The Dynamic Discounting Machine [interesting article on satellite industry -- G* as case study]
intellectualcapital.com
by Alex Schay
Thursday, March 11, 1999
Comments: 1 posts
Space ... the final frontier.
Over the last decade, engineers have successfully addressed the
capacity-to-dollar obstacles that plagued earlier commercial satellite
efforts. From 1982 to 1996, the power of the typical satellite increased
1,200%, while the subsequent costs associated with its manufacture and
operation rose only 14%. This created the kind of evolving value
equation that began to attract capital. Over the last two decades, more
than $75 billion has been poured into the global satellite industry.
Now, a second space race has ensued, and what
was once the province of competing world powers
has become a technology-inspired free-for-all -- with
the ultimate goal being a commercially viable,
seamless constellation of orbiting satellites. Of
course, the ability to provide high-speed data
communications as well as voice offerings anywhere
on the globe is what inspires many of these companies today.
Ironically, now that the satellite firms are closer than ever to providing
these services, some of their valuations in the public stock markets are
at historic lows.
Valuation: A Dynamic Process
Is this really as counterintuitive as it seems or just a natural consequence
of the manner in which markets discount future events? There is the rub.
Say you are new to this whole process and you want to get a sense of
the issues involved. Take a typical packaged good that you might buy on
a regular basis, like Campbell's soup. Now, the Campbell Soup
Company and the 20 or so analysts who issue investment ratings on
Campbell have a wealth of information for assessing future soup
consumption patterns. From one quarter to the next, management's
estimates come close to theactual numbers the firm reports. At the least,
dramatic fluctuations are few, so there is an amount of certainty in
investing in Campbell stock.
Investors have to pay to sleep well at night. Conversely, those who do not
sleep well demand a premium for bearing the risk that triggers
"investors' insomnia." Even casual observation of companies that are
awarded higher multiples in the marketplace reveals that investors are
paying up for companies that have attained a certain level of cash flow
and earnings stability.
Companies that can promise fewer nasty surprises are rewarded
accordingly. Firms that promise high -- but less certain -- future returns
also are rewarded in the marketplace until reality interjects itself into the
process.
Firms that renege on their promises are summarily flattened. That is,
actual results have a tendency to explode the models quickly. Corporate
value is based on future cash flow [Go G*], not historical cash flow, yet analysts
invoke historical performance in their estimates of future results. What
else is an analyst to do? Telling the future has always been a tough job.
Nevertheless, what may appear to the casual observer as crystal-ball
gazing is, in fact, a rational calculus to the "soothsayer." While
forecasting cash flows is not a science, it is a "discipline" some have
become surprisingly adept at.
Globalstar as case study
Now consider the information satellite-service analysts have. Horrendous
start-up costs burden satellite systems, but the promise of low operating
expenses and significant cash flow once the systems are in place act as
financial balm to both investors and financiers.
Two years ago, the satellite analyst may have asked the following
questions: How much has the firm made in the past? Nothing. How much
are they making now? Nothing -- because they are still in the process of
placing their birds in orbit. How will the public receive the service once it
is available? Unknown.
What are the assumptions in the analysts' models? Let's take satellite
operator Globalstar Telecommunications as an example (GSTRF on the
Nasdaq). The Globalstar satellite system hopes to offer 800 million to 1
billion minutes per month of telecommunications connection capacity
and ostensibly will be available just about anywhere on Earth. The
system is a low earth-orbit (LEO) constellation originally planned to
contain 48 satellites along with eight orbiting "spares" that could be used
as replacements for any of the primary 48 if one or more should fail.
Consistent with a discounted cash-flow model, analysts in 1996 might
have taken a hard look at the business and estimated that the present
value of the sum of all the firm's free cash flows out to 2005 were about
$600 million. They would have added an assessment of what the overall
business would be worth in 2005, its so-called "terminal value,"
discounted to present value of course. This might have tacked on
another $4 billion or so.
Then a net-asset value would have been determined by subtracting debt
and adding back cash and the proceeds from securities that might
convert to common equity. Dividing this amount by the number of fully
diluted shares outstanding would yield a target price. As a result of
models like these, most projections by the major brokerages had a fair
value of about $60 per share for Globalstar stock at the beginning of
1997. Indeed, its closing price on Feb. 28, 1997, was some $57.
Today, Globalstar's stock price hovers around $16, which after two stock
splits actually represents about a 12% return since February 1997. So
why the relatively flat performance over the last two years? Well, to put it
simply, nothing has occurred to upset the assumptions implicit in the
model outlined. The firm has yet to commence delivery of its service, so
investors have few developments to weigh -- except the schedule that the
firm has presented for the ultimate delivery of its product.
Reality vs. expectation
On Sept. 9, 1998, Globalstar's stock value plunged almost 40% in one
day after the Ukrainian Zenit 2 rocket carrying 12 of its satellites flamed
out in the upper atmosphere. This, of course, presented a serious
impediment to the firm's progress and thus the reception of cash flows
anticipated in the model.
Globalstar since has modified its plans and announced that it only needs
32 satellites to operate an effective service -- forecasting the
commencement of commercial service in September 1999 -- and the
stock has rebounded. As of this date, Globalstar is on track to achieve
this objective, having successfully launched four more satellites at the
beginning of February.
This is all well and good, until reality intercedes again, either vindicating
the former analysis or making a mockery of the prior projections. The first
step in assessing a company as a possible investment is to attempt to
quantify the expectations "built into" the current stock price. Once this is
accomplished, investors can try and gauge whether reality will serve a
willing partner with expectation.
If the disparity between intrinsic value and market value is great enough,
the opportunity then qualifies as a true investment.
Alex Schay is a writer/analyst for The Motley Fool.
Related Links
O'Reilly's dictionary has a comprehensive entry for satellite, including referencing
Arthur C. Clarke, who came up with the notion of geosynchronous communications
satellites (which he called "comsats") in 2001: A Space Odyssey. Iridium network
satellites are reflecting sunlight and messing with astronomical observation, although
amateurs are having a blast. And trouble with China is causing trouble with US
satellite industries.
Are companies like Globalstar and Iridium overvalued? Undervalued? Is
the satellite communications market saturated already?
Below are the ten most recent comments.
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[Post your comments]
3/11/99 1:49:20 PM Jack Handey [Jack Morgan?...]
Let's see - a satellite phone costs several thousand dollars, and airtime is about 5-7
dollars a minute. Seeing that Iridium doesn't exactly have consumers beating down the
door... yup, it's overvalued. Maybe not in a few years from now, but right now, it is.
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