Print
Email
A few months back, I mentioned how I had read through Whitney Tilson’s articles and changed my opinion of him.
Well, Tilson is nice enough to publish his thesis on basically all of his holdings. After reading his articles, I went ahead and read his thesis, and one of them really jumped out as perfect for the powerball idea series — Iridium (IRDM).
You can view Tilson’s thesis on Iridium here. The basics of it are: Iridium is trading for a fraction of the multiple of its main competitors, but Iridium is in a rapidly growing industry and taking market share. The market seems to be discounting Iridium due to concerns about funding (I feel last week’s powerball pick, ATPG, is receiving a similar discount, and bought their bonds because of it) for their next generation of satellites (named NEXT) and fear of investing in a company created through SPACs. However, taking a longer term view of Iridium reveals a company that could easily trade for 3-5x the current price in the near future if it can execute properly.
I feel like the Tilson presentation pretty accurately covers all of the potential upside, so I’m going to cover the potential downside and why this is a powerball idea. I think most of the downside centers around slide 13 in the appendix: their funding for their next generation of satellites.
The big concern here is the company will need $2.7 billion in cash through the next four years to fund their satellite launches. Given TTM EBITDA comes in at approximately $175 million, that’s a huge, huge amount. Tilson believes they will be able to fund most of it through cash from ops and government-backed, low-cost financing. The market clearly isn’t as convinced, as the stock price today implies they’ll have to pay a pretty high cost for the new capital and likely need to dilute shareholders.
The price may also be depressed due to a flood of stock hitting the market, as Greenhill, which owns approximately 15% currently, continues to sell their shares as they look to raise cash for share buybacks. Interestingly, a depressed price can really effect the value of IRDM, as they were counting on the cash from two sets of warrants being exercised to help them with their funding problems. Lower stock price = no cash from warrants = need for dilutive equity raise = lower price. Quite a vicious circle!
Also remember this: Most of the costs for IRDM come from the costs of running and maintaining their satellites. Those are fixed whether the company has one customer or 100,000. Those, IRDM has huge operational leverage. That creates even more uncertainty. If IRDM continues growing, their cash flow will grow even faster and the cost for launching their satellites will loom smaller and smaller. But if growth stops, the liquidity trap looks even worse!
Obviously, Tilson likes the stock. I don’t think it’s a bad value at these prices. But it is risky — there’s substantial upside, but serious risk of a good sized loss or even a zero if things don’t break the right way.
Instead, I think the better value might be the IRDM’s warrants (traded under IRDMZ; I’ve mentioned BAC warrants in a previous powerball post). These warrants are excersible at $11.50, capped at $18.00, and expire in February 2015. They currently trade for approximately $1.30. So why do I think the warrants make more sense than the common???
First, the upside is greater. Now let’s say Tilson is right and the stock deserves to trade for his approximately $25 target price. With the common at $8, you’re looking at just over 3x your money. With the warrants at $1.30, you’d make 5x. Note that the numbers look very, very similar if you apply Tilson’s suggested 10x EV/EBITDA multiple from peers. Obviously, the upside is capped with the warrants (if the stock could get to $35 or more, you would have been better off simply with the common) and there is some risk of the warrants expiring worthless if Tilson is wrong, but I still think the warrants make more sense.
Now consider the downside — given its huge operating leverage and funding requirements, if Tilson is wrong, this company is basically on the verge of bankruptcy. They are going to dilute the hell out of shareholders. The stock price is going to get crushed as they look to raise every last penny they can get, and they might even be handing out equity to lenders just to raise more debt. You’re looking at a zero on the warrants… but you’d probably be looking at a 50% or more capital loss in the common anyway.
I think the warrants also give you an interesting edge in that it’s in everyone’s best interest to have them exercised. Think about that for a second. Normally when a company sells warrants, converts, etc., it’s as part of a debt offering to lower the cost of the debt. When they do that, it’s in management’s best interest to keep the stock price depressed so that the warrants expire worthless and don’t dilute shareholders.
But in IRDM’s case, it’s in everyone’s best interest to have these warrants exercised — it’s likely the cheapest funding the company can get, it will help them avoid a very dilutive equity raise at today’s below BV price, and the company has built into their plans receiving the cash from the warrants. Management needs to generate as much cash as possible as soon as possible. That means no tinkering around with sales cycles to delay revenue or cash by a quarter or two to keep the stock price low. In other words, it makes sense for management to do things now to get the stock price up and get those warrants exercised. That’s not always the case with warrants.
Again, it’s very speculative. And I haven’t covered much because I think the Tilson presentation does a good enough job of covering the upside that you could get most of what you needed there. But I think it’s worth looking into, as there’s limited risk and the potential for a 5x gain in less than three years. I’ve added a very small portion into one of my tax-free accounts.
Disclosure: Long BAC warrants and IDRMZ.
Subscribe RSS
Whopper thanks for the write-up. Where is Tilson getting a forced conversion of 14.4 million warrants at $11.50 in 3rd 2012? Pg. 16 of his thesis.