Viasat, Inc. (VSAT) Earnings Call Transcript & Summary

Good afternoon, and welcome to Citi's Global TMT West Conference. My name is Kevin Toomey. I'm Citi's IMT Sector Specialist, and I'd like to welcome Viasat's CEO, Mark Dankberg, to this year's conference. Mark, thanks for joining us.

Sure. Thanks.

So why don't we kick things off with a big picture question? Can you summarize the business model and maybe some key initiatives that are underway for the next year or so, 2 to 3 years?

Yes. So we have a mix in our businesses of products and services. The services have become -- yes, sure. The services have become the biggest part of our business, and then so services basically are primarily services that we offer for residential, mobility, government and expanding into other enterprise applications and local Community WiFi remote services. So that business model is basically cell, satellite airtime to people in these different markets. And then we have a number of products that we sell that go along with those services in some markets like -- for government we'll sell the equipment that's used to access our satellites. And then we also have other product businesses that are not satellite-specific, especially in the defense market, which would include cyber security, terrestrial radio, anti-jam radio products and then some also markets and things like Earth observation.

Okay. So just so everyone knows, the mics are open. So if you have questions, feel free to jump in at any time. So what are the opportunities for satellite broadband services to increase your competitive position against terrestrial services, especially in rural areas in which federal subsidies are available to provide faster broadband?

Okay. So we don't really think of it as competing directly with terrestrial or competing with the best terrestrial services. Just to put things in perspective, there's still somewhere between 20 million and 25 million U.S. subscribers on DSL, right? So basically, what we're -- our big opportunity in the U.S. residential market, and it will be the same thing on a global basis, is to provide really good services in places where they otherwise wouldn't be available. And the definition of what makes a good service constantly increases generally. Now it would be considered 25 megabits per second or above. And often, the kind of the other big factor in determining the quality of the services, how well it works for delivering video streaming entertainment. So our opportunity in the U.S., and then the same thing would be true in other areas, would be to go after those markets. The -- it -- those are expensive markets to serve terrestrially. And we're interested in the federal subsidy market. One of the things -- I think the biggest misunderstandings about the federal subsidy markets, a lot of people think of it as -- that if you subsidize the capital investment that you're done and that those businesses are self-sustaining. In actuality, what turns out happening is those are really recurring operating cost subsidies, and so even a few billions of dollars a year don't go very far in a market that's valued at well over $100 billion a year.

Okay. So how does latency impact the competitiveness of the services and the opportunity to qualify for government subsidies?

Okay. Two different questions. Okay. So one is, if you look at what it is that makes a service valuable to an end user, I would say there's like 4 distinct components. One, the one that people really understand well is speed. That's kind of a dominant criteria that people use when buying a service. The other one that they should pay attention to, and which people learn is important if they don't have it, is volume. That is the amount of bandwidth. So you might think about it as an example. I might want to stream ultra-high def, not even ultra-high def, just high-def videos, and it might take 2 or 3 to 4 megabits a second. That's all the speed it takes. But if you want to do that for 400 or 500 hours a month, the number of gigabytes that it takes is a lot, and that turns out to be a big factor. Price is a factor. And then I would put latency as number 4 after those 3. Okay. In the government subsidy world, they basically make latency kind of a top-level criteria. What they did in the last round of subsidies, which we work -- which worked out well for us, was they put a penalty, a price penalty on services out of latency over 100 milliseconds. So up until then, we'd never qualified for any auctions, and that one we did qualify. And one of the things that was a little bit eye-opening was that I think we ended up fulfilling about 22-or-so-percent of the market off -- that was served for less -- a little less than 10% of the money. So it was a good value. How they're going to treat latency in the next round is not yet determined.

So can you size the addressable market for your government, commercial and consumer verticals, just to make us a...

So -- yes. So okay, one is they're all large. There's no way we could serve -- if you think about the -- all the opportunities before us, there's no way we could serve them all in any -- to any high extent even with all the new satellites. But I think in the U.S. market, the estimates of the addressable market for satellite broadband are in the $20-ish million range. In the in-flight connectivity market, I think it's becoming more evident that that's going to be basically a requirement for all planes and then sort of the projections over the next 10 to 15 years of 40,000 commercial jets. And think of that as a recurring market, people use kind of a rule of thumb, it's $100,000 to $200,000 a year in revenue per plane, so that's also an enormous market. Government market is probably smaller than that, but it's in the -- it's in the, probably, single-digit billions for services market. I think that one of our objectives is to grow each of those markets. In the in-flight market, there's a big opportunity to grow the engagement among passengers, which creates more economic value. And in the government market, there's lots of opportunities to basically connect forces that are disconnected now and one of the big drivers there is the cloud for DoD. So if you think about -- I think cloud computing is going to be really valuable for DoD because it gives people access to storage and compute resources and sensor data that they otherwise wouldn't have access to. But what you need is connectivity to make that work, and so what we're showing is that we can deliver that connectivity to lower levels of forces, and we think that those cloud applications as they emerge are going to drive usage.

So you've mentioned a lot of opportunity. Which customer vertical do you see the greatest opportunity for -- to increase revenue and cash flow over the next maybe 5 years?

So well, generally, what we just -- [ these will go away because of course ] -- we've gone from being asset-light company, where we were really a products and technology company, to being asset-intensive as a satellite operator. And so one of the metrics that's really important to us is return on assets, and think of that as kind of a yield management problem for our satellite bandwidth. And so one of the things we've shown is kind of a hierarchy of these applications, where the most demanding customers get the most value out of it. We'd like those to be the biggest users of our services. So that will be government, as an example. Mobile in-flight connectivity for general aviation, commercial aviation are good examples; maritime. So what we're aiming to do is to migrate our services to those highest ones. Some of the low -- like the low end one would be the U.S -- would be the residential market because the expectations for the amount of bandwidth that people consume is very, very high, and ARPU, even in the $100 range, is relatively low compared to the ARPUs or the revenues that you'd see from these government or commercial customers. So some of the things that have been really good for us is, over the last couple of years, our fastest-growing business has been the in-flight connectivity business. And when you look at the combination of equipment sales that go with that and the services that business like tripled over the last less than 2 years for us. So that one has been really good. Government business has grown really steadily, and we're now just being able to get into some of the enterprise applications that are also good high-yielding markets for us. Meanwhile, the residential business has been growing at 15-ish percent a year, mostly driven by higher value service plans, which has driven ARPU up.

Okay. So it seems like a lot of incremental capital is being poured into the home broadband market. Cable is offering faster speeds. Altice has fiber. 5G fixed wireless services from incumbents and startups are rolling out. The wireless industry has unlimited plans. Does this pose a problem for Viasat? Or...

That's competition for us, for sure, right? I mean, I would say, on the cable and fiber, you're really seeing sort of incremental growth around the edges, where the distance to the nearest sort of mid-tier fiber is kind of the dominant factor. New construction is probably easier. But the existing market, you don't see that much expansion. Wireless systems tend to have the issues that we have in terms of volume. They tend to be volume-limited, and often, they won't have the same speed that we will. So I think we tend to hold our own against a lot of the pure wireless operators. That would be like -- there's like a fixed wireless. Generally, a lot of that's using unlicensed spectrum. If you look at what people are looking to do now with licensed spectrum, like Verizon has done, they tend to go into the densest areas. They're not going to city centers, but they're going into suburbs. Those are what we would consider to be high-density markets, not our target markets at all. And they're, I'd say, struggling in those markets against the incumbents as well. Yes?

I was wondering about sort of 2 things. One is on in-flight connectivity, sort of the competition, it seems to be increasing there and sort of how do you think about that market as it develops or continues to develop. And then secondly, has anything changed over the last year in terms of sort of the benefits with merging with sats. And I mean because -- I mean now both of you are in launching on another cycle, these more high throughput satellites.

Okay. On the in-flight connectivity market, I would say the number of competitors hasn't really changed. I would say the fortunes of the competitors is diverging pretty substantially. And our view -- I mean, we've -- this is not super hard. You can go to places like FlightAware. You can get all the route information for all the airlines. You can look at where all their planes are. You can count up the number of people on the planes. And you say, "Okay, you need this much bandwidth in these places at these times in order to be able to deliver really good service." It's not going to happen with Ku-band, and I think that that's becoming evident. Also I think that one of the other things that's happened over the last few years is when we talk to airline executives and CEOs, they'll basically say, "The biggest source of complaints we have is WiFi." It's not losing the luggage and it's not on-time performance anymore, it's WiFi. And people aren't happy with high prices, and they're not happy with poor performance. So I think that, especially if you look at what happened with us when we rolled out on American Airlines, we're probably the only WiFi provider where we rolled out at scale, and people go, "Wow, that performance is really good." Most of the others, when they've scaled up, their performance had degraded because they have a limited amount of bandwidth, and the more planes they have, the worst the performance gets. So I think we're separating ourselves from the pack there. We're really optimistic about the implied market. The second, the -- what was this...

The sats.

Oh, yes. Clearly, there's a bunch of duplication of effort between us and sats, whether it's operational or capital intensive, so there's potential value in combining them. But you've got a -- it takes 2 to reach a deal there.

So just on the consumer side, what are the opportunities to improve customer growth with respect to expanding the market relative to taking share from competitors, such as EchoStar?

Well, one is I think that between the 2 of us, the total U.S. penetration's around 1.5 million. We're capacity-constrained, and I think they'll say the same thing. I think we're operating at different tiers of the market. Our services plans are generally richer and higher-priced. Theirs are generally lower-priced and don't have as much bandwidth. But I think we'd both say that we're capacity-constrained in general, so I think there's growth opportunities just by having more capacity. The other thing that we're doing that we think is pretty interesting growth opportunity but we're still testing are what we call hybrid services, where we will work with a local service provider, like a DSL operator, and we can do the same thing with wireless, where we combine both satellite and terrestrial and we dynamically route traffic so that the high speed, higher volume stuff tends to go over the satellite, the things that are latency sensitive could go over terrestrial link. That improves the responsiveness for that. Basically, if you look at things like Sandvine or other Cisco breakouts of what the applications are, only 5% to 10%, 5% is actually probably upper bound of the amount of traffic that is latency sensitive. So if we can blend those 2, it enhances our service offering, and we think that's going to grow our addressable market as well.

Okay. So is that all contributing to ARPU growth? And how much further could we expand ARPU?

Okay. So basically, just one thing to understand on our ARPU growth is we don't raise prices on existing customers even after they come out of contract. So the way we're getting ARPU growth is really kind of the way that it comes in the terrestrial market as well. The cable market, which would be -- we'll give people -- I'm just going to pick a number, 40% more service for 10% more money or something like that, right? So we're aiming -- and the other thing that we've said multiple times is we're much better off with one customer using 2 units of bandwidth than 2 customers at half the price because it's way more capital-efficient, and when they have more bandwidth, they tend to be more satisfied and leave less. So for us, if you think of it as a yield management thing, what we're focused on is revenue and earnings growth from our capital, not subscriber account, okay? But from an ARPU perspective, the other big thing that's going on that you sort of have to take out is ARPU is growing 6% to 7% a year in the cable world as well, and that's being driven by unbundling and higher-quality service plans. So we're growing 15-ish percent, so we know we can do that for a while because the ARPU of our new customers is higher than our average, so that's tending to bring that up. But we -- I think maybe there's another year or so of ARPU growth. But around less than 2 years from now, we'll have the new satellite. And in the meantime, what we may end up doing is we may end up repurposing some of our bandwidth away from residential into the other applications as those grow, that'll be in-flight, enterprise, government.

Any questions from the crowd? So could you discuss the trials with AT&T and the opportunities to alleviate concerns on latency by working with DSL providers?

So we're in the early stages of that. I would say -- I would say, there's still a lot of -- there's a lot of logistics to work through in terms of order entry coordination on the installations. Those -- that's probably the biggest issues. I would say the results for the people that we have that are enrolled in it and getting service are positive. So part of the reason we decided to work with AT&T initially was it gave us the biggest footprint. So we felt that, that would allow us to get a flow of new subscribers. We're finding that's not an issue, that that's working well. They're probably -- they have a broad collection of assets with lots of different quality issues on the DSL, and so that's probably more challenging than maybe a regional operator might be. So we might expand to a smaller, more focused partner as well. But overall, I would say, going slowly but steadily. And right now, our main objectives are more to learn and to reflect that in our go-forward plans than it is to have that drive our economic results. Our forecast of economic results aren't driven by this, but our -- sort of our assessment of the longer-term opportunities are.

Okay. So just on capacity, could you give us an update on maybe the timeline and initial operations for ViaSat-3 and maybe speak to the global opportunity it provides and what offerings could look like as you tackle many diverse geographic regions?

Okay. So one of the things I always say when it comes to ViaSat-3 is we're doing a lot of stuff for the first time. There's always risk in satellite launch schedules, so just keep that in mind. But our plan is to launch the first one, which would be for the Americas, in the first half of 2021, and we've held that for quite a few quarters. So that's what our target is. It's the first satellite of its time, so there will be few months of ground space integration, but we expect it to be in service, generating revenue before the end of 2021. If that goes per plan, the second one for Europe, Africa and Middle East would launch by the end of 2021. And we'd have global coverage by the end of '22, 2022. The -- obviously, we're the most knowledgeable and comfortable with the U.S. market, that's the U.S. residential market, the in-flight connectivity, government markets. We're getting a lot more familiar with the international in-flight markets, and those are going just as we expected. We started in the last year going into what we call Community WiFi, which is dropping really high-speed broadband into rural villages with typically a few hundred to 1,000-ish people. That's gone well. There are logistics problems, but demand, willingness to pay, ability to pay all seems promising there. The -- so the other thing we're doing is we're having to bring a global playbook. So we're going to bring sort of global views of what the services are like, how we should charge, what the service plans would look like. But we need local partners to help us deploy and roll out, and we have to have accommodations for tax and regulatory regimes in each of these countries. So Mexico was very, very straightforward. Brazil is one of the most complicated in the world from a tax and regulatory perspective. So that's actually gone pretty well. One of the good things about being in the GEO market as opposed to LEO, where in service, like in one big bang everywhere at once, we get to do it incrementally. And so I would say we -- what we expect is that we'll see different vertical markets have different roles in each of the different satellites. So for instance, in the U.S. market, we can expect good growth in the residential market when we bring out that pretty good growth in the enterprise market, plus the government and the commercial are pretty predictable. We go into Europe, I would say we expect Europe won't be as residential, won't be as big a factor as it is in the U.S., but it will be bigger than it will be in Asia Pacific. As an example, Community WiFi will be bigger in Africa than it will be in Europe. But we also know that government will be pretty big, bigger role factor in Europe, Africa, Middle East because of the Ukraine and Africa and the Middle East, and it will be a big factor in Asia Pacific because of the Pacific Ocean, the Navy Asia Pacific threats. And mobility will be a big factor in the Asia Pacific as well. So what we're doing is we're trying to develop each of those. And in some cases, that means getting on platforms, getting customers and then we'll just get roaming revenue as these platforms operate in those regions.

So you touched on government there at the end. How should investors think about the future growth prospects of the government?

I think the government business has been a black box to a lot of media investors and telecom investors, but it's performed really well. We've had double-digit growth for several years in a row, outgrown our competitors. One of the things we've pointed to in the past is really healthy backlog. Now one of the other things we've added is, besides $1-ish billion in firm backlog, close to $2 billion in what are called delivery order contracts, which are not firm but are basically ordering agreements that allow our customers to buy. So for the next couple of years, those 2 bode really well, just purely from a financial metric perspective. I think in the long run, the things that are driving our growth, and we've talked about them, are migrating our products and services from early adopters, like special forces, expeditionary forces, 82nd Airborne, which is just now going to deploy to the Middle East, this would be considered an early adopter, first responder. We're doing well at taking equipment and services that have been used in those organizations and expanding them into the mainstream Army, Navy, Air Force. If those trends continue, then it's clear we can have as good as growth as we've had for the last few years for many years, and we may be able to increase that growth.

So just to shift gears for a second, and then maybe we'll open it up to the crowd, so you serve a lot of airlines around the world. What's driven your success there? And what's your outlook for the vertical going forward?

So I think the thing that we're telling the airlines is a really good measure of performance is engagement, and that is how many people use the service, whether they pay for it or not. Basically, you can invest a ton of money and put -- it's like WiFi on, but if only 6% or 7% of the passengers use it, you're not getting value out of it. And one of the things we've heard, I mean, fairly explicitly from Delta, who is not one of our customers, is, well, we have to charge a bunch of money for this because if a lot of people use it, the service becomes bad. So the thing -- I think the thing that's really worked for us is we have many flights where there are more devices connected to the Internet than there are passengers on the plane, and the service still works really, really well. We're also one of the -- probably the only provider that provides real hard service level agreement metrics where, hey, we're going to be able to deliver 99% or 98% of the time a service that is measurably this fast, and we're doing it. And I think that the fact that we could do that and then add 600 planes for American Airlines in 15 to 18 months and still do it, I think has really caused people to sit up and take notice. And then the other part, because we're so vertically integrated, our service is just the most reliable. I think you've seen the problems other suppliers have had with the antenna systems or aircraft integration or things like that, we haven't had those fortunately.

Okay. I have a few -- we have a few minutes left. I have a few more questions. If anyone wants to jump in and ask a question, feel free right now.

I don't know if this came up, but how many additional airplanes could you add over North America beyond the American Airlines issue, where you still have headroom in terms of hitting those SLAs?

We do. We do have a lot of room, and I would say there's a couple of thousand planes we've got our eyes on. So we could add them. I think the reality is, by the time we went through all of the, what they call supplemental type certificate and the installation process, we'd have ViaSat-3 anyway. But one of the things we've said is as we add airlines and we look at what that route structure is, we may have to shed consumers, residential customers in some of these areas. We do that through churn, but we could serve the whole. I mean capacity is not a constraint for us in the U.S. market. So I think that's creating opportunity for us now.

Just touching on the global opportunity, what's the opportunity to serve the airline vertical on a global basis? And maybe give us an update on your growth opportunities in Mexico and Brazil.

Yes. So one of the things that I would say is a big differentiator for us is I think you have to look at the geographic distribution of demand when you're going after these markets. In the mobile market, that's a really big factor. And the biggest issue is the fact that even if you have a global fleet -- I mean take Singapore Airlines or something like that, right, they have no domestic market, they have a global fleet. But they have places like Singapore where airlines tend to -- where the planes tend to congregate. So being able to meet the density demand is a really big factor for us. Our system is designed for that. I think we have tons of credibility in being able to deliver that. We've also been pretty clear that we can't deliver the level of service that we do in any market unless we have a space system that can support that. So in places like Australia and Europe, we're -- do it. We've been able to do that. We made this agreement with the Brazilian -- with Telebras in the Brazilian government, and we signed up with [ Zuo ] in Brazil so we can do it there. We're working with China Satcom. We think we can do the same thing in China. So that's made us international and multi-regional. The transatlantic capabilities got us to capture long-haul, intercontinental fleets. And now with ViaSat-3 approaching, we've been able to win new planes for global, purely global carriers. I think some of that stuff will come -- we ought to make public during this year, 2020.

Great. So just on the new strategic opportunities. In the U.S., you began serving the in-home broadband market, then you use fellow capacity to sell airlines and nautical applications. What other opportunities do you see in -- for new strategic?

Yes. So the -- I mean the thing that -- in some sense, the success we had in the residential market didn't allow us to enter other markets at scale until we had ViaSat-2. So some of the other markets that we were really interested in, one is the business market, and that includes enterprises. And so one of the opportunities for us, if you look at -- in general, as an example, the cable companies are probably more competitive in many municipalities than the telephone companies are, but they don't have national footprints. So if there's an example, one example is fill-in opportunity for big national accounts. So we've been doing some testing in that area, and then small businesses are really good potential customers for us. The ability to adaptively route among terrestrial and satellite is a big opportunity for us. Because with what they call SD-WAN or software-defined wide area networking, that's a big, big opportunity in enterprise markets where they want multiple transmission modes anyway in order to have reliability for online sales or point-of-sale systems. So enterprise is a big one. Maritime is another one. And then the other -- another one is to convert our general aviation business, which we've had for quite a long while, to Ka-band, and that really kind of took us having transatlantic capacity. So over the last year or so, you've seen us sign up OEM deals with most of the major mid-sized and larger private jet manufacturers. So those are some of the new businesses that we think will scale along with government, residential, in-flight connectivity and Community WiFi.

We have about 2 minutes left, if anyone has any questions. I have a couple more. So just on investment spend, what's the current rate of spend? What's your return on capital target?

Okay. So total capital investment, probably this year, runs in the $900-ish million range. That includes sort of all forms of capital investment. That's the new satellite builds, CPE, SAC costs and also capitalized investment like capitalized interest, capitalized investments in the infrastructure. Our -- basically, our objective is to earn returns that are way well in excess of our WACC, and one of the ways that we test that -- this -- I think this is one of the most important points for investors to -- and analyst to get their head around is, when you look at return on capital for us, to make a distinction between capital assets that we've brought into service, like ViaSat-2 or investments that we've made in network infrastructure, like in Brazil, as an example, where we bring network infrastructure there. So we've made -- so we have some investments that we have brought into service and then other investments that are still pending, obvious example there would be the ViaSat-3 satellites themselves. And if you look at the investments that we've brought into service, our returns on capital are hitting our targets. They're really good.

Okay. I'll squeeze one more in here. What's your net debt leverage target? And what are the opportunities for buybacks in the future?

Okay. So what we've said is we're sort of comfortable below 4 in the net debt leverage range, and we go through cycles. So especially, right when we deploy a satellite, that'll probably be where leverage would peak. And then as we bring it into service within a couple of quarters, you can see that start to deleverage. And that was the case with ViaSat-2 right before went into service, I think we hit 5 and then we went down to the 3 range pretty quickly. It will rise as we invest -- complete the investments in the ViaSat-3. We'd like to keep it in the 4 range. If it goes above that for a quarter or 2 or so, that's manageable.

Okay. Last chance.

So I'm always a bit surprised when I see some level of investment come out of like a Google or a Facebook as they try and sort of bring the broadband to the emerging markets. I was equally surprised when Google did their fiber initiative in the United States, right? It just seems so orthogonal to me that a social media company or a search company should be out there doing sort of connectivity when it's just so naturally in your wheelhouse in terms of your core competency. Have there ever been any discussions with any of these well-capitalized firms that have ambitions to bring Internet connectivity to the world with you or a company like you?

Yes, absolutely. Absolutely. And -- but it's a complicated thing. I think basically, from their perspective, transmission is friction, right? That's -- so what they're really -- and maybe look at it as friction in terms of reach and then the quality of service, the experience that people have even in areas that are well-served. So what we -- we can help them enormously with their reach problem. But what I would say, one of the things we've learned from them is no matter what we or anybody just as a -- you could take the Apple or Amazon Go space, no matter what they do, 95% of the people who use their services are going to get it through some other transmission company. So they're -- what they're -- I think what they're really trying to do is create some competitive dynamics. And/or one of the things Facebook has said they would do is if you look at like what they did in the data center field with open compute, okay, hey, look, we're going to take all the air out of Intel, and now they're going to take all the air out of Cisco with the white box stuff or -- so those things will basically reduce cost for everybody, that's fine. I think that them having their fingerprints on a service that's actually competing with their transmission partners is not super likely, and I think that creates opportunity for us. But I also think that -- and I think it's happening. We need to prove that we're separated from the pack because they don't really understand the satellite field very well. I think that separation from the pack is happening most visibly in the in-flight space. That's helping us a bunch. So I think in the long run, there's good opportunity there to partner with those guys. And we did with Facebook in Mexico, I think that can be a scalable model.

All right. Mark, we're out of time. I really appreciate your time.

Yes. Thanks for the opportunity. Thanks a lot for attending.

Thank you. That's great.

Good to meet you.