January 16, 2020 | 1:05 PM by CY | cy@jaguaranalytics.com

Intelsat (I) – Unlikely to Walk Away with Nothing

Given the upcoming 5G revolution, many satellite companies including Intelsat had been looking forward to selling their highly valuable usage rights for the C-Band spectrum to 5G service providers. But on Nov 18th, 2019, the FCC officially announced that it will act as the sole seller of the spectrum via a public auction “before the end of 2020.”  FCC Chairman Ajit Pai said in an official statement:

“I’ve concluded that the best way to advance these principles is through a public auction of 280 MHz of the C-band… I’m confident they’ll quickly conduct a public auction that will afford all parties a fair opportunity to compete for this 5G spectrum.”

To compound matters, in early Dec 2019, Congress failed to pass a measure that would let the satellite companies share in almost half of the revenue expected from the airwave sale. This essentially means the FCC can now decide on whether the companies get paid and how much, and Ajit Pai has yet to make a public comment on whether they will receive any money.

Needless to say, the news was a huge blow to Intelsat, whose shares at one point were down a whopping 75% from when rumors of the FCC decision began surfacing. The market was essentially pricing in the scenario that the company would be walking away with nothing. However, there has since been some stabilization in the price action in recent weeks, and for the reasons stated below (as well as percentage of short float at 31%), I think the risk-reward is now skewed to the upside.

What happened, exactly?

To fully understand this situation, let’s take a look at what caused this whole mess in the first place.

First and foremost, by law, only the government owns the spectrum and only they can provide licenses for its usage. These licenses can be bought and sold between companies but they must all sign legal waivers declaring they do not own the spectrum nor do they have regulatory authority over it.

In exchange for a C-Band license from the FCC, satellite operators are typically expected to invest hundreds of millions of dollars each year to maintain the quality and reliability of their services to US broadcasters, media, and data companies. To make this task easier while preparing for the upcoming 5G wave, several satellite companies (including Intelsat) got together to form the C-Band Alliance, or CBA in short:

For months, the CBA had been trying to negotiate with FCC commissioners regarding the terms of how the companies would go about selling the spectrum usage rights. The negotiations turned out to be quite arduous, confrontational, and full of disagreements surrounding the spectrum ranges to be cleared and exactly how much of the proceeds would go to the government. Eventually, in September, the CBA made several key concessions:

  • They widened the proposed range clearance to between 200MHz and 300MHz.
  • They agreed to give the FCC essentially more influence and control over the auctioning (full details).
  • They reached an undisclosed agreement on the percentage of proceeds owed to the government.

The market took the announcement to be a positive. Then barely a month later, CBA partner Eutelsat decided to be a “bad apple” and voiced their disagreement with regards to the share of profits. Soon after, they announced their withdrawal from the CBA, stating that “Eutelsat was not aligned with other members and the CBA leadership team on certain matters.” Deciding to strike out on their own, Eutelsat began throwing a wrench into the CBA-FCC agreement by sending their own proposals and CBA-related complaints to the FCC.

Within weeks, the ugly bickering got the attention of members of both House and Senate. First, Senator Kennedy (R-LA), chairman of Senate Appropriations financial services and general government subcommittee, told Ajit Pai in a hearing that he was tired of seeing the satellite companies fighting over proceeds that belong to taxpayers in the first place, and that the government would be just as capable of carrying out the auction:

“Say you’re going to do this in 2 to 3 years. If [the CBA] can do it, then we can do it. I’m a free enterprise guy, but that money ought to go to the American people. Think of what we could do with it.”

In addition, the other 2 witnesses at the hearing, Citizens Against Government Waste President Tom Schatz and Taxpayers Protection Alliance President David Williams, agreed with Kennedy that US taxpayers, not commercial satellite operators, should be the primary beneficiaries of any spectrum auction.

Soon after, the House Energy and Commerce Committee held a hearing of their own, boldly named “Repurposing the C-Band to Benefit all Americans.” Representatives Frank Pallone Jr (D-NJ) and Mike Doyle (D-PA) said in a joint statement:

“The FCC must repurpose the C-band in a manner that promotes competition, spurs the 5G revolution, and yields revenue for important priorities here at home. What we don’t want is the Federal Communications Commission to become mired in litigation that slows 5G deployment. We must ensure the American people benefit from this process.”

Then in early November, Senator Kennedy reiterated his views in a Senate speech, even going further to say that the FCC should hold a public auction regardless of legal implications:

“There’s $60B at stake here, maybe less but not much less. It’s been my experience when government makes a decision that you get sued anyway.  If somebody’s happy and somebody’s sad, you’re going to get sued, and I fully expect whatever the FCC does, private or public auction, you’re going to get sued, but good luck finding a federal judge who’s going to issue an injunction and is going to shut this down.  I think that the case law in my opinion is on the FCC’s side.

Then finally, came the sledgehammer. On Nov 18th, Senators Roger Wicker (R-MS) and John Thune (R-SD) introduced the 5G Spectrum Act. The full bill can be found here. In essence, the Act would require the FCC:

  • to conduct a public auction of the C-band spectrum no later than Dec 31st, 2020.
  • to capture for the taxpayer at least 50% of the fair market value of the spectrum.

And shortly after, as mentioned in the beginning, the FCC decided enough was enough and announced they would be the only seller of the spectrum in accordance with the Act’s proposed guidelines. But to complicate matters further, Congress then failed to pass the related measures of similar bills because:

  • of disagreements from some senators, including Kennedy, who felt that even a 50% pay-out for the satellite companies was too much.
  • of pro-market senators (backed by spectrum users) who did not want to delay 5G any further (more on this below).

And this is basically how we arrived at the mess we have today.

The FCC is pro-market and it’s unlikely Intelsat won’t receive some proceeds at the very least

Right now, congressional deadlock means the FCC has the final say on how much will go to the satellite companies, and how much will go to taxpayers. At stake is a pot of anywhere between $40B to $60B expected from bidders. For lawmakers, the money represents promise of finally funding broadband expansions in rural areas. For Intelsat, the money offers a windfall to service a huge chunk of its $14B debt burden (and it is all this debt that creates the potential for huge upside if things go right). For his part, Ajit Pai has yet to make a public statement on whether the companies will get paid, but he may offer some clues if he decides that the FCC should vote on a plan at its Jan 30th meeting.

A key factor to note here is that the FCC is a pro-market entity. During the October hearing, Ajit Pai said the following in response to Senator Kennedy’s statements:

“We have eschewed command-and-control, top-down mandates in favor of flexible use for wireless spectrum whenever feasible. The free market best determines what technology should be deployed in what band, especially as the pace of technology accelerates more rapidly and demand for spectrum continues to grow.”

Even if the FCC will be the one holding the auction, they will probably have to consider the fact that these satellite companies have invested large sums of money in helping the government build out satellite networks while maintaining the spectrum and its infrastructure. Over the years, the CBA members have had to put Americans first in return for their licenses and make frequent upgrades to the latest satellite technology even when it wasn’t always profitable to do so. On top of that, these companies have spent billions in M&A to acquire competitors and integrate their spectrum. For Intelsat, all of this amounts to anywhere between $100M to $500M each year. It’s hard to imagine a scenario the FCC would decide to turn their backs on these companies without some form of compensation at the very least. Moreover, unlike the aforementioned “bad apple” Eutelsat, Intelsat spent the past year patiently playing nice when negotiating with the FCC, and frequently amending their auctioning proposal to reach an amicable compromise (before Congress waded in).

Moreover, both the CBA and the FCC are very much aligned in the objective of clearing the spectrum ASAP. The last thing all parties would want is a court case that could potentially delay 5G for months or even years. With Congress failing to pass measures limiting proceeds to CBA members, then from my perspective, this is now a case of the FCC auctioning the spectrum on behalf of the CBA and keeping a portion of proceeds, rather than one of hostility where the winner takes all.

Is the political risk gone?

One common argument among the bears is that just because the politicians failed to pass their measures doesn’t mean they won’t try to hijack the CBA-FCC proposal again. The problem with this argument is that time is not on Congress’ side. It takes weeks or even months for a proposed bill to be prepared, examined, and revised before it even gets voted on. And if it doesn’t pass, then it’s back to square one.

A major reason why the previous bills couldn’t gather enough votes is because many major C-Band users (who back election campaigns of both Democrats and Republicans) spoke out against the possibility of delays, via the CBA potentially challenging the government in a prolonged court case. One such C-Band representative said the following in an oversight hearing:

“A key condition of any auction and associated transition plan must be the means of ensuring the active participation and cooperation of satellite operators particularly as a transition facilitator bound by express, agreed commitments to incumbent C-band stakeholders, backed by Commission enforcement mechanisms. Satellite operators are integral to C-band programming delivery today and remain absolutely necessary to the continued viability of the reconfigured C-band spectrum for undiminished and interference-free programming distribution in the foreseeable future. As such, it is absolutely essential that the auction and 5G licensing process include mechanisms that will ensure that satellite operators remain at the table through their active and ongoing participation in the transition to and operation of the reconfigured band.”

With an auction beginning by the end of the year, and with C-Band customers on the CBA’s side, I think the satellite companies and the FCC will more than likely reach a legal agreement before Senator Kennedy can get his way. But overall, I wouldn’t say there is the political risk is now non-existent. Against all odds, Congress could still theoretically pass a law and stop the auction via retrospective implementation of the law. This would then probably result in a silly litigation deadlock going into elections while the lawmakers get an earful from lobbyists.

What’s the realistic scenario for the stock?

My base case is for the FCC to come up with a pay-out scheme that can appease both Congress and the CBA. While at a minimum, the satellite operators need to be compensated for the investments they’ve made, the FCC would also not want the bad press from appearing to pander to private corporations (especially in matters involving the taxpayer).

So, I think the most likely outcome here is for the FCC to go with something less harsh than what was proposed in the 5G Spectrum Act. Roughly an allocation of between 30% to 40% of the proceeds going to the government seems fair. That would mean the CBA still has a sizable pot to play for.

If Intelsat and their peers manage to get between a 60% to 70% cut, and plugging in a “low-end of range” total revenue estimate of $40B, that would imply proceeds of ~$25B. And that’s assuming no further clearance of spectrum in the future (in which case, the proceeds would be higher). Right now, the CBA has committed to making available 300MHz of spectrum (up from 200MHz previously) at 3.7 to 4.2 GHz, and we don’t know exactly how much of the cut will go to the rebellious Eutelsat. But I’d say anywhere between a third and a quarter of proceeds going to Intelsat would be a safe bet.

Raymond James was out with a note on Dec 19th, upgrading Intelsat to Outperform with a $12 price target. But $12 would be too conservative under this base case. Looking at past FCC Spectrum Auctions from these Stanford University slides, we can safely assume an auction price of roughly $0.30 to $0.50 per MHz-pop. Let’s say the FCC gets unlucky and the spectrum goes for mostly $0.30 per MHz-pop, that would still imply a share price in the mid-teens even if we assume other sources of revenue (satellite is a stable business) and price/sales (realistically should re-rate higher) stay the same.

Therefore, if this base case plays out, I’m expecting to target about $15 to $16, which represents at least 90% upside from current levels. On the other hand, if the anti-CBA hawks in Congress get their way and we get a prolonged court battle, or if the FCC decides to leave the CBA out to dry, I’d expect to see the stock revisit November lows around $6 (roughly 24% downside).

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