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 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 over 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 2-year cycles, U.S. residential broadband is a terrible business destined to fail.
Longs believe ViaSat is insulated from robust competition by its focus on rural households. They believe ViaSat should thrive in a large addressable market of underserved homes, using leading satellite technology to take share against 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 4 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 ARPU growth are wildly unrealistic. Investors underappreciate the magnitude and timing of technology improvements in competing terrestrial networks that directly impact 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 3 years, ViaSat has been jamming customers with commoditized add-ons like VoIP for $29.99/mo., “priority access” customer support for $5.99/mo., and anti-virus for $2.99/mo. 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 DCF-driven price targets.
To add insult to injury, while ViaSat waits 9 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 a tenth 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 $500m of equity (14% dilutive) at a price near current trading levels. ViaSat needs the capital markets for another $1bn+ 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 5 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 share from legacy telco – it is legacy telco. 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, or 50%+ downside.
I. ViaSat, Inc. (VSAT) – Investment Highlights
ARPU will not inexorably rise as forecast by the Street. It will decline. A key assumption in Wall Street models and valuations is that average revenue per user (ARPU) will continue to rise off current inflated levels.1 This view is flawed because it ignores how fragile ViaSat’s ARPU has become. After years of bandwidth constraints, 40% of ARPU is now derived from charging for commoditized equipment, non-core services, and add-ons. This weak foundation to ARPU is poorly understood by investors because of the company’s inadequate disclosures. The company’s ability to continue charging for non-core services will erode as competition continues to intensify.
- Beginning in 2014, in the wake of a strategic mistake that left ViaSat without additional bandwidth to sell, the company began emphasizing the sale of non-bandwidth “value-added” services.
- Commoditized offerings such as VoIP, Wi-Fi modems, anti-virus protection, and even better customer care began to increasingly drive ARPU growth – a trend that noticeably accelerated in the last twelve months (+13% in the most recent reporting period).
- The ability to charge extra for services that are included by competitors will eventually result in margin attrition as these highly profitable extras are ultimately included in basic service. The loss of these non-core service revenues will lead to lower overall ARPU.
- The company inflated ARPU for 3 main reasons, none of which are sustainable:
1. Without additional satellite capacity, the company has aggressively pursued a rate versus volume strategy over the past 3 years. ViaSat has systematically allowed lower-value subscribers to disconnect, while selectively retaining and targeting subscribers to whom they can upsell add-on products. This is not the strategy that will be employed when they attempt to move upmarket with ViaSat-2.2
2. EchoStar, their main satellite competitor, has also faced capacity constraints during the past 18 months. In other words, ViaSat has not had to defend its subscriber base against EchoStar and has been able to get away with uncompetitive pricing actions. That changed a few months ago when EchoStar’s Jupiter 2 became fully operational.
3. The company needs cash to fund ongoing satellite development and acquisitions, and so must demonstrate near-term revenue growth to win over investors. With subscriber levels getting worse, the only way to show growth in consumer broadband was to find contrived ways to grow ARPU through non-bandwidth related products. ARPU rose +11% in the September quarter of last year, driven by the introduction of non-bandwidth products. Ten days after earnings, the company announced a $500m equity offering to help fund their next satellite program. It inflated a metric the Street relies on, without providing granularity, so that analysts would believe growth was more sustainable