ViaSat Inc. (VSAT)
ViaSat’s Aviation Business – A Source of Misplaced Optimism
We are short shares of ViaSat Inc. Please click here to read full disclosures.
ViaSat’s aviation business is a source of market interest and bullishness. Much like shareholder enthusiasm for ViaSat’s residential broadband business, we believe much of this optimism is misplaced.
Until ViaSat-3 Asia is in service (likely beyond 2022), ViaSat lacks global coverage. This is a non-starter for many international airlines. If and when all three ViaSat-3 satellites are operational, many international airlines may already be committed to a different vendor. Even then, ViaSat will still only be a “single-string” network, meaning that its service offers no redundancy. If a satellite were to suffer from operational failure, 1/3 of the world would lose coverage for 3-4 years – a material concern according to an industry source.
Additionally, when signing on with ViaSat, aviation customers are locked into receiving service from ViaSat’s satellites. In contrast, GoGo or Panasonic allow airlines to receive service from a variety of different satellite providers, providing their infrastructure with further flexibility and redundancy in terms of sourcing bandwidth and resolving service issues or malfunctions. Given ViaSat’s non-investment grade credit profile, lack of cash flow and its questionable decision to take payload manufacturing in-house for ViaSat-3, being locked into a ViaSat-only in-flight connectivity solution increases the risk of worst-case scenarios for clients.
Lastly, but perhaps most critically, the profitability of the aviation broadband business is still very much in doubt. While competitors describe rising investment costs and a concerning lack of profits (Inmarsat recently stated indirect costs are “rising fast” and the net investment in in-flight in 2016 was $185m, Panasonic recently stated the ‘jury’s still out’ on profitability), ViaSat continues to describe an attractive margin profile. This is because much of the costs associated with R&D, FAA certifications, installations, equipment losses, and maintenance expense are not captured in the Satellite Services segment but rather in Commercial Networks where disclosure is grossly lacking and there is less investor focus. We estimate that when proper allocations of installation costs, loss on equipment sales and maintenance are made, EBITDA margins are roughly 20%. When additional indirect costs such as FAA certifications, contracting costs and R&D are included, the profitability is likely in line with peers: nominal.
ViaSat has become aggressive in recent years when it comes to selling its in-flight connectivity solutions. According to industry sources, the company is selling equipment at little to no margin to American Airlines and Virgin America. Given the competitive nature of the airline industry and the in-flight connectivity market, it defies reason to think that simply because of purported bandwidth cost advantages, ViaSat enjoys a hugely attractive business while all others are seeing a total lack of profitability. ViaSat may benefit from leveraging costs associated with certification and R&D over time, but at present the margin profile is modest and may worsen given price irrationality amid an oversupplied satellite capacity market.