|LEHMAN BROTHERS REPORT..William Kidd Analyst|
Loral Space & Communications (LOR - $2.14) 1 - Strong Buy
Company Update Feb 16, 2002
A Turnaround that Actually Turned
* Solid 4Q results: although revenue was light, lower costs and fewer eliminations helped drive a better than expected EBITDA and EPS result. Revenue of $272 million was light (versus our estimate of $324 million) due to
pushouts at SS/L, but EBITDA of $53 million was better by $16 million. Loral reported an EPS loss of $0.13 ($0.16
excluding one-time items) versus the consensus loss estimate of $0.21. Our loss estimate of $0.18 included the onetime items. SS/L’s revenue shortfall was largely cosmetic in nature due to the business segment’s fairly low margins, which make the revenue miss more noise than anything else. That said, the company’s reduction in overhead was far
more important and the main contributor to Loral’s strong quarter.
* A much healthier animal: liquidity issues are in the past. For most of last year, liquidity concerns, and even some speculation of an eventual bankruptcy stemming from an inability to refinance maturing debt, plagued Loral. In
December, Loral proved that those concerns were invalid, clearing up issues at Cyberstar (and cut its obligations by
$228 million) and extending virtually all of its bank debt to January 2005. The resulting company is still levered, but
lacks the refinance risk that some were so overly concerned about. Unfortunately, the market hasn’t given the company
adequate credit, in our estimation, for that reduction in risk or the accomplishment. The capital structure fixes also pay operational dividends. With this concern now eliminated, management can now look forward, returning their focus back
to running the company. Note: Loral ended 2001 with $229 million in cash and available credit, which we believe is
sufficient to get it through 2002.
* FSS: we anticipated a conservative 2002 outlook. In our 4Q preview, we took the initiative and moved down our
estimates slightly, being cognizant of softness in 2002 due to overall demand slowdown. Our earlier adjustments put our
Loral estimates more in line with our present thinking around FSS market evolution. For the sector, we are now
anticipating 0-2% growth in 2002 and 5% in 2003. We believe Loral should still continue to outpace the pack, but albeit
with a lowered industry bar. Specifically, Loral Skynet should remain the family leader, particularly with its strong inhouse marketing capabilities and planned launches, while SatMex and Europe*Star should more closely track the industry trend. Management, in our estimation, acted similarly, establishing a single-digit revenue and EBITDA target for its FSS business. Later years, starting in 2003, should show pronounced acceleration, driven by fleet expansion as well as an anticipated improvement in market conditions.
* FSS: debookings are now an industry norm – learn to accept it. During the company’s earnings call, it was
readily apparent that some analysts were taken aback by Loral’s FSS debookings (churn), which hit backlog by $208.2
million in the quarter, offset by $152.9 million in new bookings. Management indicated that most of the loss stemmed
from one broadband customer. Debookings of this or any noticeable magnitude are a relatively new phenomena, brought on by a number of customer/traffic types. Prior to recent years, FSS customers were much larger entities with
clear long-term satellite needs, like broadcasters and PTTs. However, in recent years, significant growth has come from a particular segment of data customers, namely foreign ISPs. These customers have seen the value of satellite
connectivity in delivering IP connectivity, particularly where fiber falls shorts. Given the parameters, it shouldn’t be surprising to learn that much of this growth has come from Eastern Europe, the Middle East and Latin America.
Unfortunately, these customers aren’t on average as likely to stay around as video or telecom customers: (1) for many
of these customers, they realize that their need for satellite connectivity is short term in nature, hence the shorter contract commitments; (2) the differential between satellite and fiber prices is so large that many customers are willing to break FSS contracts. if fiber comes early; and (3) occasionally, some smaller ISPs make for poor credit risks, but most FSS providers savvied up to that exposure long ago. Consequently, churn has started to manifest itself, in step
with the growth in data traffic. Given the causes we laid out, the real question asked of management should not be "why do you have churn?" but rather "is churn worth it?" It’s our belief that gross demand from this class of data customers, namely consumers of IP backbone traffic, continues to be the fastest growing FSS traffic segment, even when netted by churn. Clearly, slower growth segments like video and telecom traffic aren’t close competitors. VSATs and broadband, however, are doing well and could pick up further steam, but that topic seems to be somewhat of a different tangent.
Therefore, we believe that so long as more data focused, FSS companies continue to show the fruits of their data focus, the market should quickly learn to acknowledge that churn is an inescapable result of those endeavors. And with Loral in particular, Skynet has consistently outpaced its larger rivals, showing that management’s strategy works and is in the best interest of shareholders. Clearly, providing an excessive amount of transponder space to an unproven company is not what we are talking about; while that has happened in the past, we don’t think operators are supporting such initiatives today, legitimizing the churn that does exist.
* The call had a somber feel to it. The conference call’s tone wasn’t entirely reflective of the good quarter and
relatively positive outlook. Loral’s conference calls, in spite of the recent debt restructurings, continue to get off track with questions regarding debt structure minutia, which is arguably a little better than last quarter, when those questions reflected concerns. While information of any sort is clearly valuable to some, the questions do detract from the larger company message: we’re more profitable than we expected and we have no cash issues." Admittedly, no quick fixes.
However, our message is equally simple: "Don’t let the meandering style of the call mislead you, the company has met expectations and has a good outlook, even more true when contrasted against its peer group."