Telecoms are underperforming? We invest in satellites!
Despite an underperforming telecomS Industry...
At face value, the telecoms sector has looked attractive for a few years with many companies having relatively high dividend yields, low valuations and the illusion of monopolistic market structures. However, looks can be deceiving and in this case many of the cheap looking companies have proven to be value traps. Technological advances have enabled newer mobile services to compete with the incumbent fixed-line service providers. National regulators have protected consumers (at the expense of shareholders) by preventing industry consolidation forming monopolies that would otherwise be the logical strategy to achieve economies of scale and pricing power.
Given the long-term trend of underperformance, it is not difficult to find negative sentiment in this sector. When bearish sentiment appears to dominate investors’ thinking, our contrarian instincts will often have us casting a critical eye in case the apparent “group think” is missing something. Last year, satellite companies, a niche within telecoms infrastructure, caught our attention.
… and the threat of the Internet…
The origin of commercial satellite companies lies in the provision of subscription-based premium television content (such as exclusive sport and films on demand) in competition with the incumbent “free-to-air” service funded by government or advertising. High-powered satellites orbiting above the earth can transmit their signals to large areas of the planet to be picked up by any fee-paying consumer with the correct receiving equipment. Satellites success was a catalyst for the emergence of competing technology, “Cable TV”, which served areas of high population density via “co-axial” cables which were laid in the ground, physically connecting households.
For a few decades the duopoly of Satellite and terrestrial Cable TV happily co-existed with the former having the advantage that it could serve those large populations where it was not economically viable to lay cable. This changed with the invention of the Internet, more specifically Internet Protocol (IP), which enabled the digital distribution of TV content previously broadcast in an analogue form. Crucially, IP is largely agnostic to the telecoms infrastructure such that the incumbent copper wire-based telephone, cable and satellite networks could all deliver digital content.
At this point, the playing field for the competing TV services was still not level. Satellite and Cable initially had a vast capacity advantage over the incumbent telephone networks. Satellite was restricted by the lack of a “return path”, only delivering content in one direction, to the customer, whereas cable networks were the most optimal, delivering and receiving data. The cable networks therefore heavily invested in optical fibre offering the highest speeds and capacity. Incumbent telecom companies had no choice but to follow suit. Today, where it is economically viable to lay cable, both terrestrial networks can essentially offer the same consumer experience as the Satellite companies who themselves now also offer a “return path” typically in partnership with the incumbent telephone company.
Scepticism remains as to the longevity of the satellite-based infrastructure now that the competitive playing field has become level. Reflecting this pessimism, the sector has de-rated with the major players falling by almost 50% since peaking in 2015, from a premium to a discounted valuation relative to the market. So, what attracted Morphic to invest in Société Européenne des Satellites SA (SES), one of the leading satellite platforms?
...we invest in satellites company SES
Founded in 1985, headquartered in Luxembourg and listed in Paris, SES was the first private satellite operator in Europe. It has grown from a single-market business to a global operator through a strategy of acquiring minority interests in regional operators. The Group now operates a fleet of over 50 satellites. This far-reaching infrastructure enables it to offer coverage to 99% of the world’s population. As well as serving the premium Video market, it has also developed services to satisfy telecoms demand from three other market segments: Enterprise (serving corporates); Mobility (serving shipping, offshore installations and aircraft); and, Government (military and secure communications).
Our analysis indicates that SES has the attributes that we look for in high quality business, including:
- Oligopoly market structure
- High barriers to entry
- Governance structure that is acceptable to the US Government (major client)
- Global scale, serving both mature and emerging markets
- First mover advantage – unrivalled orbital position of recent acquisition O3b
- Good orderbook visibility
Contrary to the bearish view of the majority of analysts, we believe that demand for capacity in the Video segment will not shrink, evidenced by existing and new customers signing up for capacity to provide new ultra-high definition services.
Figure 1 - Morphic ownership of SES
Although early, we continue to believe that the current valuation, a forward PE ratio of 18x, and a sustainable dividend yield of 6.6%, does not reflect the potential growth opportunity that the recent acquisition of 03b brings to SES. The acronym stands for “Other 3 billion”, referencing the population of the planet without high speed internet access. Its satellites orbit in closer proximity to the earth providing high capacity with lower time lag (due to distance) which enhances the service offering to the Enterprise, Mobility and Government segments and is a significant point of differentiation in respect of its peers.