “5,” with “1” representing a “Buy” recommendation and “5” a “Sell.” We cover nine publicly traded satellite companies, many of which are the best of the breed: large, well-funded, market share leaders with seasoned management teams. However, we do not believe that any of them currently warrants a “1” rating. Most are “2s” and “3s” with an attached “H” for “high-risk,” or even “S” for “speculative.”
Over the long-term, we remain upbeat about the prospects for the satellite industry, particularly for point-to-multipoint satellite media applications, such as direct broadcast satellite television (DBS), consumer broadband satellite services (BSS), and satellite radio (DARS). Because transmitting data via satellite is more expensive than terrestrial options, services that use satellites to broadcast data to multiple recipients will fare better that point-to-point services such as satellite telephony, which require single recipients to subsidize the entire cost of a transmission. In general, satellite media services offer the strongest long-term growth potential.
Over the past couple of months, we have written extensively about the deterioration of the DBS business model. Our thesis, and the basis for our December downgrade of the DBS stocks, is that returns on a per-subscriber basis are falling as subscriber acquisition costs (SAC) have been rising faster than average revenues per user (ARPU), while average subscriber lives have shortened due to rising churn rates. We expect this trend to continue until late 2001, when the roll-out of incremental services begins to gain traction and inflate ARPUs. Once these services gain substantial market share we expect returns to be high due to the relatively modest investment needed to roll-out these services. We also believe these services will have a positive impact on churn rates, driving up average subscriber lives.
We are a bit more sanguine about the prospects for satellite telecom services. In its current configuration, satellite telephony has not proven to be economically viable. The failures of Iridium and Globalstar demonstrate that there is just not a big enough subscriber universe to cover the large fixed costs of these global communication platforms, although we do hold out hope for smaller regional GEO providers. We also believe private satellite network (VSAT) providers will continue to gain market share, but caution investors that the heady growth days of these companies are over as they have begun to saturate their core markets. We also like the FSS business over the long-term, and would be focused on companies that are learning how to become fully integrated service providers. Nevertheless, this industry has significant overcapacity which will continue to put downward pressure on pricing for some time to come. We expect diminishing returns from FSS companies, until new service offerings, such as datacasting, begin to gain ground.
Of the DBS companies, we like Pegasus ($22.69) the best, based on current valuation. We are currently recommending Pegasus with a 2H and 12-month price target of $33. The company, which is the largest reseller of DirecTV in rural markets, trades at a significant discount to both Hughes ($18.95) and EchoStar ($27.38) on a per-subscriber base, even after accounting for less favorable economics of its programming licensing arrangement. We are also recommending Hughes with a rating of 2H and a price target of $24. We will feel more comfortable recommending this stock once we have better clarity regarding the company’s merger strategy. We rate EchoStar a 3H, based on valuation, and have a 12-month price target for shares of Dish of $27. This is a company we believe is getting a premium on the assumption that it can continue to build upon its flawless past execution.
Among the other companies we cover, we are recommending both Sirius ($13.38) and XM Radio ($6.94) with ratings of “2S” and price targets of $25 and $15 respectively. We believe that recent concerns over problems with the Sirius satellites’ solar panels and slow consumer rollout are overblown and do not significantly increase its risk profile. Sirius does not have the launch risk of XM, and has already demonstrated that its receivers work. We have reduced our price target for Sirius and XM by 25 percent from our fair market DCF valuation to reflect increased market uncertainty.
Gilat ($12.75) is rated a 2H and has a price target of $20. At current levels we believe this stock is undervalued, trading at just 13x 2001E EPS. However the company has a lot of creditability to restore, following last quarter’s earnings mishap. Loral ($2.34) is rated 3S and has a price target of $6. Right now we believe the company is trading at less than its pure-asset valuation. However, given its current cash flow problems, we caution investors to stay by the sidelines. Orbital Sciences ($6.10) also carries a rating of 3H. Its price target of $10 is based on a sum-of-the-parts analysis. Among the stocks in our universe only PanAmSat ($37.94) was spared from price target reductions. PanAmSat is rated 2H and has a price target of $46.
Armand Musey is the satellite communications analyst at Salomon Smith Barney (“SSB”). He can be reached at 212-816-6008. The foregoing article should not be considered as a recommendation with respect to any security. SSB and its affiliates may maintain a long or short position in, act as a market maker for, or purchase or sell a position in, securities of referenced entities and may also perform investment banking, advisory, or other services for any such entity.