The UK government is trying to address this issue. As part of its Broadband Delivery UK intervention (BDUK) programme the plan is to deliver superfast broadband to 90 per cent of the population by the end of this year, rising to 95 per cent by the end of 2017. Currently 78 per cent of households have a broadband connection – up from 65 per cent five years ago. The problem being that even if this target is reached, it doesn’t mean all households will be able to access superfast coverage (deemed to be 24Mbps capability). That’s because some premises are simply located too far from the cabinet that provides access to high download speeds.
Technology analyst Michael Armitage at broking house Arden Partners believes that even if 80 per cent of premises get superfast speeds by the year-end, in rural areas where line lengths are inevitably longer than the national average, the figure “will often be as low as 50 per cent”.
Blue sky thinking
One solution to this problem is to look to a satellite internet service provider to provide an alternative high-speed broadband service. However, the typical £300-£400 upfront cost of the equipment required to access satellite broadband can be a deterrent. That’s one reason why the government announced a scheme to defray the entire cost of equipment purchase at the tail end of last year. It’s very good news for satellite providers, and for Satellite Solutions Worldwide (SAT:5.5p) in particular, a small-cap company that listed on Aim last May. Satellite Solutions’ Europasat satellite business currently has 12,000 customers, representing 35 per cent of the total in the UK and, following a number of acquisitions made last year now has 13,000 customers in Europe, representing an 8 per cent share of the market there.
My attention was sparked in mid-January when Satellite Solutions announced a contract award with BT (BT.A) making it one of the satellite broadband retail service providers under the UK government scheme to offer subsidised satellite broadband to up to 300,000 homes and businesses with internet connections of under 2 Mbps. Under the satellite scheme, the UK government will provide funding for the capital cost of the dish and modem equipment, connection fees and professional installation for qualified participants, which could be worth up to £350 per end user. The scheme was launched in December, and Satellite Solutions is offering a number of packages ranging from a basic service of up to 10 Mbps download and 2 Mbps upload with a usage allowance of 10 GB, to ‘super-fast’ satellite broadband services of up to 30 Mbps download and 2 Mbps upload connections.
The Welsh government estimates that up to 42,000 homes and businesses may qualify for the subsidy across Wales.
These initiatives could prove a game changer for the company as they remove the hefty barrier-to-entry cost for customers on the acquisition of the kit, while also increasing the addressable market in the UK. And Europasat’s ‘entry level’ tariff, S3 Promo, is pretty competitive for potential customers in remote rural premises: offering 20 Mbps download, 2 Mbps upload, with a 3 GB data cap, but with unlimited off-peak downloads, the service costs a modest £28.98 per month with VoIP (which allows for free or very cheap phone calls made over the internet) included. This compares with the BT standard monthly tariff of £30.49 for a package offering up to 17 Mbps, including line rental and ‘anytime’ calls.
So for people struggling with sub-2 Mbps speeds from BT, the satellite alternative is attractive both on cost grounds and availability. It can also be used as a back-up in the case of natural disasters or for corporate continuity planning, and has advantages for expats and second home owners who need to ‘port’ their broadband. Satellite Solutions buys capacity from the three commercial communications satellite owners with a European footprint – Eutelsat, SES Astra, and Avanti Communications (AVN) – and then resells that capacity to end-users, plus a margin, so is able to offer a two-week connection on orders.
New customers are generally acquired by Satellite Solutions through direct channels – telesales and via the website – and also through the 300 satellite service resellers operating in Europe that share the margin. The company has also been acquiring distributors whose customers are then migrated on to its Europasat platform.
Satellite Solutions has made seven acquisitions of resellers since the shares listed, including the purchase of two companies in France: Sat2Way SARL, one of the largest providers of satellite broadband, and Vertical Connect. These deals brought in more than 9,000 customers at an average cost of £165 each.
This means that Satellite Solutions now has over 10,000 customers in France, making it the second largest satellite broadband provider, so is well positioned to target an addressable market of 1m homes with broadband speeds of less than 2Mbps, or 3 per cent of the total market. It’s worth noting that the French government is also incentivising the roll-out of satellite broadband by offering subsidies across many areas via its ‘subvention’ scheme, with a stated commitment to enable 150,000 broadband subscribers on satellite by the end of 2018. Satellite Solutions has signed agreements with 44 out of the 54 regional departments in France to sell its satellite broadband under the French government’s incentive scheme.
Co-founder and chief executive Andrew Walwyn also sees opportunities in Poland. About 35 per cent of the 5m homes in Poland have broadband speeds below 2Mbps, so having acquired the customers of two providers of satellite broadband services at the end of last year Satellite Solutions is well placed in this market. It’s also well positioned to exploit opportunities in Scandinavia as the largest operator in Denmark.
SSW at an inflexion point
Having built up scale, the business should turn profitable this year. Without factoring in any more acquisitions, but reflecting the full benefit of the seven made since May 2015, Arden Partners expects Satellite Solutions to grow revenues from £7.4m to £13.5m in the 12 months to end November 2016 to produce operating profits of £300,000. This factors in organic growth of 20 per cent in the current customer base of 25,600, a sensible prediction considering the company generated underlying growth of 25 per cent last financial year.
It’s the potential to scale the business by acquisition, combined with ongoing growth in the existing client base that really excites me. In fact, the target is to grow the customer base to 100,000 by the end of 2017, implying the acquisition of around 64,000 customers over the next 21 months at a cost of £20m based on a subscriber acquisition cost of £300. The profit implications of this growth could be huge.
Factoring in average revenue per user (ARPU) of £30 per month, a conservative assumption given that Satellite Solutions currently earns £41 per month, albeit it does acknowledge lower ARPU earned in Europe, and a reseller margin of 30 per cent when these clients are ported onto Europasat’s platform, then each 10,000 of new client acquisitions adds around £1m to cash profits.
Of course there is a £300-£400 client acquisition cost – assuming new customers don’t benefit from the aforementioned government subsidies – to take into consideration too. This implies an annual interest charge of around £350,000 needs to be deducted from the £1m cash profits if all these acquisition costs are debt funded. Still, the implication is that if Satellite Solutions can achieve its 100,000 customer base by the end of 2017 then it could be generating cash profits of £7m over and above Arden’s current forecast.
Mr Armitage currently predicts that, excluding further customer acquisitions, the current client base should be able to produce revenues of £15.6m in the 12 months to end November 2017 to generate pre-tax profits of £1.4m and EPS of 0.47p. In other words, the shares are only trading on 11 times next year’s likely earnings, but forecasts look heavily skewed to the upside given the ambition of the board to grow the business both organically and by acquiring more European satellite service resellers. And Satellite Solutions has the infrastructure to act as a consolidator in a fragmented market, having invested about £1m in a scalable customer servicing platform, Aurora, with the capacity to handle 100,000 customers, four times the current number.
The returns from this acquisition strategy exceed cost of capital by quite some margin. Assuming a 20 per cent churn rate, implying a five-year customer life, then Arden calculate this will generate a 23 per cent gross internal rate of return on each £300 acquisition cost (assuming a 30 per cent reseller gross margin and ARPU of £30). This means that by using financing to fund the next stage of acquisitions, rather than the company’s modestly rated paper, it will be significantly earnings enhancing.
Net cash was £1.7m at the end of November which will easily cover working capital requirements this year without recourse to additional funding. But to finance further acquisitions, I understand that Satellite Solutions is looking to tap alternative sources of funding, including invoice discounting, trade finance and even funding from the European Investment Bank and other national lending institutions.
So this is a company offering the compelling mix of a rapidly expanding customer base, rising margins, a move to profitability, and a likely stream of positive newsflow on earnings-accretive acquisitions. There is a lot to like.
Of course, investors are cottoning on to the opportunity, which is why Satellite Solutions’ shares rose 50 per cent to 6.67p in the weeks after the BT contract win. They have also had the opportunity to assess prospects following last week’s upbeat trading update which highlighted a growing recurring revenue base, and a strong pipeline of acquisition targets, subject to funding.
Bearing this in mind, Satellite Solutions’ management team is experienced. Non-executive chairman Michael Tobin was formerly chief executive of FTSE 250 data storage group Telecity prior to its takeover; Mr Walwyn previously handled the disposal of Tiny Computer’s internet service provider business to Tiscali and the sale of the company to Time Computers; and finance director Frank Waters played a major role (alongside Mr Walwyn) in the £42m sale of a mobile phone retailer to what is now Telefonica. The board has skin in the game too: Mr Walwyn owns 15.8 per cent of the share capital, and chief technical officer Simon Clifton has a 10.2 per cent stake. The free float is around 47 per cent.
Needless to say, I am positive on the investment case and feel the shares are now worth buying on a bid-offer spread of 5.25p to 5.5p, valuing the equity at £16.9m, and offering significant upside to my 12-month target price range of 9p to 10p. Please note that if the spread widens ask your broker to deal directly with market makers for a better quote as past trades indicate a 0.25p spread or less is the norm.
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