Is the SatCom Wholesale Model Nearing End of Life?

The satellite communications industry is undergoing a reorganization of business models in the face of maturing video broadcasting and the drum of disruption from mega constellation players such as Starlink. Historically, the industry modelled a typical oligopoly with a few dominant global and regional players utilizing critical orbital positions alongside solid barriers to entry and low exit. As a result, operators set and maintained prices in booming DTH markets, driving enviable EBITDA margins north of 80% and IRR of sometimes over 35% in hotspot video neighborhoods. With the stable video segment maturing, operators began expanding into less profitable remote connectivity and mobility solutions while maintaining an EBITDA-friendly wholesale business model.

Following the wave of recent acquisitions and consolidation in the industry, the value chain landscape is changing to reflect the evolution of business models and the entry of new players that have taken a different go-to-market approach. These approaches are broadly categorized under wholesale and service-focused business models. C-level executives across the industry and investors are evaluating the business model evolution and asking fundamental questions on the way forward. How do the business models compare on critical metrics such as top-line growth, turnover, profitability and return on investment?

What the Numbers Say

Over the past five years, wholesale-focused and retail operators have seen significantly diverging trends in revenue growth, according to NSR's Satellite Industry Financial Index, 12^th Edition. While traditional wholesale operators averaged -3.3% revenue declines over the last five years, service-focused operators recorded a high single to double-digit growth over the same period. For example, ViaSat Satellite Service and Hughes Services averaged 19.2% and 8% revenue growth YoY between 2017-2021 despite launch delays in ViaSat-3 and Jupiter-3 programs. Other examples exist of regional operators with franchised retail or managed services business models with double-digit YoY growth. At the same time, regional wholesale operators such as Avanti struggled to drive fill rates.

The unfolding of Starlink's aggressive customer acquisition and revenue growth is even more pertinent in illustrating the top-line movement of the service-focused business model for new operators. As of September 2022, Starlink reportedly reached 700,000 consumer broadband subscribers globally. Not minding Starlink's Ukraine shipments, a back-of-the-envelope calculation suggests Starlink is likely on track to hit $1 billion in annual revenues by 2023 and will be the industry's first operator to hit a billion-dollar mark in about two years of commercial operation. While Starlink is a unique example, given the scale of SpaceX and the branding of Elon Musk, it is unlikely that the company could achieve similar top-line results in a wholesale business model.

In terms of asset efficiency, NSR tracks two competitive metrics: annual revenue per operational satellite (ARPOS) and turnover ratio. ARPOS measures an operator's ability to generate revenue from its satellite fleet, which questions the business model of operating over 50 GEO satellites for under $2 billion in annual revenue. Over the last five years, the rest of the industry averaged $35.5 million in ARPOS, while ViaSat SS and Hughes Services recorded $299.8 million and $257.3 million over the same period, respectively. Admittedly, ARPOS could be a better metric if revenue from the utilization or resale of leased capacity is excluded. Hence, turnover ratio comes closer to assessing $1 of invested assets to $1 of revenue earned on a comparative basis amongst operators. Again, ViaSat and Hughes outperform the rest of the market with 47.5% and 30.3%, respectively, in turnover in 2021. For context, ViaSat is able to generate 47.5 cents for every $1 in assets. In contrast, Telesat, which runs a complete wholesale model, recorded a 12.7% turnover in 2021.

Bottom Line and Cash Flow Tell a Different Story

Despite the weakness in the wholesale business model, traditional operators continue to post enviable EBITDA close to 80%, with YoY weakness kicking in as revenues shrink. Telesat, APT Satellite and Eutelsat posted solid EBITDA margins in 2021. NSR estimates Intelsat's EBITDA margin fell to below 50% in 2021 following the consolidation of Gogo Commercial Aviation. On the other side, Globalstar (24.7%), ViaSat (36%) and Hughes Services (40%) underperform the market in 2021. However, Hughes Services sees improvements in EBITDA and bottom line, from 32% in 2017 to 40% in 2021, which indicates that the retail service business model could be profitable in the long run. Although with similar technology stacks, Iridium and Globalstar diverge significantly on market segments and end-user composition, reflecting the difference in their financial performance.

Perhaps, the most critical benchmark is how the various operators perform on Free Cash Flow, which is a good proxy for how much longer an operator can burn invested capital before returning money to shareholders. ViaSat continues to invest in the high CAPEX Viasat-3 program and inorganic growth in pursuit of scale. In 2021, ViaSat spent over USD 990 million in CAPEX, of which USD 568 million was related to the ViaSat-3 constellation and ground infrastructure. However, despite 36% YoY revenue growth from organic and new businesses' consolidation in 2021, ViaSat’s financials show that positive FCF and bottom-line profitability are still far out into the future. Starlink's business model will inarguably toll a similar path with years of venture capital burn before reaching FCF.

Are there indications that the service-focused business models will ever reach positive FCF and bottom-line profitability? The short answer is yes. Hughes Services' YoY improvement in EBITDA, bottom-line and ROCE, alongside Iridium's stellar performance across most critical metrics, corroborate that other service-focused operators could be on a path to benefiting from economies of scale. However, greater financial prudence and capital structure management are critical in accelerating the process.

Market Implication

NSR tracks backlog and years of backlog to annual revenues as a proxy for future demand, which is a leading indicator of future revenues. The industry average for years of backlog to annual revenues fell from 3.0 in 2019 to 2.7 in 2021, which points to shrinking contract durations and weakness in the typically long-term video segment. Pricing declines also contribute to overall top-line weakness. Apparently, the wholesale business model is disproportionately affected compared to service-focused businesses. Nevertheless, wholesale business segments still have stable revenue commitments and account for most of the industry's existing relationships.

The industry's most transforming factor is beyond the financial numbers but found in the competitive dynamics. The above financial performance overview buttresses that the industry's oligopoly is disappearing, with legacy operators holding on to a stunted pie in the old order. The revenue growth opportunities lie in market verticals where wholesale business models seem to be dwindling or non-existent: consumer broadband, mobility, backhaul and enterprise data. Moreover, the wholesale relationships that catalyzed these verticals are vanishing. For instance, Telesat's famed wholesale deal with Hughes on Telstar-19 may unlikely repeat in the future, with Hughes banking on Jupiter-3 to fill its capacity needs. Bulk leasing by Gogo in the CA business will now reside internally within Intelsat in the future. On a vertical basis, Inmarsat/ViaSat’s dominance of the inflight connectivity market, SP/operator consolidation, and Starlink's entrance further confirm that a pureplay wholesale operator may have difficulties capturing IFC demand. Expand the IFC example into other market segments where vertically-integrated operators are aggressively growing market shares.

A counter-argument is Globalstar's wholesale deal with Apple, which will undoubtedly transform Globalstar's financials in the long term. The direct-to-devise market is a unique opportunity, not a standard for traditional satcom data segments.

The Bottom Line

In the face of changing industry landscape, a hybrid business strategy seems ideal. Finding a pre-launch anchor customer(s) with a commitment for 30-40% of satellite capacity will remain a practice in the industry, given the high CAPEX of launching a satellite. However, securing a distribution network is becoming the holy grill for operators looking to scale. Differentiation and efficiencies at the network application level will help market winners rise.