Seth Klarman has continuously added to his stake in the satellite company ViaSat (VSAT) over the years. It ranks as one of his largest investments and like many of his investments, difficult to discern the value of. Unlike his investment in Vivendi (VIVHY) which requires but a glance at the financials to see its attractiveness, ViaSat is one that is priced at a steep premium to earnings. ViaSat is also priced at a premium to book value. Its assets, which include satellites in orbit, are hardly ones that will fetch much liquidation value, particularly as technology rapidly changes in the sector.
But what ViaSat does appear to have is an indomitable position in delivering high-speed Internet access to obscure regions in the U.S. and the world. The company recently launched a satellite with throughput capacity of 140 gigabytes/second. It will offer 12 megabits per second of broadband to customers making it the high speed option for those living outside the reach of high speed cable or fiber optic lines. ViaSat expects to service some 1 million customers with this new satellite. Hughesnet recently launched a satellite capable of 15 mb/s, but these two companies are largely the only game in town in delivering high-speed satellite broadband to rural locations and that is evident in pricing.
ViaSat is pricing its new high-speed Internet access from $50 per month for a 10 gigabyte data plan to $130 per month for 25 gigabytes per month. Keep in mind that with few options in rural areas this pricing is not out of line. There are disadvantages to the service, however. Because of the satellite’s high orbit, certain services such as VOIP and gaming would suffer as there would be a gap during transmission. But overall download and upload speeds will be substantially improved and it could open up new markets.
ViaSat has established joint ventures with JetBlue (JBLU) in delivering broadband on airplanes and recently with DirecTV (DTV) on bundling satellite TV and broadband together. ViaSat is also active in the government sector and provides communication resources for the U.S. military. However, that portion of its overall revenue has declined from about 30% to 20% in the past couple years as commercial satellite broadband has taken off.
ViaSat is hailed as one of the leading small cap companies with great potential, but that is really all it is. A deal it is not. Looking at the financials, ViaSat earned $0.17 per share in its most recent 10-K (ending March 2012) and $0.84 per share its previous year giving it a price to earnings of 40 for that year’s earnings. Earnings were muted because of various one-off costs relating to acquisitions customer subscriber growth. Revenues have grown from $680 million to $860 million over the past three years and revenues should continue to grow with haste as the company rolls out its high-speed offering.
In its recent analyst day the company made an interesting observation of the high return on capital of “satellite TV” companies (exhibit 3). As the chart notes, DirecTV and Dish had return on invested capital in excess of 40%. The problem with this claim is that Dish is not a pure satellite company as this satellite analyst notes. Dish has instead leveraged its network and is piggybacking off satellite companies likely giving it an edge on return on capital. DirecTV has also seen its asset turnover increase over the decade though the company does appear to be very active managing its satellites.
ViaSat probably won’t be making high returns on capital any time soon as the presentation seems to imply. The company should be able to grow earnings per share substantially and does appear to have a moat around this business, but it will be years before it is producing enough earnings to rationalize a 40% return on capital. Current capital (debt plus equity) stands at around $1.4 billion while the company’s most profitable year was 2009 when it made $39 million.
Intuitively, a capital-intensive business involved in developing and launching satellites into space (as ViaSat recently launched a $400 million one last year) does not seem like it will lend itself to high returns on capital. The returns will come when and if the company can be successful in creating a deep network just as DirecTV has done.
Perhaps this is what Klarman is hoping for, but it does not seem to fit the mold of most value investing frameworks. I’ve found the website Satellite Today to be enlightening on the dynamics of the satellite industry, specifically the articles by this columnist. Some satellite analysts believe there will be a shakeout in the satellite industry with companies such as ViaSat and Hughesnet rounding out the top. Developments like this would certainly play out in the favor of ViaSat. Still these satellite companies will be competing against terrestrial broadband such as fiber optic lines, 4G, LTE and other mediums for Internet transmission. ViaSat will have to bring its prices down and data throughput up in order to maintain competiveness in the long run as the terrestrial competitors encroach.
A monopoly (or duopoly) on high-speed Internet in rural America may not return a high return on capital immediately. Nevertheless, it should return a sustainably high profit margin and this may justify Klarman’s conviction.
Disclosure: Long ViaSat