By helping thousands to stay connected during the Ukraine conflict after the country’s ground-based telecommunications infrastructures were destroyed by the invaders, both Starlink (STRLK) and Viasat, Inc. (NASDAQ:NASDAQ:VSAT) have provided a new perspective on satellite-based internet.
While privately held Starlink, as SpaceX’s (SPACE) internet broadband unit, gets most of the media attention, Viasat, the incumbent, has also made progress. It has helped Ukrainians to keep in contact with their families and access social media to bring some normalcy to their daily life.
By analyzing its third-quarter 2022 financial results, which were released in early February, and continually referring to Starlink as a benchmark in the same way that disruptor Tesla (NASDAQ:TSLA) forced automakers to ramp up their electrification and production strategies, my aim with this thesis is to show how satellite-based internet could radically change the way capital expenses are done.
I start with Viasat, which has been around since 2012.
Viasat’s growth making headlines despite Starlink
While Viasat may not provide the same download speeds as fiber service providers, it remains a key provider of internet access to airline companies alongside Gogo, Inc. (GOGO). Moreover, despite news of Elon Musk’s venture being the subject of interest by airlines with its faster internet service, Viasat’s sales continue to increase sustainably, namely by over 25% on a year-on-year basis in Q3. Revenues also are increasing on a sequential basis, as shown in the table below.
These increased are mainly due to 53% more IFC (in-flight connectivity) service revenues compared to the prior-year period, in addition to acquisition-related revenues from RigNet and EBI. Additionally, Viasat recently announced that it has been chosen by Southwest Airlines (LUV) and NASA to deliver real-time communications for one of its projects.
Looking ahead to May 24, when the company announces results for its fourth quarter, it should garner more revenues. Its satellites, which orbit above the earth at 22K miles, now beam down more internet traffic to Ukraine in addition to other subscribers already served in Europe. In fact, the company has been so successful that it was attacked by hackers, potentially backed by nation-state actors, on February 24.
This may adversely impact Q4’s revenues, depending on the duration of the outage. However, to offset any shortcomings, the company has seen higher ARPU (average revenue per user) due to prioritizing its existing bandwidth away from residential customers towards IFC and mobility services, at least in the U.S.
Coming back to the cyberattack, there was an attempt to also interfere with Starlink’s system, but the latter was able to deflect the attack by a timely upgrade of its system, which appears to be more flexible as it is based on software. This shows some of the risks faced by satellite-based service providers, but there is also competition.
Cable companies like Comcast (CMCSA) and communication service providers (“CSPs”) like Verizon (VZ) are rapidly expanding their fiber footprints and offering bundled internet access and TV services. These are, in fact, Viasat’s real competitors. Furthermore, there is the fixed wireless access (FWA) technology, based on 5G, being proposed by mobile network operators like T-Mobile (NASDAQ:TMUS).
However, whether it is 5G or fiber, these rely on long-term and expensive ground-based works to install thousands of antennas on top of tower masts, or dig miles of trenches. Now, compare this with the agility of satellites to have restored communications services in Ukraine. In this respect, Vodafone Ukraine’s (VOD) radio access teams used Starlink’s terminals called Dishy McFlatface to restore communications rapidly. In the city of Irpin, for example, where all of the city’s cell towers had been brought down, engineers just had to hook receiving units at mobile base stations and power them on using generators to communicate with Starlink’s constellation of satellites orbiting the earth above Ukraine.
Alternatively, it would have taken months of hard work and millions of dollars to repair the crippled communications infrastructure consisting of cell towers interconnected through backhaul fiber-optic connections.
Consequently, satellites together with ground-based gear have in a way set up new time and cost benchmarks for the provisioning of internet services. Taking into consideration that the internet speed for browsing, accessing social media, and basic streaming is less than 50 Mbps, it is possible to provide wireless services at a fraction of the cost of setting up classical mobile-cellular networks. Tellingly, AT&T’s capital expenditure was more than 21 times the amount spent by Viasat on average during the last five years.
In addition to capital expenditures, there are high operating costs to manage ground-based infrastructures, as engineers have to stringently select locations based on signal strength. Compare this with the completely unplanned and speedy fashion in which space-based equipment can be installed with widespread coverage provided within a matter of days. Thus, time and cost should be factored in for valuation purposes.
With inflation at a 40-year high and supply chain disruptions now becoming more a norm, costs have been rising rapidly. Also, to provide fiber and mobile cellular services, CSPs need the latest generation semiconductors as well as sophisticated instrumentation to provide the best performance in view of competition. These factors are prompting a rethink among governments and the private sector, especially in developing countries about how to implement mobile coverage, considering that not everyone requires the internet to stream the latest movies or play interactive games.
Consequently, in addition to classical application areas like remote mountainous regions where costs of deploying cell towers can be prohibitively high and politically unstable locations where service providers would think twice before laying fiber connectivity, this decade should see an expansion of space-based communications. Here, estimates put the worldwide satellite internet market at $18.59 billion by 2030 after growing at a CAGR of 20.4% from $2.93 billion in 2020.
In this respect, Viasat’s annual growth of over 19% is aligned with the forecast. However, with a trailing price to sales multiples of 1x, investors are underestimating its market potential. Adjusting for a P/S of 1.5x or 50% more which puts it more at par with Verizon or Comcast, I obtain a target of $57 (38 x 1.5) based on the current share price of $38.
This is a high target and may prove difficult to achieve in the short term as with talks of an economic downturn becoming louder, the market now favors value stocks or those which have a low Price to Earnings ratio which is not the case for Viasat. Investors are also enticed by dividends.
Talking profitability, as shown in the quarterly income statement table above, Viasat is suffering from a rise in the cost of revenues and operating expenses. Again, learning from the way Starlink was able to use its more software-oriented infrastructure to rapidly mitigate the threat of cyberattacks, more can be done by Viasat to replace hardware-based processes with efficient AI applications.
Another area that should improve margins is the LEO-to-GEO relay. Here, for example, Iridium Communications’ (IRDM) LEO (low earth orbit) spacecraft are also used for providing internet services transmits data to one of Viasat’s GEO (geostationary or high earth orbit) satellites, which then forwards the data to the ground. This enables more cost-effective communications services and can be performed by ViaSat-3’s constellation. This brings higher margins due to lower variable costs. For this matter, Viasat already has a collaboration with Iridium for LEO crosslinks that enables lower latency or higher performance data transfer.
Pursuing this further, Viasat’s management has transformed the company into a high-growth one while at the same time managing to keep the debt to equity ratio at less than 100% (table above). This was achieved partly by lowering expenses. In this respect, for Q3-FY2022, capital expenditures were reduced by 2% on a YoY basis.
On the other hand, the company generated 29% less cash flow during the same time period due to an increase in working capital as shown in the diagram below.
Continuing the cash metric this time with Starlink, the company was also facing a cash flow problem that delayed its IPO. However, with the success in Ukraine, things could be changing. For this purpose, Starlink should be valued at over $4.4 billion, considering Iridium’s market cap and also the fact that both companies use LEO positioning for their satellites. Tesla’s shareholders are guaranteed to participate.
First, Viasat, which remains profitable, is a buy after falling by nearly 15% since the beginning of 2022 as shown in the chart below. However, the stock may be volatile depending on its ability to improve cash flow in Q4.
Second, while Viasat’s satellite technology differs from Starlink, any improvement which can be brought in terms of flexibility of deployment and upgrading of customer premise equipment should increment profitability. This is analogous to Tesla’s higher gross margins with respect to peers in the automobile industry. The satellite company should also benefit from more attention turning to the relatively lower capital expenses offered by satellites compared to ground-based solutions in a world where the cost of doing business is rising vertiginously and priorities are changing.
Finally, the world’s richest man needs money to finance the Twitter (TWTR) deal while Tesla’s shares are down by more than 27% on a year-to-date basis. Thus, Starlink could go public imminently, also benefiting Viasat’s stock due to news-induced momentum.