So it's been three weeks now since Intelsat (NYSE: I) reported Q4 2018 earnings, and after enjoying a brief post-earnings bump in share price, the company's stock has sunk steadily ever since. In fact, by the close of trading Thursday Intelsat stock was down a whopping 28% from its earnings day share price.
Reviewing Intelsat's Q4 report
Well, there were rumors that the U.S. Congress might try to nationalize some of the proceeds from its sale of spectrum rights to 5G wireless broadband providers for one thing. That risk could certainly be weighing on the stock. But for the time being, those are only rumors -- and until Congress takes affirmative action to prevent Intelsat from profiting from the spectrum it holds, I'm hesitant to give them much weight.
But you don't really have to believe those rumors to find reason for investors to be wary of Intelsat. After all, Intelsat missed earnings pretty badly last month, reporting an $0.81-per-share loss in Q4 that was three times worse than Wall Street's expected $0.26 loss. For the year as a whole Intelsat's losses more than tripled, from $1.50 per share lost in 2017 to $4.63 per share lost in 2018. Considering that for-profit companies are ordinarily supposed to, you know, earn profits, those losses seem good enough reason for investors to begin cashing in on a stock that has still roughly quadrupled in just one year's time.
On top of all that, Intelsat issued new guidance in its earnings report, warning investors of what look to be -- at least at first glance -- multiple years of much higher capital spending than what we saw in 2018. Even assuming stable cash flow, that seems like it could imply weakening free cash flow for the company going forward. And given that Intelsat really needs cash if it's to have any hope of paying off its $14.3 billion debt, that sounds like bad news.
But is this news as bad as it seems?
Free cash flow ups and downs
The answer to that is a bit complicated. Let's walk through the math:
In 2018, Intelsat generated $344.2 million in positive cash flow, and spent $255.7 million of that on capital investment, leaving $88.5 million as its "free" cash flow. This was a big improvement over the $2.6 million in free cash flow Intelsat generated in 2017, and an even bigger improvement over the company's negative $35.8 million in FCF in 2016.
Now, a big part of the reason Intelsat was able to generate such strong free cash flow was the fact that the $255.7 million it spent on capex was much less than it had told investors to expect it to spend in 2018. Indeed, in its earnings report one year ago, Intelsat laid out the following expectations for future capital investment:
- $375 million to $425 million in 2018, which implied $400 million at the midpoint, or about $145 million more than the company actually spent.
- An even greater $425 million to $500 million in capex in 2019.
- $375 million to $475 million in 2020.
As you can see, Intelsat surprised investors by spending a lot less on capex last year. And while those numbers will now begin rising, judging from its forecast Intelsat's plans to spend large sums on building new satellites are in fact much less ambitious today than they were one year ago. Intelsat's capex forecast for the next three years now looks like this:
- 2019: $250 million to $300 million;
- 2020: $275 million to $350 million; and
- 2021: $250 million to $350 million.
Taken at the midpoints, Intelsat is now projecting that the next two years will see it spend roughly 33% less on capex than it was planning to a year ago. And in 2021, Intelsat says capex spending will continue to trail off.
What this means for investors
On the face of it this seems like good news for shareholders. Less capex means less of a drain on cash flow, leaving more free cash flow available to pay dividends, buy back stock, and -- crucially -- pay down debt. But there's still one final caveat here that investors would be well advised to emptor.
As fast as Intelsat's capex budget has been falling, its cash flow has been shrinking even faster. According to the latest data from S&P Global Market Intelligence, Intelsat racked up more than $1 billion in cash from operations in 2014, but by 2018 that figure had fallen to just $344 million -- a decline of 67%.
If Intelsat spends what it says it's going to spend on capex going forward then this level of cashflow should suffice to keep the company in the black, free cash flow-wise, and provide the money Intelsat needs to whittle away at its debt. If operating cash flow shrinks much further, however, then even with reductions in capex, Intelsat could soon be right back where it was two years ago: burning cash.
If that is what happens, the 28% reduction in share price Intelsat shareholders have endured over the past month could pale in comparison to the pain they'll endure going forward.
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