by Theresa Foley

Investors looking for new satellite stock issues last year came up practically empty-handed as only one satellite IPO, from XM Radio, was issued, but the private equity market stepped in to selectively make up the difference, providing billions of dollars in new investment, especially for broadband and Internet-related ventures.

The slow down came after several consecutive years during which four or five satellite firms successfully went public. As a result, the block of about 30 satellite stocks that are often tracked as a segment by Wall Street analysts did not expand last year. “It wasn’t a condition of the market, which was good for issues overall,” Marc Crossman, a satellite analyst at J.P. Morgan, says. XM debuted in September at $12 a share and by December was trading at $26. “XM went up because it was priced cheap. It was priced at a 40 percent discount to CD Radio,” Crossman said.

In comparison, CD Radio (renamed Sirius), had an uneventful year, selling in the high $30s at the start of the year and dropping down into the mid-$20s by the end.

“Investors became more wary of the start-ups,” says John Bensche, senior vice president and satellite analyst at Lehman Brothers. Early stage companies will have to rely on private equity and high yield bond issues for financing, putting off their IPOs until they are closer to having a cash flow. This is a significant change in the market from two or three years ago, when numerous satellite companies were able to go public well before they were ready for operation.

While IPOs were scarce, several companies floated secondary stock issues, including CD Radio, Pegasus, Echostar, Globalstar, Loral, Iridium and Gilat.

A Year Of Highs And Lows

Within the sector, satellite stock performance went to extremes in 1999. Iridium’s collapse cast a pall over most early stage ventures. “The pain has been felt primarily in the MSS sector,” says Tom Watts, first vice president at Merrill Lynch. “The lesson there is that mega-projects are not a sure thing, and that you can’t necessarily rely on big sponsors. The Motorola decision not to back Iridium was a shock to everyone.”

MSS undoubtedly was the biggest disaster for the satellite stock sector. Iridium and ICO’s shareholders have stock that is expected to be essentially valueless, no matter what the outcome of their respective bankruptcy proceedings. Other mobile satellite companies are not likely to be able to raise money at all until Globalstar’s performance is in.

DBS was the biggest and best story for satellites on Wall Street last year. In 1999, DBS went mainstream, helping the satellite industry gain legitimacy in the eyes of investors. “It became a credible threat to cable, especially with local into local, and the stocks have responded dramatically,” says Armand Musey, senior satellite analyst at Banc of America Securities (BOA). “The world is starting to render a verdict on satellite technologies. There is a large market for DBS. A certain skepticism exists for satellite voice, and at the same time, there is overwhelming confidence for data over satellites, thus you see things like ICO making its move to become a voice-data combination.”

“DBS has been tremendous, performing like Internet stocks and producing three to four times the value at the beginning of the year,” says Watts.

“You could be blind and pick the right stock. Hughes, Echostar and Pegasus all more than doubled. Every single one was on fire,” Crossman says. Echostar in particular produced stunning results. “Dish began the year at $10 and is now at $70… seven times the money,” Crossman says.

“The question is, how much higher can those stocks go? I think it is much higher. I have Hughes targeted at $120, Pegasus at $115 and Echostar at $110,” Vijay Jayant, managing director and top satellite analyst at Bear Stearns and Co. Inc., says. “In DBS, everything is working.”

Marc Nabi, vice president at Morgan Stanley Dean Witter, says DBS subscriber additions could level off this year as cable television operators increase their marketing expenditures for the roll-out of new services. In the nearer term, however, the local programming legislation for DBS companies passed in late 1999 should attract subscribers. “DBS stocks in 2000 won’t be a five-bagger, but they will outperform all levels of comparable sectors, like cable and media,” Nabi says. “These companies will have better EBITDA growth rates because of operating leverage. They will have a huge level of cash flow, and more important, free cash flow, which investors like.”

An Important Coin Toss

The analysts are divided when it comes to predicting performance for other sectors, such as satellite radio (DARS), fixed satellite services (FSS) and mobile satellite services.

“The year 2000 is a coin toss,” Crossman says. “If Globalstar succeeds, everybody gets funded. If Globalstar is in trouble, mobile stocks are dead.” Globalstar’s debut was making many investors nervous.

“Everybody will be watching the rollout,” Jayant says. “Due to the two bankruptcies, the bet is against them. If there is a positive surprise, it could be a big stock.”

Around March 31, Globalstar is supposed to release top line revenue numbers for its mobile phone service, but some analysts expect CEO Bernard Schwartz to be as secretive as he can about the figures, especially if they are not strong.

Globalstar will not come up against the pressure of its bank covenants as quickly as Iridium did. When Iridium started service in late 1998, bank covenants that required a strong number of subscribers and incoming revenues took effect about seven months later. Iridium’s inability to meet those targets triggered the bankruptcies. Jayant points out that Globalstar’s covenants on its loans do not kick in until March 31, 2001, when Globalstar must show aggregate revenues of $100 million during the prior 12 months. That gives Globalstar more than a year to make its business plan work or be fine tuned if needed, which is more time than Iridium had. Globalstar’s bank covenants become more aggressive after that, but until then, the company has some breathing room, he says.

“Globalstar is bifurcated; it will be either worthless, or worth significantly more than what it is trading at today, as we begin to see the demand characteristics of the market,” Nabi says.

Analysts also are watching to see how Lockheed Martin’s transformation plays out. Lockheed Martin’s telecommunications strategy still needs to be implemented, comments one analyst. “It’s the one very attractive property they have.”

Satellite radio could be a strong play this year, according to Jayant. “We took XM public in October 1999 and it more than doubled by the end of that year. My strategy is play the concept, not the stock, and own a little bit of both (XM and Sirius). The companies are pretty similar and for this year, it is a milestone stock,” with potential to increase in value as the firm meets its pre-operational milestones, he says.

The satellite industry could be a focal point for convergence, with those phenomena driving some stocks. “DBS providers will provide some kind of data. Broadband companies will hook up with DBS and MSS projects. Other players, like Microsoft and the telcos, will enter the satellite business [in some fashion],” says Musey. All this jockeying among the players leads to massive amounts of speculation about potential deals, and just sighting two executives together in a public place can produce rumors that move stock prices, he says.

Satellite companies will have substantial cash needs this year, making “less and less room for entrepreneurs. This is increasingly a game for companies with large balance sheets,” Watts says.

Future Stocks

The next wave of IPOs, which should begin to occur in 2000, will come from the fixed satellite services sector, in particular from former government organizations that are going private, such as New Skies Satellites, Eutelsat, Inmarsat and Intelsat, Nabi says. He also believes several international DTH companies, like Sky Perfect and Sky Latin America or Galaxy Latin America will issue IPOs.

To get into broadband and Internet services, many companies will need new investment. Watts cites Ibeam, Skycache, Tachyon and Interpacket as among the firms he expects to see tapping the markets soon for capital to expand their Internet-related satellite businesses. He recommends Internet-related satellite investments to his clients at Merrill, which named Gilat Satellite Networks in December as its top play for 2000 because of its consumer-broadband strategy.

Across Wall Street, many analysts are anticipating a GM move to spin off Hughes as a separate stock, something they began watching for in fall 1999.

At our deadline, Hughes and Boeing announced that Boeing would acquire Hughes satellite manufacturing business, a change that could affect the stock of both companies.

Jayant also expects Hughes to consider an IPO for DirecTV in 2000, since the project is undervalued and underleveraged as the top U.S. DBS company, in relation to the market value of competitor Echostar.

A Maturing Market

The market has grown more sophisticated than it was when only a handful of satellite stocks were available. Investors and analysts continue to try out new tactics for profiting on satellite stocks, some near term, fast plays and other strategies requiring patience.

“The simple strategies, like making money on a launch event, especially on the FSS side, or seeing a price jump the first day of service, are gone,” Musey says. “It now takes a more complex strategy. That means understanding the market and how the business is going to evolve. To make money, people are looking for ways to leverage into the data side. Echostar is a good example. It’s viewed as a highly desirable partner for a data business, since it would be easy to add that onto its video service. So Echostar has huge value.”

When a price spread appears on related stocks, some investors have played those prices against each other. For example, this fall, Loral was selling at $14 and Globalstar at $30, leading some investors to load up on Loral since its low price did not reflect the value of its 46 percent stake in Globalstar. The difference between Comsat and Lockheed Martin stock prices just before the 49 percent purchase of Comsat by Lockheed also provided an arbitrage opportunity.

Additional strategies for making money on Globalstar likely will be put to work in early 2000 as the figures for early usage and revenues are released around March 31. The stock price may go down when the subscriber numbers are released, especially if they are low. Investors who believe in the long term business potential may choose to load up on the stock, and then wait for Globalstar to unveil a hybrid voice/data plan that would cause the stock price to jump.

A slower but possibly safer strategy is to pick the best long-term stock plays and stay with them for a longer period of time. Banc of America’s (BOA) equity report on the satellite industry, The Big 3, issued in October, emphasized the benefits of such a strategy, selecting Hughes, Loral and Orbital Sciences (OSC) as stocks that are undervalued and likely to appreciate by the end of 2000.

BOA’s Musey says the diversified companies have appeal because they are expanding beyond manufacturing, first into services, and then into consumer services. These moves have required big investments, but are taking the companies far from the guaranteed cost-plus margin defense sales where they started life into a “nimble, competitive” and global consumer market.

Loral, at $17 a share, was riskier than Hughes, Musey says, due to the earlier stage of many of its ventures, but the “upside potential” is greater.

Orbital Science’s 1999 stock performance was dismal as it sank by December to $12-$14, near its IPO price from a decade ago, after adjusting its books twice in 12 months due to accounting irregularities and reporting that Orbcomm subscriber numbers were building much more slowly than were predicted. However, BOA calls OSC a giant in its chosen niche markets with great long-term value, and a target price of $41 for year-end 2000. In 2001, Orbcomm could reach break even, giving OSC even more value.

“OSC’s challenge is to improve its credibility with the Street and create expectations that can be met and beaten, rather than over-promising, as has been the practice. Investors are waiting for the accountants to sign off, suggesting there are no more skeletons in the closet,” Jayant says. Its cash reserves could be consumed fairly quickly, requiring the company to find a new strategic partner to help out. Jayant expects Orbcomm’s momentum to pick up in the second half of the year, and in the meantime, Orbital will be trading very cheaply.

Nabi recommended DBS stocks in 1999 and continues to do so. However, he would advise clients to start to shift toward fixed satellite service companies in the latter half of 2000, including Panamsat, Loral, Asiasat and SES Astra. In addition to the FSS securities, investors may want to think about putting their money into mobile satellite stocks in the second half of 2000, depending on how well Globalstar does at demonstrating the market.

The rumor mill also demonstrated its ability to move satellite stock prices in 1999. Gilat was supposedly the target of a buyout or deal involving Microsoft, according to reports that started during the late summer and peaked around early November, raising Gilat’s price substantially as investors loaded up and waited for big news.

While the number of publicly traded satellite companies remained static in 1999, the number of institutional investors following the sector did not. Musey estimates that twice as many institutions were looking at satellite stocks last year as the year before. Jayant agrees that the number had grown due in large part to the DBS sector’s performance. “The investment base is larger than a year ago, and at the same time, it’s differentiating between companies on their type and management, where before all the satellite companies were lumped together,” Jayant says.

New Analysts Join The Industry

Another trend is the big spike in the number of analysts covering satellite stocks. Dozens of analysts are now following the business, with many small firms having analysts that listen in on the financial teleconferences and write up reports on the companies.

The Institutional Investor rankings indicated that 16 analysts are now devoted to satellites, compared to nine the prior year. Another 18 analysts were included who cover some part of the satellite business.

“I don’t envy any analysts their positions. Predicting future performance is still in many ways shooting in the dark,” says Peter Nesgos, an attorney in satellite finance with law firm Milbank, Tweed, Hadley and McCloy. “Who could have guessed Echostar would perform as brilliantly as it did on developments in legislation and growth in subscriber base? Who could have predicted ICO’s bankruptcy at the time of its IPO?

“In fairness, this market shifts unpredictably, frequently. It’s very difficult to analyze and project where you combine significant technical risk–satellites do fail–and this shifting demand in communications,” says Nesgos.

While the satellite and launch businesses may be grounded in science and technology, the financing side of the business, in particular the high risk equity game, is proving to be more a combination of a small dose of knowledge and a large amount of willingness to gamble on the future.

Theresa Foley is Via Satellite’s Senior Contributing Editor.

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