sats - anon write up 02 13 2012

8/3/2019 SATS - Anon Write Up 02 13 2012

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Echostar: Pie in the Sky

January 19, 2012

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Echostar (SATS) Write Up

Recommendation: Buy

Stock Price: $25

Fair Value Target: $35 or HigherBull Target: $50

Bear Target: $18

Market Cap: $2,038MM

Average Trading Value: $4.7MM per day

Description

Echostar is a satellite leasing, set top box technologies, and broadband satellite company which was

spun out of DISH Network in 2008. In June 2011, SATS acquired Hughes Communications, whichoperates satellites for broadband communications. SATS operates in three divisions: Echostar Services,

which leases satellites, mainly to DISH; Echostar Technologies, which sells STBs including Slingbox; and

Hughes. Charlie Ergen, the Echostar Chairman and Founder of DISH, owns approximately 44% of SATS

equity and 56% of the voting rights. In addition, he owns approximately 54% of DISH equity and 90% of

DISH voting rights.

Thesis

SATS is an undervalued, underfollowed, and hard to understand stock. SATS previously had no investor

relations and does not provide guidance or non-GAAP clarity. As a result, SATSs complex financial

statements make the Echostar business seem unpredictable. However, when properly analyzed, SATS

generates substantial FCF and has a clear growth path. In particular, the acquisition of Hughes adds

steady, strong EBITDA/FCF growth over the next few years. Further, the new IR will provide investors,

and potentially new sell side coverage, with clarity on SATS businesses. There are several catalysts over

the next few months capable of revealing undervaluation: the launch of Jupiter 1, Hughess new

+$300MM satellite; the growth of Slingbox as a popular 2012 consumer electronics item; and a set top

box upgrade cycle from DISH as their Hopper/Joey STB system is rolled out.

Valuation

I value SATS on three metrics: NPV (DCF), Asset Value, and Breakup. I would rank them in that order.

NPV To value SATS on a cash flow basis, one must adjust SATS earnings for deal related costs and

amortization of intangibles related to acquisitions, which have a significantly negative effect on GAAP

earnings but a positive effect, via lower taxes, on FCF. In addition, SATS has recorded GAAP taxes despite

GAAP operating losses due to capital gains taxes related to their profitable investment in Terrestar debt.


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In addition, SATS has NOLs and accelerated depreciation credits that will substantially reduce cash taxes

over the next few years.

To estimate SATSs present FCF generation, I annualized SATS Q3 earnings after adjusting for deal

related costs and amortization of intangibles. I then ran various growth and discount rate assumptions. I

believe annualizing Q3 earnings is sufficiently conservative as Q3 is a seasonally weak quarter, DISH hadexcess STB inventory for the past two quarters, and SATS earnings should expand significantly in 2012

and 2013.

Note: My NPV calculations use a DCF based upon FCFE.

In a no growth scenario with zero value assigned to cash and marketable securities, I calculate a fair

value of $13.15 and $10.86 at a 12% and 15% cost of equity, respectively. Importantly, this scenario

gives no value to SATSs $1,734MM of cash and marketable securities. While SATS has significant debt

($2,398MM) and large growth capex needs, it is doubtful all of their cash and securities are necessary as

part of working capital. SATSs combined capex and working capital needs have not exceeded $350MM

in any year of publically available data. If we were to assume 50% of cash and marketable securities areavailable for distribution to shareholders, it would add $9.85 per share in value. Thus, at a price $21-

$25, SATS stock reflects a no growth scenario despite a history of growth and large growth

opportunities. (Note: If SATS were to use its cash to pay down debt, the 12% and 15% cost of equity

scenarios would yield $21.68 and $17.81).

Assuming 10% EBIT growth (basically just mild Hughes growth) that trails towards 2%, yields $28.57 and

$21.97 at a 12% and 15% cost of equity. A more bullish, yet still conservative, scenario of 15% EBIT

growth yields $38.39 and $29.06. Again, these valuations give no value to the $19.70 of cash and

marketable securities and are calculated after interest costs.

SATS appears unstable due to its complex financial statements. However, SATS generates strong FCF at

present and has several strong growth opportunities over the next few years. Assuming the modest 10%

EBIT growth scenario and two years of peak capex needs required in cash, I value SATS between $34 and

$40 per share. A successful launch of Jupiter 1 and strong ramp of rural broadband subscribers would

warrant a $50 or higher valuation.

Asset ValueSATS is difficult to value on an asset basis as this requires assigning value to Echostars

satellite fleet. There is little comparable information available; it is calculated on a per case basis and

rarely done. SATS has a TBV of $17.77 per share. Orbitting satellites are a scarce resource and public

pure play satellite companies (VSAT, LORL) typically trade at a significant premium to TBV. Furthermore,

book value for satellites are calculated pre-launch and a functioning, orbiting satellite is likely worth

more than one on the ground. In addition, several of SATSs satellites are still in use though they have

been fully depreciated. I believe TBV is a sufficiently conservative asset valuation.

Breakup A breakup is unlikely given SATSs cash flow generation and majority owner Ergens long term

outlook. However, for arguments sake, I provide one. Assuming a 25% discount for Hughes relative to

where SATS purchased them in June, 4x EBITDA for the residual SATS business ex-Sling (versus VSAT at

10x EBITDA), 8x EBITDA for Sling, and book value for their remaining cash and marketable securities, I

value SATS at $31.91. Sell side break up values are in the $40-$50 range.


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Catalysts

Jupiter 1 Launch In Q2, SATS will launch Jupiter 1, a state of the art +$300MM Ka-satellite that will

increase Hughess capacity by 1.5 MM to 2.0MM subscribers versus ~0.6MM customers today. While

fully insured with a high chance of success (greater than 90%), the launch is both a catalyst and a risk forSATS. Satellite stocks typically rally into a launch, and the results of the launch will move the stock. A

successful launch will add $300MM to $500MM to annual EBITDA, conservatively. Compared to SATS

2011 adjusted EBITDA of ~$500MM, Jupiter 1 represents a tremendous growth opportunity.

Importantly, I believe SATS stock currently represents a no-to-very-low growth scenario. A successful

launch should significantly enhance the NPV of SATS and a failure is already priced in. (Not that the stock

wont sell off the next day if the launch fails)

Slingbox Slingbox is a device and technology that enables consumers to watch their television via the

internet on any device (computer, tablet, cell phone, other TV), anywhere in the world. While the

company has owned the technology since 2008, the proliferation of smart mobile devices and the

increased download speeds create a favorable backdrop for increased growth. At CES 2012, SATSannounced a deal with Broadcom to incorporate the Sling technology in STBs available in Q3 2012. In a

December 2011 interview, the CEO of Best Buy described Slingbox as his favorite new technology. Cable

providers have typically been cool towards Slingbox as it was owned by one of their rivals, Dish Network.

However, given recent disputes with content providers over television versus streaming rights, some

MSOs, such as Time Warner, have warmed to Sling. The growth path for Sling is not certain, but SATS is

not pricing in any growth and if Sling becomes a hot item, SATS shares would benefit.

STB Upgrade Cycle At CES 2012, DISH announced their new set top box system, Hopper/Joey, which

will be made by SATS. Over the past few quarters, DISH has been saturated with STB inventory and SATS

equipment sales have slumped as a result. The announcement of an upgrade cycle by DISH, while

relatively immaterial to an NPV calculation, should provide a modest medium term catalyst as a

fundamental headwind shifts to a tailwind.

Earnings Clarity While unimportant to an NPV valuation, GAAP earnings and the consistency and

clarity of GAAP earnings often drive stock prices. In the case of satellite stocks, such as LORL and VSAT,

many investors follow EBITDA given the large depreciation costs. SATS has previously frustrated

investors with their unwillingness to provide clarity and to help the Street. However, two important

changes should ameliorate this. First, the acquisition of Hughes, while complicated from a GAAP EPS

standpoint, adds less volatile, strong EBITDA growth that should be more palatable to investors.

Currently, due to the time lag between the Q2 launch of Jupiter 1 and the immediate interest

expense/amortization expense from the Hughes acquisition, the coming clarity and consistency of SATS

EBITDA growth is lost on investors. Over the next two years, SATS EBITDA will grow in a more stable and

consistent manner than the past few years. Second, after acquiring Hughes, SATS kept Hughess IRdepartment. At CES 2012, SATS management indicated a modest commitment to increased investor

communication. This increased communication should help more investors uncover the value in SATS.

Increased Sell Side Coverage SATS is currently only covered by two analysts: Macquarie and Citi. As

SATS has grown significantly in size since the Hughes acquisition, increased sell side coverage of the

name is rumored and would likely be positive.


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Risks

Jupiter 1 failure Close relationship between DISH and SATS Sluggish STB business Continued transparency issues


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Tangible Book Value Break Up Value

Loral Stake 136.5 Hughes at 25% Discount to Acquisition 1,631.3


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Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Base Year (Q3 Annualized)

Acquisi tion Adjuste d EBI T 313. 20 313. 20 313. 20 313. 20 313. 20 313. 20 313. 20 313. 20 313. 20 313. 20 Acquisi tion Adjuste d EBI T 313. 2

Interest Expense 156.00 1 56.00 1 56.00 1 56.00 156.00 1 56.00 1 56.00 1 56.00 1 56.00 156.00 Inte rest Expense 156

Taxes 55.02 55.02 55.02 55.02 55.02 55.02 55.02 55.02 55.02 55.02 Taxes 55.02

Net Income 102.18 102.18 102.18 102.18 102.18 102.18 102.18 102.18 102.18 102.18 Net Income 102.18

--EBIT Growth 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Implied GAAP EPS 1.16 1.16 1.16 1.16 1.16 1.16 1.16 1.16 1.16 1.16

Int A mort and Me rge r Ex p. 103.00 80.20 78. 60 63.30 50.00 40.00 30.00 20.00 10.00 0.00

Tax Rate 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35

Tax Benefit 36.05 28.07 27.51 22.16 17.50 14.00 10.50 7.00 3.50 0.00

Four Tax Free Years 55.02 55.02 55.02 55.02 0.00 0.00 0.00 0.00 0.00 0.00

Total Cash Tax Benefit 91.07 83.09 82.53 77.18 17.50 14.00 10.50 7.00 3.50 0.00

assume FCFE = NI + Tax Benefit

Ne t Income 102.18 102.18 102.18 102.18 102.18 102.18 102.18 102.18 102.18 102.18

Total Cash Tax Benefit 91.07 83.09 82.53 77.18 17.50 14.00 10.50 7.00 3.50 0.00

FCFE 193.25 185.27 184.71 179.36 119.68 116.18 112.68 109.18 105.68 102.18

Implied NPV

@12% $13.15

@15% $10.86


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Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Base Year (Q3 Annualized)

Acquisition Adjusted EBIT 344.52 378.97 416.87 458.56 498.31 534.89 567.04 593.57 613.46 625.85 Acquisition Adjusted EBIT 313.2

Interest Expe nse 156.00 1 56.00 1 56.00 1 56.00 1 56.00 1 56.00 1 56.00 1 56.00 156.00 1 56.00 Inte rest Expense 156

Taxes 65.98 78.04 91.30 105.89 119.81 132.61 143.86 153.15 160.11 164.45 Taxes 55.02

Net Income 122.54 144.93 169.56 196.66 222.50 246.28 267.17 284.42 297.35 305.40 Net Income 102.18

--EBIT Growth 10.0% 10.0% 10.0% 10.0% 8.7% 7.3% 6.0% 4.7% 3.4% 2.0%

Implied GAAP EPS 1.39 1.65 1.93 2.23 2.53 2.80 3.04 3.23 3.38 3.47

Int A mort and Me rge r Ex p. 103.00 80.20 78. 60 63.30 50.00 40.00 30. 00 20.00 10.00 0.00

Tax Rate 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35

Tax Benefit 36.05 28.07 27.51 22.16 17.50 14.00 10.50 7.00 3.50 0.00

Four Tax Free Years 65.98 78.04 91.30 105.89 0.00 0.00 0.00 0.00 0.00 0.00

Total Cash Tax Be ne fi t 102.03 106.11 118. 81 128.05 17.50 14.00 10. 50 7.00 3.50 0.00

assume FCFE = NI + Tax Benefit

N et Income 122.54 144.93 169. 56 196.66 222.50 246.28 267. 17 284.42 297.35 305.40

Total Cash Tax Be ne fi t 102.03 106.11 118. 81 128.05 17.50 14.00 10. 50 7.00 3.50 0.00

FCFE 224.57 251.04 288.38 324.71 240.00 260.28 277.67 291.42 300.85 305.40

Implied NPV

@12% $28.57

@15% $21.97


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SATS - Income Statement (US$m) 2007 2008 2009 2010 PF2011E PF2012E PF2013E

EchoStar Technologies 1,554 1,941 1,710 2,071 1,826 2,071 2,175

EchoStar Satellite Services - 189 174 262 291 375 405

Hughes and other - 20 20 18 701 1,293 1,605

Revenue 1,554 2,151 1,904 2,350 2,818 3,740 4,185

QoQ

YoY 38.4% (11.5%) 23.5% 19.9% 32.7% 11.9%

Cost of revenue - equipment 1,438 1,495 1,267 1,553 1,454 1,709 1,914

% of Revenue 92.5% 69.5% 66.6% 66.1% 51.6% 45.7% 45.7%

Cost of revenue - services and other 16 221 203 236 506 701 784% of Revenue 1.0% 10.3% 10.7% 10.1% 18.0% 18.7% 18.7%

R&D 66 35 44 46 50 64 67

% of Revenue 4.3% 1.6% 2.3% 2.0% 1.8% 1.7% 1.6%

SGA 100 164 140 144 297 434 491

% of Revenue 6.5% 7.6% 7.4% 6.1% 102.2% 115.8% 121.2%

SGA - DISH 0 0 0 0 20 30 33

% of Revenue 0.0% 0.0% 0.0% 0.0% 0.7% 0.8% 0.8%

Impairment/Litigation 0 613 0 0 2 2

Total operating costs and expenses 1,621 2,527 1,655 1,979 2,327 2,940 3,291

Adjusted EBITDA (67) 236 249 371 491 802 895

D&A 10 264 244 229 390 580 643

% of Revenue 0.6% 12.3% 12.8% 9.7% 13.8% 15.5% 15.4%

Operating Income (76) (641) 5 142 101 220 251

Interest income 10 35 26 26 13 20 20

Interest expense (1) (32) (32) (26) (85) (156) (156)

Unrealized gains 3 (408) 432 147 22Other net (10) (9) (6) (1) (14) 0 0

EBT (73) (1,055) 425 289 36 84 115

Tax Expense/ (Benefit) 2 (97) 61 84 27 29 40

Tax Rate (2.9%) 9.2% 14.3% 29.2% 74.5% 35.0% 35.0%

Income from continuing operations (75) (958) 365 204 9 55 75

Income discontinued operations 0 - - - 0

Net Income (75) (958) 365 204 9 55 75

Adjustments (112) 0

Adjusted Net Income (75) (958) 365 92 9 55 75

Basic shares 90 89 86 85 86 88 90

Dilued shares 90 89 86 85 88 88 90

Reported EPS ($0.84) ($10.73) $4.24 $2.40 $0.11 $0.62 $0.83

Adjusted EPS ($0.84) ($10.73) $4.24 $1.09 $0.11 $0.62 $0.83


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sats - anon write up 02 13 2012

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