BW very bullish article on LORAL (LOR) (also a takeover target, MSFT wants to buy in too)
Look, Up in the Sky...It's Loral! Well, Not Yet
Its $17 stock could soar -- once investors realize that its Globalstar system is not another Iridium
It wasn't surprising that the railroad revolution of the late 1800s made railroad owners, not railcar manufacturers, capitalist titans. If you own the road, after all, you'll end up with a lot more revenue than if you just sell the cars.
Loral Space & Communications (LOR) found itself on the wrong end of that equation when the Cold War ceased. The country's premier manufacturer of satellites for defense uses was suddenly faced with slowing government demand for military birds and a simultaneous explosion in demand for commercial telecommunications services. Unfortunately, Loral made the cars rather than owning the road.
Things have changed since then, however, and Loral has learned its lesson. Although its revenues still come predominantly from satellite construction -- for the first three quarters of 1999, that division contributed some 80% of sales -- its telecommunications services segment is growing by nearly 50% a year. Not only is Loral creating a new revenue source, its gross margins on the new business are as high as 80%.
DIRTY WORD. Nevertheless, Loral's stock was anchored at $17.13 as of the close of market on Nov. 16, giving it a price-to-sales ratio of 2.9 -- much lower than the 4.0 average for the S&P telecommunications equipment sector. Why the stock is so cheap at a time when the company's margins and revenue are growing can be summed up in one word: Globalstar (GSTRF).
That's the new satellite phone system that should become fully operational sometime in the next few months, of which Loral owns 46%. Unfortunately for Loral, the first fully functioning satellite phone system, Iridium, was launched earlier this year -- and is already on the verge of disaster. That has led investors and potential customers to lose interest in Globalstar and other such satellite networks at exactly the time when the providers could most use some hype.
One of the blessings of such an environment, though, is that expectations have been dramatically diminished. A year ago, both Loral and analysts predicted that the company would sign up more than a million customers by yearend 2000. Recently, CEO Bernard Schwartz lowered his estimate to half that, and many analysts think that an even lower number could be good enough for the first year to be called a success. "If they have 200,000 customers by the end of next year, it will be a huge relief for Loral," says Armand Musey, an analyst at Banc of America Securities who rates the stock a buy. "In addition to their equity stake, they have guaranteed $500 million in Globalstar's debt, so they will have a big load off their back."
BETTER MODEL. Even 200,000 customers is a tall order when you consider that Iridium has only a few thousand, vs. the 1 million it was supposed to have attracted by now. But Globalstar's approach is significantly different than Iridium's, in that Globalstar phones work both as regular cell phones and as satellite phones when the caller encounters a gap in cellular coverage. One of the biggest problems with Iridium's sales pitch was that you could use the phone only on the company's network, which cost as much as $3 a minute.
Globalstar's charges are less than $2 a minute, and start only when there's a gap in cell-phone coverage. In addition, Globalstar's satellites are expected to last as long as 15 years, nearly twice as long as Iridium's, which significantly cuts their long-term cost. "Globalstar has a model that works much better than Iridium's, and that has a huge amount of upside for Loral if it is even a little bit successful," says Rob Kaimowitz, an analyst with ING Barings who rates the stock a strong buy.
Luckily for investors, Loral is also more than Globalstar. It continues to be the world's leading manufacturer of satellites. It also has a thriving Fixed Satellite Services business, which means that it leases space on some of its own satellites to corporate customers. That business accounted for $87 million in sales in the third quarter, a 29% increase from 1998's third quarter.
HOLY GRAIL. Loral also is selling an end-to-end broadband data pipeline via satellite that could in the long run be its biggest revenue and profit producer. The key here is selling a full set of services in addition to transmission. For instance, the company is designing a system for movie theatres to receive new trailers to add into their digital projection systems every day, rather than waiting for a weekly shipment of film. Loral will be selling the transmission space, the receivers, and even the software that makes everything come together. "Data services is the Holy Grail of the satellite industry, and Loral has a chance to be a leader there," says Banc of America's Musey. The incentive for Loral to expand this business is that once it has launched its satellites, it can earn up to 80% gross margins on the business.
Despite the company's upside, Loral's stock doesn't seem to want to move. Maybe once the Globalstar picture becomes clearer -- perhaps by the first quarter of next year -- the stock will get dislodged, one way or the other. And if Globalstar is a flop? Loral has plenty of other birds in hand to keep it busy for the long term.
Jaffe writes about the markets for Business Week Online
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