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Are FSS operators facing a GX moment?

GX represents a new type of service for Inmarsat The success Hyperinflation providing new record of prizes aside, real value capabilities that for accelerating creation has substantially to be innovation and constrained augment theirat leveraging scarce least capabilities legacypartially by funds is quite the boundary remarkable conditions of the economic system

With much fanfare, in 2010 Inmarsat PLC announced that it was investing $1.2 billion in a breakthrough new program: Global Xpress (or GX). In addition to being a technological tour de force with near global coverage at planned speeds of 50 mbps, Global Xpress represented a strategic departure for Inmarsat, which heretofore had been committed to providing service using the Mobile Satellite Service (MSS) band. In contrast Global Xpress will use the Ka band, which has previously been used for providing fixed services, and radically different user terminals as a result. Combined with its extensive reuse of spot beam technology to provide lower cost capacity, GX represents a new type of service for Inmarsat providing new capabilities that substantially augment their legacy capabilities.

Inmarsat Global Xpress spot beam coverage However, this new capability is coming at substantial cost! Inmarsats announcement came on the heels of its $1.5 billion investment in Inmarsat 4 satellites, which were finished just two years earlier. Given that the Inmarsat 4 series has a design life of 13 years, this substantial incremental expenditure for GX is going to need to result in equally impressive revenues to justify itself and it looks set to at least partially cannibalize the revenues its predecessor Inmarsat 4 system is generating. While its hard to say that this is a direct consequence, Inmarsats equity has

Inmarsat 4 satellites, which were finished just two years earlier

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suffered since the Global Xpress announcement as compared to other public FSS operators such as SES and Eutelsat (recent problems at Lightsquared have also contributed, as well as increased MSS competition in general).

InmarsatEquityvs.FSSFirms
ISAT 20% 10% 0% 10% 20% 30% 40% 50% 60% 6/7/2010 10/7/2010 2/7/2011 6/7/2011 10/7/2011 2/7/2012 SES ETL

Global Xpress represented the logical response take the best of the competing technologies, combine it with Inmarsats market leadership and print money

We are quick to note that Inmarsat is simply responding to technological and competitive dynamics that are affecting its core business and are not criticizing in as much as we believe it had little choice. In 2010, Inmarsat was facing pressure from service providers such as Ship Equip and KVH that employed tracking satellite antennas using Ku band capacity, which greatly lowered the cost per bit compared to Inmarsat 4. Likewise, in the case of technology, ViaSats HTS satellite program as well as Hughes Spaceway and Jupiter programs proved that with vast new spectrum resources and heavy spectrum reuse designs satcom cost per bit can come down by more than an order of magnitude compared to traditional Ku band. Global Xpress represented the logical response take the best of the competing technologies, combine it with Inmarsats market leadership and print money. All well and good, except this effectively meant that Inmarsats investment in Inmarsat 4 was, at least partially, stranded and as the market recognized this over time it got priced in. But then, if Inmarsats stock is being penalized because of the heavy investment needs of Global Xpress, which in turn we would argue was driven by evolution in technology and the marketplace beyond

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Inmarsats control, the question arises whether the remaining FSS operators face a similar risk from the advent of HTS satellites. With their 50+ satellite fleets and substantial financial leverage to boot (especially at Intelsat), this is not a trivial issue were talking about ~$10 billion in sunk fleet investments. given the higher cost of these massive spot beam designs as compared to conventional satellites, employing them for [data networking] may not always be capital efficient While the marketplace will be the ultimate arbiter, ViaSats Exede broadband offering (soon to be augmented by an enhanced HughesNet) offers broadband connectivity at a breakthrough cost per bit that is likely to seriously affect demand for Ku VSAT networks in the North American market. We already know that Hughes has transferred significant amounts of Ku traffic from other FSS birds to its own SPACEWAY Ka bird releasing the unused Ku capacity into the marketplace. With over 200 Gbps of capacity between them, ViaSat-1 and Hughes own Jupiter satellite are likely to extend this trend, further depressing conventional Ku demand in North America even as they drive expansion of the overall market for satcom. Beyond North America, Newsat, Avanti, Eutelsat, Yahsat and others also have multi spot beam high capacity satellites that are going to remake these markets as well. So, what is the magnitude of this effect on the operators? First, we need to point out that these new satellite designs are optimized for data networking (typically via VSAT), not broadcasting. So, while they do very well for carrying enterprise and government data traffic, they offer no particular advantage for distribution of video to consumers or cable head ends. In fact, given the higher cost of these massive spot beam designs as compared to conventional satellites, employing them for these services may not always be capital efficient. So, if the real threat is to networking traffic versus video broadcasting, who is at risk? The operators use somewhat different language to describe their respective customer bases, so we have limited visibility into their revenue sources. With that said, according to its 2011 SEC form 10-K, Intelsat received 47% of its revenue from Network Services and 29% of its $10.7 billion backlog was for these services. At year end, Intelsat had $6.0 billion (net of depreciation) of satellite assets. Likewise, SES receives 25% of its revenue from voice and data services, with 6.6 billion in total backlog (no breakdown by type was given). In the case of Eutelsat, which derives 20% of its revenue from data services, at year end 2011 the firm had 5.3 billion in backlog, 93% of which was video

If the untimely obsolescence of a significant amount of satellite capacity drives a new round of capex as operators upgrade their fleets , who is best positioned to spend the cash?

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leaving the firm significantly less exposed to networking traffic. Finally, in the case of Telesat, 42% of revenues come from enterprise services against a backlog (type unspecified) of $5.4 billion. If the untimely obsolescence of a significant amount of satellite capacity drives a new round of capex as operators upgrade their fleets, much as Inmarsat had to, who is best positioned to spend the cash? Looking at the finances for the larger FSS firms, we start with Intelsat, which has $15.5 billion in net debt (8.1x EBITDA). For comparison, SES has net debt/EBITDA of 3.0x and Eutelsat has net debt/EBITDA of 2.5x. In the case of Telesat, after adjusting for a proposed dividend recap, the firm carries net debt to EBITDA of 5.1x. In coming years, the ability to more aggressively pursue the opportunities this potential upgrade cycle represents could be a value differentiator for investors and the less levered players are going to have greater flexibility. Balancing this potential negative impact to the global FSS operators fleet valuation, we note that the trend to extract new revenue streams from depreciated satellites that we identified in 2009 (largely by virtue of using tracking antennas to monetize inclined capacity - see Turning Space Junk into Cash at www.nearearthllc.com/analysis/presentations/vol5.3.3.pdf) remains intact. In addition, the FSS operators have significant advantages that Inmarsat does not diverse service revenue streams (i.e. data and broadcast) as well as substantial booked backlog. Thus, we expect the financial effects of a new HTS inspired capex cycle to be significantly more muted in their case than has been the case with Inmarsat. We suspect the major FSS companies are all over this new development and certainly have more time to consider their responses. All of them have the financial and technical resources to respond, if they so choose. However, predicting the level and timing of new market demand created by HTS price points is not a trivial endeavor. Some will get it right, some will bet wrong. In our view, the less risky path is to be bold like Inmarsat rather than denying the nearer term fleet obsolescence the arrival of HTSs may represent. Potential beneficiaries of an accelerated construction cycle would also include satellite manufacturers such as Loral, Astrium and Boeing and launch service providers such as ILS and SpaceX. Alternatively, the pressures from this sea change could drive new rounds of M&A activity, as operators figure that they can buy faster

we expect the financial effects of a new HTS inspired capex cycle to be significantly more muted in [the FSS operators] case

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than they can build. We suspect that investors in several of the smaller operators mentioned above could view this as their ultimate exit strategy. Of course, the ultimate winners will be customers with lower cost, better coverage service. And, who can complain about that?
By John Stone Near Earth LLC

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