My previous article in January 2024 was an update reflecting on the operational milestones achieved by SES S.A., particularly completion of the C-Band spectrum monetization effort and roll-out of the medium-earth orbit (MEO) O3b mPower constellation. Like the sell-side analysts covering SES S.A. (OTCPK:SGBAF), my main question for SES moving forward was what management’s plans were for the massive windfall of cash (about $3 billion) from the C-Band monetization. We received the answer to this question in Q1 2024: SES will be acquiring Intelsat for $3.1 billion.
Bottom line up front: I believe the price tag for Intelsat is a bit high at face value, but with potential for greater returns on the back of significant cash flow over time when considering large amounts of synergies compared to bigger share repurchases and special dividend payouts. There is also the optionality of further spectrum monetization, easily surpassing returns from a capital allocation strategy of repurchases and dividends. This is all weighted against the backdrop of higher execution risk. I conclude with a Buy rating on SES S.A.
Intelsat Acquisition Makes SES S.A. A (Growing) Satellite Behemoth
Business Mix and Growth Consideration
With 100 geostationary satellites and 26 medium-earth orbit satellites, the pro-forma Intelsat and SES combined company will be the largest non-LEO satellite operator on Earth. With massive scale, global operations and coverage, and multi-orbit service offerings, the combined company has the redundancy, resiliency, capability, and infrastructure available to continue to grow its government and defense network business for the U.S. and EU as well as enable sovereign satellite solutions for the EU and support its telecommunications and media business with limited capital expenditure requirements moving forward.
Like SES, Intelsat had been transitioning its business from declining media transmission to networking. At the time of acquisition, Intelsat’s €2B 2023 revenue has a 70-30 split between networking and media, which, when compared to SES’s 50-50 split, indicates a positive mix-shift toward growing business verticals. The combined company would bring the business mix to 60-40 between networking and media, which helps to further accelerate SES to be more heavily weighted toward growth verticals.
Commercial aviation and in-flight Wi-Fi (formerly known as Gogo) make up the biggest revenue contributor for Intelsat at about 30%, or $640M. This profile is favorable to SES, whose mobility vertical at 15% of total revenue is underpinned primarily by the cruise industry. Mobility has been growing at double-digit clips across both companies, more than offsetting the low-to-mid single digit declines in the video and media businesses. Since Intelsat and SES have focused on different mobility areas, the combined company should be a force multiplier that complements each other in different verticals while leveraging cost synergies in regard to capex and opex (think gateways, portals, and ground equipment that can be consolidated by the combined company). In the Q1 2024 earnings report, SES printed a 24.5% YoY growth in mobility and Intelsat reported 29% YoY growth (19% of that from in-flight services), signifying continuing rampant growth in the mobility businesses. Altogether, I believe this means that the pro-forma company should experience greater growth rates than SES standalone.
Mobility Revenues (€M) | 2021 | 2022 | 2023 | CAGR |
---|---|---|---|---|
SES | €203.00 | €260.00 | €282.00 | 17.86% |
Intelsat | €468.00 | €541.00 | €588.00 | 12.09% |
Margins Consideration
Regarding margins, Intelsat has around 41% and SES around 50%. The dilution in margin is supported by management with the following claim:
In terms of share – in terms of margin of that business, you know, all of us are looking in the satellite industry of prospects of do we add managed services into our pure wholesale selling of the satellite capacity. And we’re all concluding that what the customers need is that integration capability. So that managed services layer on its own is lower margin of course than our typical capacity selling, if you will, but pure capacity selling pure pipe selling just like it is for telcos is a dangerous place to be if you don’t add value on top of that. So we’re convinced adding value on top of that is critical for us in order to be able to continue to drive our capacity business as well as – which is a high margin business, as you know, and provide compelling solutions to our clients. So the combination of both gives you, you know, certain compelling positioning for the markets, for the customers and ability to grow. And that’s how I see Gogo and how Gogo plays a part in it. – Adel Al-Saleh, SES CEO
This is a narrative that is also pushed by U.S. Space Force and Intelligence communities as well, in particular, the need for integrating capabilities and services. With their longstanding history and heritage as operators and their relationships with U.S. and EU government entities, Intelsat and SES have an advantage in providing the managed services sought by customers. Reducing the complexity, overhead, and operational requirements on behalf of customers and governments with managed services and value-added over-the-top capabilities beyond being a “bent pipe” will reduce margins but provide differentiation and additional moat around the business, especially in a time when competition, mostly from LEO operators, is growing.
One aspect that management did not go into detail on is the opportunity to lift margins on Intelsat’s business through capacity allocation optimization. Currently, the separate companies are mixing different verticals across the various spot beams collocated on their satellites. There is an opportunity for the combined company to consolidate capacity, say, from SES GEO satellites to Intelsat’s GEO satellites for in-flight connectivity, reducing equipment requirements and integration complexity. Alternatively, this could lead to reducing the infrastructure requirements vis-à-vis satellite constellation, especially as new software-defined satellites get launched. This means that the combined company can reduce the number of satellites needed to maintain or even grow capacity and support customer demand, leading to reduced capex and higher margins.
CapEx Consideration
The satellite industry is wrought with high capital expenditures and low profitability. SES and Intelsat, however, are both highly profitable (40%+ margins) and generate strong cash flows during nominal cycle periods. Both companies are coming off a period of high investment – Intelsat following its acquisition of Gogo’s commercial aviation business and SES following its deployment of its next generation MEO O3b mPower constellation. Thus, the acquisition is well-timed as these two large capital outlays are largely in the past and management can dedicate their focus primarily to the acquisition and synergies.
The 2024 financial period is expected to be the last year with greater than normal capital expenditures, with 2025 marking the beginning of ~€625M in annual capex. This is roughly €200M more than standalone SES was projecting. It should be noted that the capex expectations are markedly lower than depreciation expenses. For example, depreciation expenses for SES were €603M and €642 for FY23 and FY22 respectively. Standalone SES capex projections were €500M in 2024 and ~€350 in the nominal 2025-2028 period. This phenomenon is due to a combination of reduced GEO satellite demand from the video transmission business and technological improvements through software-defined satellites improving spot beam optimization capabilities to deliver the same amount of capacity to customers with fewer satellites. Since GEO satellites have lifespans on the order of decades, all of this means the pro-forma company should experience a sustained period of higher cash generation for longer as it moves past the heavy investment cycle beginning 2025.
Debt Consideration
The debt structure for both companies is favorable, particularly for SES. While SES has a balanced maturity profile out to 2030 and weighted at fixed 3% costs for $3.6B outstanding, Intelsat has 6.50% secured notes due March 2030 of $3B. Intelsat comes with $1.3B in cash, while SES will be taking on an additional $1B in debt term loan to finance the acquisition. None of this gives me much pause, as both businesses are high cash-generating businesses coming off a major infrastructure refresh. Management expects 2024 free cash flow to be about €800M; thus, netting the special dividend payout of €110M in October leaves about €700M in free cash flow at the trough of the cash flow profile recovery period, which normalizes from 2025-2028. Management is targeting returning to under 3x leverage within 12-18 months post-acquisition. The combined company should have the financial flexibility to continue buybacks, payout dividends, and pay down debt. Following the acquisition announcement, credit agency Fitch gives SES a positive outlook, saying the following regarding leverage expectations:
Fitch expects such metrics will improve to 2.5x and around 11%-12%, respectively, within 18 to 24 following completion of the acquisition, which is more consistent with the ‘BBB’ rating.
Mid-band Spectrum Hidden Assets
I believe the primary drivers for SES’s pursuit of the Intelsat acquisition are Intelsat’s balance sheet and cash flow. After Intelsat’s portion of the C-band accelerating clearing award to the tune of $5 billion, net leverage for Intelsat in 2023 is 2.2x, leaving SES with plenty of financial flexibility and an investment grade book. However, Intelsat’s balance sheet comes with another important consideration: nearly 200 MHz of C-Band spectrum intangibles.
Intelsat and SES S.A. were the two biggest holders of C-Band spectrum licenses between 3700 and 4200 MHz and each have successfully monetized their allocation of the lower 300 MHz band which was won predominantly by Verizon (VZ) in auction and facilitated by the U.S. Federal Communications Commission. The satellite operators have migrated their operations to the upper 200 MHz through a combination of new satellite launches and existing constellation reconfigurations. Between the two satellite operators, the lower 300 MHz band netted nearly $10 billion, $5 billion for Intelsat and $4 billion for SES, not including reimbursement costs. This works out to $33 million per MHz, or approximately $1.10 per MHz-POP for the population centers being cleared by the satellite operators.
The SES-Intelsat merger comes with contingent value rights, valid for 7.5 years post-closing, for 42.5% of spectrum-sale proceeds up to 100 MHz of spectrum. This strongly hints the two companies’ desire to further monetize their remaining C-Band spectrum, especially as the primary application of video transmission continues its decline and demand for C-Band capacity from space-based platforms reduces. Both companies continue to maintain operating licenses in high population density centers, such as 105°W (West Coast U.S.) and 101°W (East Coast U.S.), so a $1/MHz-POP estimate for 100 out of the remaining 200 MHz C-band is not unreasonable. Assuming the contingent value rights are able to be exercised, this leads to an additional $1.5 billion in unlocked value from intangible assets on the balance sheet. The current market capitalization of SES is $2.33 billion and pro-forma enterprise value about $9 billion ($4 billion of current SES enterprise value and $5 billion of implied Intelsat enterprise value at the time of acquisition).
Mid-band spectrum remains an extremely valuable asset, given its balanced characteristics for communication applications and high demand by terrestrial telecommunication companies. As 5G continues its infrastructure build-out across the U.S. and Europe, I expect the likelihood for monetization of spectrum held by these satellite operators to be very favorable. In either case, this remains an optionality for unlocked value and not a necessary condition for sufficient returns.
Acquisition Rating and Investment Expectations
Undeniably, spending the $3 billion C-band windfall on special dividends and buybacks would be an easier capital allocation path. However, given the points discussed in this article, there is an opportunity for SES to realize greater investment returns through its acquisition of Intelsat. The acquisition strategy comes with higher execution risk, but I believe a large part of that is subdued thanks to both companies flawlessly completing their urgent time-sensitive priorities surrounding C-band migration and completing their investment cycles, allowing management the time and space needed to follow through with the acquisition and integration correctly.
First, the easy part. SES will be paying a special dividend in October 2024 of €0.25 a share, or 5% yield. Then, starting in 2025, it will be moving to a semi-annual dividend structure, starting at €0.50 a share, or 10% yield. An investment through October 2025 would amount to a 15% return over a 1-year period (assuming flat share price). I view this as favorable for a stock I consider falls under the sluggard category (of which I always like to have one within my portfolio), particularly as SES (and the combined company) have very long duration contracts (~10 years) leading to highly visible revenue expectations and with strong cash generation properties.
SES currently has an active share repurchase program of €150M, or 6% of the current €2.5B market capitalization, expiring 2025. The company has a recent history of share repurchases that paused in 2023 due to its heavy investment period and management transition. I expect share repurchases to resume post-acquisition once management hits their 12-18 month target of less than 3x leverage.
Shares Outstanding | 2020 | 2021 | 2022 | 2023 | CAGR |
---|---|---|---|---|---|
(Millions) | 570.1 | 558.9 | 549.9 | 550.5 | -1.16% |
Management expects a mid-single digit EBITDA growth profile through 2028. Due to the high visibility revenue across both companies, revenue growth over the past 3 years, 40 – 50% margin realization, and identified synergies outlined by management, this is a reasonable expectation. Regarding synergies, management includes identified synergies of €260M within the first 3 years in their guidance, but I believe this will ultimately be an underprediction given the amount of consolidation that can occur.
For 2024E, the multiple we pay for the pro-forma company is:
- €3.5B EV SES
- €3.0B financing package
- €1.7B Intelsat debt less cash and C-band reimbursement
- €1.8 EBITDA (no synergies included)
- €1.0 CapEx
- = ~4.5x EV/EBITDA
- = ~3.1x P/FCF
With the mid-single digit EBITDA guide beginning 2025, the multiple drops to under 3x EV/EBITDA. Including synergies and netting back non-cash revenue from Intelsat pro-forma enterprise value, management’s acquisition multiple of Intelsat comes out to around 5.5x EBITDA. In my previous article, I looked at a peer comparison across other satellite and telco companies, all of which had a worse balance sheet, a worse growth profile, or a worse profitability engine. The acquisition of Intelsat does not change my view that SES is perhaps the cheapest satellite/telco play, and in fact, this acquisition bolsters my perception of the stock even if it just seems that SES acquired cash flows for a nominal sum. I expect a multiple rerating to occur when SES can convince the investor base that it is well beyond its reliance on the declining video business and that its role will not be supplanted by LEO operators. I believe such a rerating is more likely now that the combined company is clearly and objectively the most important non-LEO operator in the world. Its role in the value chain is clearly recognized by LEO operators, as SES leads its partnership with Starlink to provide managed services to the cruise industry and Intelsat leads its partnership with OneWeb (OTCPK:ETCMY) to provide managed services to the aviation industry. Investors seem to be the remaining cohort of nonbelievers. A successful rerating, in my view, should bring SES share price to the €8 – €10 range.
If we consider the hidden asset of C-band spectrum and the spectrum can be monetized anywhere near the price achieved from 2021-2023, the combined company is an outright steal at these prices at around 2x EV/EBITDA.
Conclusion
While we wait for a multiple rerating of SES+Intelsat and/or monetization of spectrum assets, we should be able to achieve a 10-13% return on the back of the progressive dividend and share buyback policy, which makes the waiting game much more palatable.
At first, I was hesitant, but after going over the acquisition details, I am more comfortable with what SES acquired, and I have a favorable view of the Intelsat acquisition. I especially like the acquired spectrum and the contingent value rights that are part of the acquisition package, suggesting that these assets were a big consideration of the deal and monetization is likely, should the opportunity arise. Finally, given the unprecedented speed and success rate of satellite deployment throughout the C-band migration period in 2021-2023, I am confident that SES and Intelsat will be able to execute on this merger of equals, mitigating risk.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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