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  • Chris Mayer

Cheap with a Catalyst

Updated: Jun 25, 2019


The S&P500 hit a new all-time high last week. Yet, as always, there are still quality assets on sale. Below, we take a look at one idea... and further down below, a couple of June buys…


I think an interesting opportunity exists in Echostar (SATS) to own a growing, un-levered, non-cyclical asset trading for ~5.75x EBITDA and with at least a 7% free cash flow yield.


A recent transaction will make this apparent, but it won’t happen until the second half of the year. (Disclosure: Woodlock House is long shares of Echostar with an average cost of ~$38 per share)


Back in May, Echostar announced it was selling certain assets to Dish Network in exchange for 22.9 million Dish shares. (In an interesting twist, the shares will go to Echostar shareholders. If you don’t want to own Dish, you can sell your shares and just own Echostar). In addition, about $253 million of liabilities transfer to Dish.


Here’s what the enterprise of Echostar looks like pro-forma, roughly (in billions):

Market cap, 4.12

Less Cash, -3.27

Plus Debt, 3.5

= Enterprise Value 4.35

Less value of DISH, -0.9

= Net EV, 3.45


So, call it $3.5 billion in EV.


What do you get for that?


What remains at Echostar is essentially Hughes Network Systems with other interesting assets that could be worth a significant sum. For now, let’s focus on Hughes.


Hughes basically provides broadband satellite service to individuals and businesses. Over the last few years, sales growth clocked in at ~10% annually and EBITDA growth at ~14%. Not bad.


Last year, EBITDA was $601 million – just for Hughes. Echostar, net of the Dish transaction, trades for about 5.75x EBITDA. Viasat is probably Hughes closest comparable. Hughes is much bigger and is not competing directly with cable/DSL. Nonetheless, Viasat trades at a multiple more twice Echostar’s. Even if Echostar traded for 7x EBITDA, that would be quite a lift for the stock.


Now, Echostar is capital intensive. EBITDA net of capex last year was $211 million. Echostar’s capex fuels that double-digit EBITDA growth as they add satellites and capacity. If you normalized capex, you’d get a much higher free cash flow yield. Something to keep in mind.


We also have to think about interest expense. Echostar’s balance sheet, as you can see, is bizarre and inefficient. It has $3.2 billion in cash and $3.6 billion in debt, a situation that resulted in Echostar paying $160 million (net) in unneeded interest expense.


But that will start to correct itself. In June, Echostar will pay off a $900 million note on which it pays 6.95% interest. Net, Echostar will save about $40 million in interest annually.


That’s ~$250 million in free cash flow . Which means you’re paying ~14x free cash flow for a ~7% free cash flow yield. And that’s looking backward. I expect the year-end 2019 numbers to look better as we see more growth.


These are rough numbers. There are more adjustments you might make. But there are also a couple of free kickers here that add to your margin of safety.


For example, Echostar owns 49.0% of Dish Mexico, “an entity that provides direct-to-home satellite services in Mexico.” Dish Mexico generated $440 million in revenue last year and a loss of $20 million. There is limited disclosure here and I don’t know what Dish Mexico might be worth, but it’s not nothing.


They have other investments, such as spectrum assets in Europe. In total, Echostar carried these investments at $228 million at year-end. You can play around with what these various things are worth. I won’t get into them here. But they are all free options on top of your ~7% free cash flow yield.


Charlie Ergen owns just over half of the stock, which I like. (Though some investors may worry this creates a risk of self-dealing). The company has a buyback in place that could allow them to purchase up to 28% of the shares Ergen doesn’t own. Though, they haven’t bought back much stock yet.


All in all, it seems a good risk-reward proposition to me.


*** June Buys


The sell side suddenly seems to be taking a liking to my names. I’m not usually in this position.


Goldman Sachs added Vivendi (VIV) to its "Conviction Buy" list. The crown jewel at Vivendi is Universal Music Group, of which a 50% stake is up for sale. Disclosure: Woodlock House owns Vivendi at an average price of about €22.


Goldman values Universal Music Group at €28.8 billion, which is on the lower-end of valuations I’ve seen, but certainly reasonable. I think the floor for UMG ought to be Spotify, which the market values at about $27 billion currently. Either way, such valuations compare favorably with Vivendi’s market cap of €31 billion. (Basically, depending on how UMG goes, you could wind up getting a lot of other stuff for almost nothing).


I really like Vivendi. The valuation is compelling. They own a unique asset in UMG. And they have a big buyback in place. We took advantage of the decline in May and added to our position.


On a sum-of-the-parts basis, Goldman says Vivendi is worth €32 per share. Again, take these with a grain of salt, as they say. But I find that valuation also reasonable.


Another June buy is, to my shock, Fairfax Financial Holdings. RayJay initiated with a buy and a price target of C$780. They called the current valuation (at 1.06x book value at the time) “unfair.” RayJay rests price target on 1.15x their estimate of book value one year from now. Again, seems a reasonable set of assumptions to me.


I’m thinking longer-term, however, and don’t particularly put any weight on book value one year from now. I think Fairfax has a good shot at producing 10-15% returns for several years. That’s plenty given the relatively low risk of a permanent capital loss. Disclosure: Woodlock House also owns Fairfax Financial at an average price of around C$608.


One more idea to throw in here: Fairfax India. RayJay had little to say about it. (I’ve written about it here before.) The stock slipped under $13 per share on Friday and seems a timely buy here. Disclosure: Woodlock House owns Fairfax India at an average price of $13.47. We’re a bit underwater here, but I have no major concerns. If this isn’t at least a double in five years, I’ll be very disappointed (and surprised).


One of Fairfax India’s largest investments, IIFL, split in three. But only one of the three pieces trades at the moment. The other two will follow soon. This could be a catalyst for Fairfax India when they do trade. We will see.


But I am thinking long-term here, too. I want exposure to the growth in India and Fairfax India is a good way to get it. You also get exposure to a unique asset: the Bangalore airport, which is a third of NAV. I also like the value-minded management team at Fairfax India and trust their network will find interesting things to do.


Thanks for reading. Send me mail: info [at] woodlockhousefamilycapital.com.


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Published June 22, 2019

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