VSAT: Flawed planned broadband

ViaSat considers itself a leader in satellite technology, capable of producing bandwidth economics competitors can’t match. For the sliver of revenue generated from delivering broadband to an airplane, that may be true. For the 70% of EBITDA that comes from delivering broadband to homes and small businesses, it is not. ViaSat (VSAT) provides inferior technology in a hyper-competitive market. The company’s main business is selling satellite-based basic home Internet service to U.S. consumers.

Unfortunately, its technology is no match for terrestrial internet providers today, let alone during the next few years as terrestrial competitors dramatically increase speed, capacity and coverage through rapid technological advancements. For ViaSat, forced to compete against terrestrial by launching satellites that exhaust capacity in two-year cycles, U.S. residential broadband is a terrible business destined to fail.

Longs may think ViaSat is insulated from robust competition by its focus on rural households. They think ViaSat should thrive in a large addressable market of underserved homes, using leading satellite technology to take market share from legacy telco and cable operators. Once ViaSat-2 is operational, subscriber trends will meaningfully improve – that’s when a stock stuck in neutral for nearly four years will finally lift off.

Every part of this bull thesis is critically flawed. Based on both speed and capacity, the company’s value proposition has lost every shred of commercial viability since its last satellite launch. Sell-side estimates that call for a tripling of gross subscriber additions, stable churn (customer disconnects), rising margins and continued inflated average revenue per user (ARPU) growth are wildly unrealistic (see “Lipstick on pig,” left). Investors underappreciate the magnitude and timing of technology improvements in competing terrestrial networks that directly effect ViaSat’s target market. 

VDSL, G.fast, DOCSIS 3.1 and fiber roll-outs are dramatically improving the capability and coverage of landline networks. Wireless 4G LTE is ubiquitous, unlimited data plans are offered by all four major carriers, and massive increases in spectral efficiency are fueling exponential gains in mobile speed and capacity. The changes in technology are not Science Fiction nor progressing slowly over many years. The competitive advantage that drove ViaSat’s subscriber performance with the launch of ViaSat-1 five years ago no longer exists. ViaSat-2 will not drive substantial subscriber growth and ViaSat-3 will have stranded capacity.

Satellite consumer home Internet – like pagers, Blackberries, pay phones and VHS players – will soon become nearly extinct in the United States, a tiny footnote in the technological landscape with products owned by a negligible fraction of households.

Like many technology businesses facing near-term obsolescence, ViaSat uses non-core products and misleading reporting metrics to disguise its doomed principal business. One particular aggressive tactic has been to use classic telecom gimmicks to inflate average revenue per user (ARPU). For the past three years, ViaSat has been jamming customers with commoditized add-ons like VoIP (voice over Internet protocol) for $29.99 per month, “priority access” customer support for $5.99 per month and anti-virus for $2.99 per month. These temporary ARPU contributions will erode under competitive pressure, just like charging for caller ID, voicemail and call-waiting did for legacy wireline carriers. ARPU forecasts across the street do not properly account for the high level of non-bandwidth revenues that are unsustainable in a competitive environment. When ARPU inevitably declines, so will EBITDA estimates and discounted cash flow driven price targets.

To add insult to injury, while ViaSat waits nine more months for its next satellite to be operational, EchoStar’s new Jupiter 2 is in the market now, poaching the few final adopters of satellite home Internet. ViaSat is currently slashing prices to avoid losing 10% of its customers before the end of the year.

Amid this deteriorating competitive position, the company is burning cash and tapping the capital markets for external funding. Since becoming a satellite services company, ViaSat has never generated positive free cash flow. The last time the company needed funding, it sold $500 million of equity (14% dilutive) at a price near current trading levels. ViaSat needs the capital markets for another $1 billion plus of capital over the next few years, which it will then invest in a business – satellite consumer home broadband – that will have mostly disappeared in the United States within five to 10 years. The company withholds disclosures required to accurately assess the health of the consumer broadband business, downplays the unit’s eroding competitiveness, and inflates metrics used in valuation, all to retain necessary access to the capital markets.

ViaSat is not an innovative company taking market share from legacy telecom firms; it is a legacy telecom. Subscriber metrics will woefully underperform expectations and it won’t be long until the market realizes that satellite-based residential internet is a business in terminal secular decline. We place fair value at $35, a downside of 50% or greater. 

As of press time, hedge fund Kerrisdale Capital Management was short VSAT.