The satellite industry is one which is rather complex and opaque at first glance, and the time needed to develop a meaningful understanding of its dynamics relative to the small number of investable opportunities often leads investors to look elsewhere. Having carried out a review of the industry, including interviews with the main satellite operators, resellers and customers, we believe the satellite industry currently bears a striking similarity to the telecommunications sector in the 1990’s – a market experiencing a flood of capacity coming to market with a race to the bottom on pricing, as supply growth outpaces growth in demand. Back in the 1990’s the consumer proved to be the winner at the expense of the operators, and we believe history may repeat itself in the satellite sector, with negative implications for satellite operators’ earnings.
If one were to take the outlook commentary from each of the industry operators at face value, a relatively rosy picture is painted. Often they will cite pressures across the industry as being specific to another competitor, and are keen to promote their unique competitive advantages which they will claim act as barriers to success for other operators. This positive rhetoric, however, does not add up when taking into account the glut of capacity coming to market and the resulting pressures on pricing that are already becoming evident across the sector. We have recently entered a new generation in satellite construction, where technological advancements mean that the capacity each new satellite is bringing to the market is increasing at an exponential rate. As shown by the graph below, over the next 4 years these so-called high throughput satellites (HTS) are set to increase supply in the market by multiples of where we stand today.
Source: Barclays Research estimates, Company reports
For satellite services, the ability to cover a global footprint is an important trait, particularly when addressing the maritime sector (a core area for Inmarsat). Currently all of the main operators in the sector are working towards launching their own global HTS constellations. Inmarsat emphasise that global coverage via their new Global Xpress (GX) product is one of the ways in which they differentiate themselves from other HTS services in the market, and that their customers value Inmarsat for their ‘globality and mobility’. Whilst their offering is indeed differentiated, we struggle to believe that it offers a compelling choice to the maritime industry and thus question their ability to gain profitable market share.
Following some simple channel checks we determined that their new global offering does not necessarily provide any competitive advantage when considering satellite reseller packages. These resellers can construct global coverage packages for customers by patching together capacity from a range of different satellite operators across various regions of the world. From the perspective of the consumer, these packages may typically offer superior economics as well as the flexibility stemming from the usage of multiple providers of coverage.
Additionally, Inmarsat’s new GX offering uses an entirely different spectrum (called Ka band) to that which the maritime industry has historically operated on (the ubiquitous Ku band). This means ship owners that opt for Inmarsat’s service will have to install expensive new antennae and implicitly forego the flexibility of accessing other operator’s satellites. With the merchant marine segment (Inmarsat’s targeted end market) in a cyclical downturn and an increasing number of ships being laid up, we question the level of demand for expensive high throughput satellite services – put simply, will fleet operators facing tough market headwinds be willing to bear the cost of upgrading their satellite packages, so that sailors can stream video on Netflix and access Facebook?
Finally Ka band also suffers from interruptions to service due to rain (so called “rain-fade”), a particularly relevant issue for the maritime industry, which Ku-band does not. One may wonder why Inmarsat chose such a spectrum given these issues. The answer seems to be that they did not actually have a choice as when it came to launching their GX service all orbital locations and spectrum rights in Ku-band had been taken up – perhaps a consequence of Inmarsat being “late to the party”.
Outside of maritime, aviation is a large and growing application to which high throughput satellite capacity is being dedicated, and the other major area of expected growth for Inmarsat. Within aviation, Europe remains relatively underpenetrated in terms of in-flight Wi-Fi connectivity. Inmarsat’s solution is to partner with Deutsche Telekom to create an Air to Ground (ATG) network across Europe using telecoms towers to deliver connectivity to aircraft rather than satellites. Worryingly though, the ATG network is still some distance away from being operational and in the meantime, competitor Viasat has signed contracts with SAS, Finnair and El Al air for the provision of in-flight WiFi.
Source: Barclays Research estimates, Company reports
US-based satellite operator Viasat is one of the primary disruptors in the industry. Uniquely it manufactures its own satellites whose capacity is multiples of all other providers’ satellites, giving them a huge advantage when negotiating contracts with end users. The charts above graphically depict Viasat’s technological advantage.
For Inmarsat, the problem is that Viasat is targeting the aviation market as well, and worryingly has so far been successful in new contract wins. However Viasat claim they are not being complacent about the threat of Inmarsat’s ATG network and are satisfied that tests they have run (and incidentally shared with the airlines) show that the ATG network will not be able to compete with the economics of Viasat-3 (their newest satellite due in 2020). Airlines need only look to the US and the success that JetBlue has had with Viasat-1, and the fulfilment of the Air Force One contract (arguably the highest quality of service aviation contract available) to give them confidence in Viasat’s ability to service the European short haul sector. Inmarsat have no such comparable example to fall back on, in fact the closest comparable would be the ATG network in the United States operated by Gogo, which has dramatically failed to live up to expectations according to analysts covering the sector. While Inmarsat will claim this is an unfair comparable given they are allocating far more spectrum to the European ATG network relative to Gogo, it is certainly an example the European airlines will take into account when assessing the options available to them. Nonetheless, Inmarsat are keen to stress that they are close to winning the contract for IAG’s European short haul fleet. While this would be a key contract, it needs to be remembered that Inmarsat have been in advanced discussions since early 2014 – the longer this contract is delayed, the greater the number of alternative solutions become available to IAG, and the greater the risk to Inmarsat in our view. Indeed, Inmarsat lost the IAG long haul contract earlier this year to a competitor, after having previously been seen as one of the front runners for the deal.
With the satellite industry at the beginning of a transformative stage and pricing headwinds set to increase as capacity accelerates, it is tough to be optimistic about the future profitability of many satellite operators. In this context we believe Inmarsat’s current revenue guidance for 2018 looks at risk - a 9% revenue CAGR from their 2015 base. Indeed, annualised 9-month revenues this year are down 2%. This means that to meet its guidance, Inmarsat now needs to deliver a revenue CAGR of 15% over the next two years. Notably, a significant part of the expected growth is from transferring existing customers on to their new GX satellites. There is an implicit cannibalisation effect here which we also believe is not fully appreciated. Added to the headwinds for the sector in general, we believe this guidance to be unrealistic and expect those investors holding out hope will be disappointed.
Argonaut Capital Partners LLP is authorised and regulated in the UK by the Financial Conduct Authority (FCA), FCA Reg. No.: 433809, Registered office: 4th Floor, 115 George Street, Edinburgh, EH2 4JN. Co. Reg. No.: SO300614. This document has been provided for informational purposes only. It does not constitute investment advice. This document is for professional clients & eligible counterparties only as defined by the FCA, with the experience, knowledge & expertise to make educated investment decisions and understand the associated risks. The document therefore should not be relied upon by retail clients. Non-professional clients and non eligible counterparties should seek professional advice before making any investment decisions. It is the individual investors responsibility to ensure that any investments made and it's tax liabilities meet your personal requirements and are compatible with the country in which you reside. Information and opinions expressed in this material are subject to change without notice. They have been obtained or derived from sources believed by Argonaut Capital Partners LLP to be reliable but Argonaut Capital Partners LLP make no representation as to their accuracy or completeness. Fund Partners Limited (formerly IFDS Managers Limited) is the Authorised Corporate Director (ACD) of FP Argonaut Funds and is authorised and regulated by the FCA. Registered office: Cedar House, 3 Cedar Park, Cobham Road, Dorset, BH21 7SB.