HOW DID IT FIND TROUBLE?
Iridium is supposed to be the final frontier of the cellular world -- one phone and one number, able to be used anywhere in the world. The dream of a seamless and truly global cellular network allowed the company to raise nearly $5 billion in both debt and equity and launched the stock up to a high of $72 3/16 little more than a year ago. However, the dream has turned to financial nightmare as product delays and a variety of other snafus have plagued the company, causing the stock to fall from orbit.
While a technological feat, Iridium has been a marketing disaster. Not that the advertisements are bad, but the company greatly overestimated the demand for its products. There simply aren't too many people in the world willing to spend four figures for a phone and upwards of $7 a minute for their telephone calls. Plus, even if a potential subscriber could get his hands on a phone (which have been in short supply), the phones are as heavy as bricks compared to the featherweight offerings of the traditional cellular world.
The train of bad news to Iridium shareholders has been seemingly endless the past few months. The company's CFO left in March, and on April 22 it was announced that the Iridium's CEO had also jumped ship. Then came the earnings on April 26, which were nothing short of terrifying. In the first quarter the company had $1.5 million in revenue, $199.1 million in interest expenses alone, and a net loss of $507.1 million. Needless to say, analysts' downgrades and class action lawsuits have been in great abundance among all this turmoil.
The most recent blow to shareholders came last week when it was announced that the company had hired Donaldson Lufkin & Jenrette in order to restructure Iridium's costly debt. It was also revealed that the company was likely to miss the 27,000 subscribers it needs by the end of May to be in compliance with some of its debt covenants. With a business model that has a high amount of overhead both operationally and financially, it is little wonder that Iridium shares are flaming towards the ground after missing its subscriber and usage targets.
Iridium World Communications Ltd. is the publicly traded subsidiary of Iridium LLC. The only asset of the Iridium Ltd. is its 13.25% equity stake in its parent company.
Iridium LLC (the parent company) is a limited liability company that has built the world's first phone system that can be accessed from anywhere on the planet. The system utilizes a combination of ground-based antennas and a constellation of low-orbit satellites so that users can make calls and accept pages around the globe. The company started commercial service in November 1998.
Beyond the publicly traded subsidiary, Iridium LLC is owned by a consortium of other companies. The most notable member of this consortium is Motorola (NYSE: MOT). Not only does Motorola own roughly 20% of the equity in the parent company, but Motorola is also the primary contractor for the entire project.
At the end of March, Iridium had a little over 10,000 customers.
Income Statement* 12-month sales: $1.6 million 12-month income: ($1,554.6 million) 12-month EPS: ($10.91) Profit Margin: N/A Market Cap: $184.7 million (*Results for Iridium LLC, the parent company. Market Cap for Iridium World Communications Ltd.) Balance Sheet** Cash: None Investments: $302.5 million Total Assets: $302.5 million Total Liabilities: None Shareholders' Equity: $302.5 million (**For Iridium World Communications Ltd.) Ratios Price-to-earnings: N/A Price-to-sales: 115.4
HOW COULD YOU HAVE SEEN IT COMING?
Iridium's business model uses a great deal of leverage, both operational and financial. The operational leverage comes in the form of having an extremely high fixed cost and a low variable cost for the service. In other words, the fixed cost of running and maintaining the satellite system is obviously quite lofty while the cost of adding a paying customer to the system is fairly low. While the model works well if there is a sufficient amount of business, the result is also quite ugly if demand is overestimated. Operational leverage is always an important risk factor to think about.
Financial leverage (a.k.a. debt) is also another risk factor that investors should be cautious about. With members' equity of the parent company running at less than 6% of the total assets, it should have been readily apparent that the company was financed in an extremely risky way.
Watching the company's top brass jump ship should have been an additional warning sign that perhaps the ship was sinking. Even if that wasn't enough of a wakeup call, the first quarter earnings should have alerted investors that trouble was ahead. With the customer count barely topping 10,000 after five months of availability (little more than 150 subscribers per satellite), it should have been apparent that the company had completely misread the demand situation for its product.
Iridium is also an excellent example of a company with a complicated corporate structure, something to be wary of. Iridium Ltd., the publicly traded portion of the company, only owns 13.25% of the parent company. This means that the "real" market capitalization of the entire company is actually about 7.5 times higher than the market capitalization for Iridium Ltd.
WHERE TO FROM HERE?
It may be difficult to imagine Iridium falling any further after watching it trade at nearly a tenth of the value it did a year ago, yet it appears that the real trouble for Iridium is just beginning. Unless the company can magically increase demand for its service and sign up a boatload of subscribers, there is little hope for profitability under the current operational model. The fixed costs of operating a satellite network are enormous, and a vast subscriber base is needed to cover those costs. Unfortunately, subscribers are going to be difficult to come by with the current rate structure of the service, not to mention the bulky phone handsets.
Having almost $500 million in annual interest expenses alone also makes for a fairly high financial hurdle to cross. With Iridium burning cash at an alarming rate, there is little doubt that the company will need yet another cash infusion over the coming year to keep itself liquid. This will probably mean massive dilution to current shareholders of Iridium since the equity markets are essentially closed to the company. Also, bondholders will undoubtedly want a chunk of ownership in exchange for a relaxing the company's debt obligations.
It's important for investors to remember that when a company hits bankruptcy that it is the holders of the company's debt that are in the driver's seat, not the stockholders. Those who hold the debt have first claim on assets while shareholders are considered last. Iridium is not bankrupt just yet, but the restructuring news and probable violation of the debt covenants is an ominous overtone of what could be coming down the line. Even if the company can avoid bankruptcy, it is likely to come after watching current shareholders get massively diluted out of their stake in the company.
In short, whatever value there once was to the equity in Iridium is disappearing quickly, and a reversal of this trend will take nothing short a miracle. If holders of the stock haven't already done so, they should consider disconnecting from Iridium altogether.
-- Paul Larson ([email protected])
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