Iridium Communications Inc. (IRDM) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the presentation slot for Iridium Communications. My name is Anthony Klarman, and I'm the telecom, cable and satellite analyst for Deutsche Bank on the fixed income side, and I'm pleased to have you all with us here to hear the presentation and overview from Iridium. Iridium is a mobile satellite communication services company. The company recently completed a multiyear, multibillion-dollar fleet upgrade of its satellite constellation, which provides voice, data and other forms of communication services to the United States' government, businesses, nongovernment organizations and consumers. Pleased to have with us here today the company's Chief Financial Officer, Mr. Tom Fitzpatrick. I'm going to now turn it over to Tom to run you through some slides, which should be loaded up in your presentation viewers. And Tom, thank you very much for joining us, and the floor is yours.

Of course, Anthony, thanks for having me. Good morning, everyone. I'll skip through the safe harbor pages and start on Chart #4, which is tied to a stark financial transformation is underway. And we, at Iridium, describe ourselves as a mobile satellite communications company with a proven track record and an exceptionally bright future. And our proven track record is on the back of the satellite you see to the left, which was launched in the late '90s. Our satellite constellation is one of a kind. It has unique functionality that I'll be describing for you that is a source of competitive advantage. And it is that network architecture that enabled us to build the business that we have now and have the track record that we have now with some 1.3 million subscribers and EBITDA in excess of $330 million in 2019 that we just completed. The bright future is all about the picture on the right is our brand-new satellite constellation, which we fully completed in February of 2019. And as you can imagine, since the network architecture of our old constellation is a source of competitive advantage, that same architecture was used in our new satellite constellation. But the new constellation, since it is a state-of-the-art telecommunications network, opens up what we consider to be vast new revenue opportunities for us in the area of broadband communications and our hosted payload, Aireon, which will revolutionize international air traffic control. And so the completion of our network upgraded last year ushered in really a stark financial transformation. And you can see that illustrated on the chart below. You see sort of the mountain as it would appear that grows over time to approaching $500 million worth of CapEx per year. We invested over $3 billion in our new network between 2010 and wrapped it up in 2019. All the while we were building our new network, we were growing our EBITDA on the back of our old constellation from $134 million in 2009 up to $332 million in 2019, so a 9.5% CAGR over the construction period. But the stark financial transformation occurs by virtue of the steep drop-off in CapEx that you see here. We estimate that CapEx, which you can see average in the hundreds of millions of dollars sort of for the last decade, will fall to approximately $35 million and stay there for about a decade. And so what happens as a result is Iridium becomes a provider of significant free cash flow for the next 10 years. Certainly, quite a transformation from the ground, which we most recently covered. Now I'll move on to Chart 5. Because I indicated that our network architecture is the source of competitive advantage, let me describe its unique characteristics. First, we're a low Earth orbit satellite constellation, about 500 miles from the Earth. Contrast that with geostationary satellite companies like our head-to-head competitor, Inmarsat, they're 50, 5-0 times further from the Earth than we are. And what that does is it creates physics -- laws of physics create challenges for them in delivering the same services that we deliver, and we use that to our competitive advantage. So low Earth is one area of differentiation. We're also a mesh network. And that's one of a kind as well. And so if you consider our network, if you stood in the moon and looked at down at the Earth and you cut the earth into 6 planes, we have 11 satellites in each plane going around the Earth in near polar orbit every 100 minutes. And if -- the way our call is routed, it goes up to the satellite immediately above, where it's being originated, and it's handed off in space between satellites, too. If it's commercial traffic, it comes down in Tempe, Arizona, our commercial gateway, and it is terminated on the public service telephone network or the Internet, depending on the nature of the traffic. The U.S. Department of Defense is our oldest and largest customer. Their traffic is handled the same way, except for their traffic terminates in their own proprietary gateway in Hawaii. And that mesh hand-off in space, again, no other satellite network does that. The alternative is so-called bent pipe routing, which means that the traffic goes up to the satellite above, where it originates, but it needs to come down to a landing station in relatively close proximity to where it originated. So you can imagine U.S. Department of Defense find that -- would find that bent pipe architecture in here. And that they don't want their traffic being landed in close proximity to where it originated for obvious reasons. It's originating in Afghanistan and other war-torn places. They really like the handoff-in-space dimension of the Iridium network architecture and the ability to terminate their own traffic. The other element of differentiation is geostationary satellite is just that, it's stationary. It's sort of above the equator. So it can't see the far north and far south areas of the globe. And so we have the furthest reaching network because we cover the entire globe, and geostationary can't because of their architecture. They're stationary over the equator. And because they're stationary, if a user happened to be blocked by an obstruction on a geostationary satellite, then until they move and get unobstructed, that call or data transmission is not going to go through. The Iridium network is different in that our satellites are not stationary. They're moving around the Earth. And multiple satellites have a look at the ground where the traffic is being originated. And if an obstruction is blocking the view of one satellite, there's another satellite coming immediately behind it with a different look angle, and the obstruction can easily be removed. So I would characterize our network as sort of self-healing in that ways. The multiple look angles resolve obstructions. And the net of it is it's just that we have less latency than the competition. Our calls, our data transmissions go through with less latency than the competition, okay? So that's how the network works, and that's why we consider ourselves to be unique. If we turn to Page 6, you see these are the areas where we do business. In land/mobile, where our satellite phone is kind of the gold standard, we were -- our network was built for handheld mobile communications, unlike some of our competitors who have kind of cobbled together an offering. If you sort of, for example, the geostationary that coupled together an offering, and because they're 50x further from the Earth, they have not really been able to make much of an impact on our legacy satellite phone business. We -- our fastest-growing segment is in IoT services. It turns out that mobile communications for a satellite phone transfers very well to an IoT device. These are matchbook size modems with very small antennas, and we're doing very well there. Our new satellite network, Iridium NEXT, we will have broadband speeds that are actually faster than the competition, Inmarsat, and we think that we'll make significant inroads with our service product both in Maritime and Aviation. We go to market, I'm on Chart 7 now, we go to market through a partner ecosystem that is some 450 strong. We're a legacy of going -- so that is -- we are a wholesaler. And so using that network of dealers and distributors is very efficient, enables us to scale globally very easily. And it's just very -- they build the end user, we build -- only build -- we have about 1.3 million subs. We're building 450 partners. And so it's efficient, it makes us scale, but it's also a source of advantage in that our partners have deep domain expertise in the vertical markets they cater to, and they -- or act as kind of a product development operation for us. And if they come to us with ideas, that the latest thinking in Maritime, for example, or the latest thinking in IoT, they come to us with new product development ideas that they think that will resonate in their vertical markets. And they've been a source of our product development for 20 years. And so this -- the depth and breadth of our partner ecosystem, we consider that to be an advantage as well. On Page 8, we just lay out for you our 2019 revenues, $560 million in 2019. The vast majority of that, about 80%, is our service revenue. It's recurring in nature, highly predictable. It's been growing at about 7.7% CAGR between 2009 and 2019. The majority of it is in just think of access in airtime, much like what you see in terrestrial wireless. The balance of our revenues is our equipment and engineering and support revenues. On our equipment, we make about 40% margin. So we don't subsidize our gear. Our handsets are highly profitable. Our engineering and support is kind of episodic in nature, and it's driven by upgrades to -- that we're doing for our U.S. DoD customer, principally to their gateway in Hawaii. Moving on to Slide 9. A little bit further of a breakout in our service -- recurring service revenues. So our service revenues in 2019 were $447 million, up about 10% from the prior year. Our commercial voice business grew about 6%. That comprises our legacy handset business and our growing Iridium Certus business. Commercial IoT grew by 13%. It's our fast -- one of our fastest-growing lines of business. Our subs grew faster than that. They grew by over 20%. And we think that the Internet of People becoming the Internet of Things is a very good trend for us. We think most projections say that we're in the early stages of that trend, and we think that we're going to be the satellite provider of choice to the IoT. Our hosted payload business are payloads that we have on our new constellation, most significant of which is our joint venture in Aireon that I'll describe in a minute. But we also have payloads with Harris Corporation. You see significant growth there in 2019 from 2018, up about 52%. That just -- that is all contractual revenue. And the rate of growth is just because it reflects the full ramp-up of our new satellite constellation that was completed in early 2019. We see our hosted payload revenues kind of leveling out at about $47 million. That's the full ramp of the contracts. It still has some room to grow in 2020. Other data services is principally our satellite time and location business. You see our U.S. government revenues were up 10% from $88 million to $97 million. That reflects the first year of what is a new 7-year $738.5 million contract that we signed up with the U.S. DoD in September of last year. Moving on to Page 10, our guide for 2020. Our service revenues, we see them growing between 6% and 8%. Our operational EBITDA, we see between $355 million and $365 million, up about 9%. Cash taxes will be negligible through about 2023. And our net leverage will be down from 4.8x, where we closed 2019, down to about 4x in 2020. On to Chart 11. Let me describe Aireon for you. If you look at the bottom of this chart, you see that the ability to actively surveil aircraft today is about 30% of the globe. And so air traffic can be actively managed by air traffic controllers in 30% of the globe. The method or the equipment by which air traffic is controlled is being changed. The old method was radar that dates to the second world war. In industrial countries around the world, that is all being ripped out and replaced by new technology, so-called automated-dependent surveillance broadcast. That is the new equipment that surveil and enables air traffic controllers to manage aircraft. And in industrialized countries around the world, by law, you must -- aircraft must be fitted with an ADS-B receiver if they enter from the United States, for example. And so that new technology is happening, and the FAA is spending millions of dollars as our airliner -- airline companies around the world spending millions of dollars to put this new equipment in. The trouble with this brand-new technology is it has the same limitation that radar had, which is it can't see planes over the oceans and vast landmasses, where there's not ground infrastructure. And when that is the case, where that's the circumstance, aircraft need to adhere to very strict, unflexible rules regarding their flight path. For example, planes over the oceans need to be separated by 60 nautical miles, and they have very limited ability to ascend and descend because they're off the radar. Enter Aireon. What Aireon is, is a payload on all of the Iridium satellites, our brand-new network that was just launched, that completely cover the globe 100% and see the equipment that's already going on planes anyway, this ADS-B equipment, such that the globe goes from 30% able to be surveilled up to 100% able to be surveilled. And that yields significant savings in fuel. Because when you can actively surveil and direct an aircraft, they don't need to fly 60 nautical miles apart. They fly 15 nautical miles apart. There's much more ability to ascend and descend to take advantage of better flying conditions, et cetera, the Gulf stream, et cetera. And so Aireon estimates that basically their addressable market, which fundamentally is their cut, if you will, of global fuel savings, they estimate their annual TAM at $750 million a year. So a very, very meaningful opportunity. You should know that Aireon is up and running. They are actually NAV CANADA and the UK NATS, who are both customers of Aireon and investors in the venture, are using the technology to direct aircraft over the North Atlantic currently. In fact, Aireon has signed 15 data service agreements with other air navigation service providers around the globe. And they've agreed -- signed agreements with 35 countries. Our 6 equity investors include some of the largest ANSPs in the world. NAV CANADA, UK NATS. And the ANSPs of Ireland, Italy, Denmark are also investors. So this is an up and running company that we think will be very profitable and have meaningful impact on Iridium going forward. Chart 12 just shows you an illustration of the kind of the operations of Aireon for ADS-B to consider. Chart 13, talk about our capital structure road map. We undertook significant refinancing activity in 2019. Our constellation -- our new constellation was built using export credit finance, supported by the French state, which was tailored to our needs, and we couldn't have gotten the project done without it. Upon completion of the network, that financing became kind of inappropriate for us. It was very restrictive. So we took it out and put in a Term Loan B in November of last year. We then did a Tack-On to the Term Loan B and took out our 10.25% high-yield notes in February of 2020. So we'll exit 2020 at about 4x leverage. We've established a target of net leverage of between 2.5 and 3.5x OEBITDA. Obviously, the firm would delever below 2.5x just if you look at the rate of delevering that we're predicting for 2020. And so we would intervene to cause that leverage to not go below 2.5 using shareholder-friendly things, dividend, buybacks and the like. Moving on to Page 14, just to sum up kind of what I've told you. We have a track record of superior operating performance, EBITDA at 9% growth from 2009 to 2019. Our new network is a brand-new, state-of-the-art telecom network. We think that opens up significant new revenue opportunities for us. Now that we have completed the new network, we think we have about a 10-year CapEx holiday. We see negligible cash taxes through 2023, and we don't get to the statutory rate until 2028. So it feathers in between 2023 and 2028. So you put that together, the strong EBITDA growth and the CapEx holiday and low taxes, you get really strong cash flow conversion. We see continued deleveraging. And then once we're in our target range of net leverage, we'll have the ability to do shareholder-friendly things. And we think that will enable us to maximize shareholder returns. We think Iridium is really a very rare combination of growth and free cash flow. Going on to the next chart. Bear with me a second here. Okay. So on Chart 15, we just lay out our pro forma free cash flow in 2019 and 2020. In 2020, if we take the midpoint of our guidance, we'd be at $360 million in operational EBITDA or about 9% gross. Back, our working capital and CapEx, our pro forma interest expense is about $90 million, not much in way of cash taxes. That would give you a pro forma free cash flow of about $208 million. So interestingly, you've got free cash flow growing at more than double the rate of EBITDA. And we think that's something that the free cash flow growing faster than EBITDA is going to be our circumstance for some time, given the flat CapEx that we see. And so you get -- that throws off a free cash flow yield over 5% and a free cash flow conversion of about 57%. Our basic point is we think we stack up very well against other companies in the communications infrastructure space, the tower companies, some of the fiber companies and data center companies. And we think that in measuring us against these statistics, we stack up pretty well. And just in summary, we have a very unique network architecture, and we think that's a source of competitive advantage. We have strong business fundamentals. We characterize by recurring revenue base. We think that we're going to capture share in new satellite -- with our new satellite network, and our global distribution partners are -- again, are a source of competitive advantage. We think that our CapEx holiday is going to fuel growing free cash flow for a significant period in the future. With that, let me turn it over to you, Anthony, for any questions.

Great. Thanks, Tom, for that overview. We do have a few minutes left, so I was going to run through some questions here. Maybe I'll start with a few questions on just kind of some pieces of the operations. You did make some mention of the U.S. government contract that you renewed last year. The government's, I think, by far, your largest single customer and is now locked in under a 7-year deal. Can you just remind us what is included in that contract and sort of how the escalators work? And then I think you had talked previously about the potential incremental revenue opportunity to the contract from Certus and whether there has been any discussions preliminarily with the government as to how they may take advantage of some of the new features that are available on the new constellation versus the legacy constellation?

Right, right. So the new contract, the 7-year contract for $738.5 million, it is an all-you-can-eat contract, so they can add as many traditional handset subscribers and IoT subscribers as they have a need for under the contract, and it's a fixed price. Obviously, if the shareholder count were to go down, that does nothing to our revenue. It's kind of a take-or-pay from that perspective. So again, it includes those 2 services. It does not include our new product, Certus services. And we think that there's a $100 million opportunity there. Inmarsat has that much business with the DoD. And we've signed up with one of our partners to sell into the U.S. DoD. We think the U.S. DoD is very interested in our Certus product. In fact, they're making upgrade to their gateway in Hawaii to accommodate our Certus product. And so we think that, that represents upside to the $738 million contract we have with DoD.

Great. And if I could now pivot to the IoT data space. I think the previous guidance was, in terms of growth potential, a $75 million run rate incremental opportunity as you exit 2021. A lot of that growth or at least a significant piece of that growth, if we go back to the Analyst Day from the early second quarter of last year, was going to be coming in Maritime. I guess, in light of what is happening, broader global economy, have you seen any impacts yet kind of in the Maritime pacings? And how should we think about sort of where you are most levered to capturing the growth potential to hit that $75 million incremental run rate opportunity that you had spoken about previously?

Right. And you're talking about our broadband business, right? The IoT, the broadband, yes?

Yes, broadband. Yes, yes.

So our broadband business -- yes, no problem. No problem. So our broadband business, just by way of background, on our old network, we built a product called OpenPort that was inferior to the fleet broadband offering of Inmarsat. We -- our data speeds were 128 kilobits per second. They were 220 to 400. So with slower data speed. And notwithstanding that, we built a business that got to on 10,000 ships and had about a $25 million run rate as we exited 2018. Well, into our new network, our new network is a state-of-the-art telecommunications network, we built broadband capability that is actually faster than the Inmarsat offering. Our Certus offering is 350 kilobits per second to 700 kilobits per second. So it's faster. It's built on the Iridium network, right. So Inmarsat is 50x further from the Earth, so their antenna is way bigger than ours. Our -- I think our Certus product is made by Cobham, is like 1/4 the size of Inmarsat. So we're smaller, cheaper, cheaper antenna because it's smaller. And we're pricing our service cheaper than theirs. And so what we said is, "Hey, we've got a product that's faster and cheaper and smaller than the competition. We ought to be able to take some share." And that's particularly because this sleek broadband product is old. It's been around for quite some time. We estimated that around 70% of Inmarsat's installed base is out of contract just because they've had the product for so long. And so you have -- the situation is ships, the Maersks over the world are desirous of more data speeds, just like everyone is, right? And so we're coming to market with an offering that offers those data speeds, and it's cheaper. And so our target was to take that 25 -- what was it, $25 million kind of exit rate in '18 business up to $75 million as we exit 2021. And our business is growing month in and month out, and, it' just going to be a question of pacing. We've said that we kind of learned the cycle time, if you will. There's been a lot of Certus terminals procured by the channel in the thousands, but we don't get paid until the channel actually puts the device on an end user ship and they start using it. And so we're observing how quickly that takes. But the feedback from the channel and from end users is they really like the product, it works as advertised, it's easy to install. And so we're optimistic that we're going to continue to see some nice growth out of that Certus product line.

And Tom, maybe to stick with that for a second. I guess, it sounds like there are 2 sort of avenues of growth there. One is just some market share shift, where there's one incumbent, who's very dominant in that space today, and you're able to offer something that obviously is superior to what your legacy capabilities would have been on the old network. I guess, I'm wondering if you have seen or heard any anecdotal evidence yet of impacts from global slowdown. I think Maritime is thought to be one of these kind of global industries where it has broad-based kind of macroeconomic exposures. And are there any sort of headwinds or incremental anecdotal tidbits that you have on what you've seen thus far with respect to some of the progress you were making in Maritime?

Right. So, I mean, Maritime has not been a really -- the industry has not been growing for a few years, right? So the value proposition that we bring forward is more data, faster, cheaper. So it's not sort of discretionary ships need it. They're -- we weren't relying in our kind of -- in our thinking, how we thought about it for the Maritime industry to grow. It's rather the installed base of ships need faster data speeds just to get their business done. And that was our projection. We'll see. I don't think anybody can call really what this coronavirus impact is going to have one on the industry. But like I said, we weren't -- it wasn't like we were projecting a big growth in Maritime as our fundamental assumption.

Yes. And then if we could talk a little bit about Aireon. Obviously, aside from the hosted payload payments, which you mapped out on one of the earlier slides between Aireon and Harris, it's pretty clear how that works. I guess, I'm wondering if you could maybe just remind us on what -- some of other incremental opportunity for you is with Aireon and when some additional payments from Aireon are triggered. And then if you can remind us on just the timing around the share repurchase of a portion of Iridium stake that they have that is contractually set up to be sold back at some point in the future?

Right. So Aireon has paid us -- they owe us $200 million for hosting the payload on our satellites. They paid us over $50 million towards that $200 million. That balance is an interest-bearing receivable at LIBOR plus 350, I believe. Aireon's plan is they were able to pay off the $50 million that I referred to before they became operational. So it's kind of unusual, right? So the way they were able to do is they secured financing from kind of an infrastructure fund that took a look at the fact that their payload worked, and they had contracts with quasi-government agencies for multiples of what we were owed. And that facility that they've put in place enabled Aireon to make the $50 million payment. Aireon continues to sign new customers. They are signing up new air navigation service providers with regularity, who represent additions to their existing customer base. They will be profitable from operations this year by virtue of that. So as their plan is that the more customers they add, the more their credit statistics support a kind of a regular way high-yield offering, which they would intend to knock out the infrastructure financing that they've put in place a couple of years ago and upsize it because they will -- their pro forma credit statistics would enable that. And in that undertaking, they would, first, pay up the balance that were due on our hosting. And they estimate that's going to happen late 2021 or into 2022. Then they continue to sign up more and more customers, and they would do kind of a tackle onto the high yield that they do in 2022, later 2023, depending on their pacing of contracts. And with that attack on financing, they would acquire certain of our interest for $120 million. They'd make $120 million payment to us, and that would leave us with 22% of the company. They then expect that they'll become a dividend payer no later than 2024, again, using the same type of an approach where they would raise high-yield finance based on their ever-improving credit statistics and commence paying dividends no later than 2024. And they estimate that their dividend payments to us will eventually be more than the $40 million we get from them in our capacity as a vendor to them.

Got it. That's very helpful. We've got a couple of minutes left, Tom. I wanted to maybe sneak in a capital structure question or 2. Our published model and your guidance has your net leverage number at around 4. It wasn't that long ago that, that number was over 6. You mentioned wanting to get to within your leverage range, which will happen presumably very quickly after 2020. And you mentioned on the slide, obviously, shareholder-friendly activities, repurchases, dividends, things of the like. But you also mentioned potential strategic opportunities. I was wondering if you could sort of tell us a little bit about some of the things that you and Matt and maybe the Board are thinking about as ways that you could potentially look at some strategic avenues for the free cash flow that you're going to generate, given that you'll be generating free cash flow growth that's sort of well in excess of the EBITDA growth that you see in the business.

Yes. So what we've said is what we're not going to do is we're not going to sort of buy up the channel. We're not going to vertically integrate and like buy a feed cast or -- because we're not going to compete with our partners. We've said that and that's kind of fundamental to our strategy. There is really nothing on our shopping list, if you will, right now, Anthony. Our Plan A is shareholder returns. And to the extent that something comes up that has strategic merits, we've got a very effective hurdle rate, if you will, and that we can model what we think happens to the shares when we do significant buybacks, for example. And a strategic kind of investment or acquisition would have to feel, like on a risk-adjusted basis, it beats that kind of quantifiable return that we get from doing shareholder-friendly things. So that's how we think about it.

Yes. And then one final question. You mentioned the 10-year CapEx holiday. Is there some point prior to year 10 where you have to start thinking about the R&D and other things associated with sort of the next phase of the evolution of the network? And how should we think about sort of when non-NEXT CapEx or OpEx or R&D needs to start getting spent to prepare for, again, the longer-term future?

Right. So the way we came up with the 10 years, right, if you just look at what happened with our first-generation constellation, right, it was launched in the late '90s. It had a design life of 8 years and it lasted over 20 years. And we de-installed it, it was working just fine. So considering that, it sure feels like our new constellation, which had a design life of 12 years with state-of-the-art electronics, it's going to last 20 years. And so we throw 10 years out there in terms of the duration of the holiday, thinking that's conservative, because we think that the existing constellation is going to last us 20 years. Now having said that, we're thinking about what that next -- what that successor network should look like already. But there's a difference between thinking about it and spending on it. And we feel quite confident that the spending on it part is 10 years out.

Yes. So to sort of take that one step further in the last point, you put up a free cash flow and free cash flow per share slide for '19 and '20 earlier. You have guidance out there that shows a growth in the exit run rate for broadband as you exit 2021. I guess, would it seem to be that a rational expectation would be that you see similar types of growth potential in free cash flow and free cash flow per share, even past 2020, given that you've already guided to some growth figures as you exit the run rate for 2021?

Right. Yes. No, we think with holding CapEx flat, right, whatever you grow your EBITDA by, you ought to grow leverage free cash flow at a more rapid rate. And that's only kind of amplified by the profile of the firm, which is a delevering firm. So if the firm's delevering, then interest is going lower as you do so. And so that, like I said, amplifies the fundamental kind of situation, which is growing EBITDA, flat CapEx equals levered free cash flow growing faster than EBITDA.

Great. Well, we have run to the end of our time period here, Tom, but I want to thank you very much for joining us. And I want to thank all the investors for dialing in as well, and for everyone's flexibility that they've shown us here in helping us to accommodate an alternative format for the conference. And the hope would be that next year, we are all back in Palm Beach sitting in the conference room. So thanks, everyone, for joining us. And Tom, thank you very much for being with us today.

Great. Thanks a lot, Anthony.

Thank you. Bye now.