Shares of in-flight Wifi provider Gogo
(GOGO) are down 97 cents or almost 7%, at $13.23, after Northland Capital Markets
’s Paul Penney
today initiated coverage of the stock with an Underperform rating, and a $6.75 price target, writing that fierce competition
will delay its ability to become profitable, and will strain its balance sheet.
And discount airlines
, its next opportunity, don’t hold much promise, he thinks.
As a result, "we believe GOGO’s shares are excessively overpriced
on both an absolute and relative basis,” writes Penney, referring to a multiple of 18.8 times his Ebitda projection
for next year, compared to valuations for peers of 6.7 times.
“We believe a more rational valuation
level to be $6.75/share
, which equates to 11.25X our 2018 EBITDA estimate of $92.3M."
Penney writes that what “sparked our apprehensions” are estimates calling for an 86% or create jump in Ebitda next year, to $113 million, after a decline of 9% last year, in a "hyper-competitive” market for airplane WiFi.
There are six or seven competitors
in any given market, notes Penney, and “as we looked closer at both Gogo’s domestic and international market share positioning, we believe there is an increasing level of vulnerability driven by a blend of evolving airline customer dynamics, increasing commoditization and technology related deficiencies."
On the domestic (US) side, GOGO is the clear market share leader today with ~66% of the total market (equating to ~2,791 total connected planes) and represents ~59% of total revenues. However, we believe there are clear signs of risk in GOGO’s dominance today, as the airlines proactively move away from having a sole connectivity provider to a “multi-sourced” model. In the end, the airlines motivations for moving to a more diversified service provider model could be driven by a variety of different factors: 1) Lower costs, 2) Improve technology related offerings, 3) Broaden bandwidth capacity and/ or 4) Drive faster implementation timing.
Already, American Airlines
and Alaska Air have been swapping out Gogo, he writes:
In fact, these “clear signs of risk” have been clearly tangible and more frequent of late; as two of GOGO’s sizable US customers (American Airlines and Alaska Airlines) have either undisputedly moved or threatened to move their IFC business from GOGO to a competing IFC provider […] At the time, an American spokesperson clearly articulated their desire to multi-source so they could “upgrade our fleet with the latest and fastest Wi-Fi service as quickly as possible”. More recently in August 2017, GOGO’s long-term customer Alaska Air put out a competitive RFP (Request For Proposal) that ultimately concluded in a re-newel agreement with GOGO. While many investors and bullish analysts misperceived this announcement as a “new customer win” for GOGO, we believe it not only clearly demonstrates the airlines desire to aggressively look to reduce costs / enhance their quality of service, but likely resulted in a reduced contractual rate.
Bulls, he writes, would like to believe there are "4 domestic airlines that are potential new GOGO connectivity customers
,” but he thinks that’s wishful thinking, especially given the four most likely, including Spirit Airlines
, are “ultra-low cost carriers,” the discounters.
They “charge for everything and anything they can,” including water, coffee and soda, Penney observes.
“We believe the likelihood of one of these airlines investing in IFC or having their customer base pay much of anything for the service greatly tempers our enthusiasm for any meaningful level of incremental revs / EBITDA contributions."
The “ field of dreams
” nature of this business will continue to drive costs up for Gogo, he opines:
The long term bull case on GOGO rests on the old adage from the 1989 baseball movie classic Field of Dreams – “If you build it, they will come”, as GOGO’s near term high / accelerating levels of CAPEX and OPEX will soon dissipate with an eventual boost in revenues / EBITDA on the other side. We believe this long term theory is far reaching and flawed, as new connected aircraft installation and ongoing IFC service costs will remain stubbornly high for GOGO.