Can Avanti Communications break even?

18th Nov '15 by Mark Simpson

10 comments 20196 reads

Avanti is communications company operating satellites. Currently they have 4 operational (ARTEMIS, HYLAS 1, HYLAS 2, HYLAS 2-B) with plans to launch 2 more in 2017 (HYLAS 3 & HYLAS 4).

They have been heavily loss making so far but promise rapid growth that will deliver profitability to the company in the future:

‘…management expects cash generation to grow swiftly as revenues exceed Avanti's largely fixed cost base.’ Q1 2016 Trading Statement

http://www.investegate.co.uk/avanti-comms-group--avn-/rns/1st-quarter-trading-update/201511120700084267F/

Things were going well on this front until H1 2015 when recurring revenue started to drop. (H1 2016 is estimated by doubling Q1 2016 revenue.)

[Note: H2 2015 showed a non-recurring revenue boost of 25.1m related to the sale of spectrum rights. However since the notes to the cash flow statement show this as a net cash cost to Avanti of $25.1 it seems fair to exclude this as revenue.]

This sort of drop off in revenue can mean one of two things. Either customers are using less of £AVN ’s services, or they are paying less for them. This is what Avanti Communications (LON:AVN) say on this topic:

‘Average Fleet Utilisation was at the upper end of the 20% to 25% range during the period’ Q1 2016 Trading Statement

‘Avanti's average pricing remained stable.’ Q1 2016 Trading Statement

‘This was lower than Avanti's prevailing run rate of growth, due to a larger amount of equipment and government revenue in the previous year, which, although recurring, tends to be recognised on a non-linear basis.’ Q1 2016 Trading Statement

‘Avanti's Fleet Utilisation was within the 20% to 25% band at the end of 2015, having increased from the 10% to 15% range in the prior year.’ 2015 FY Results

Based on these comments I’ve added estimate of the utilisation to the revenue graph :

564c85569a2f03AVN_Revenue_vs_Utilisation

So it seems that data rates are stable but customers are paying less for £AVN’s equipment or value added services meaning that rapidly increasing utilisation is not turning into increasing revenue.

What is interesting is to scale up the Q1 2016 revenue to get the maximum theoretical revenue at full utilisation as Avanti suggest we do in their 2015 annual report:

If we take 23% as ‘the upper end of the 20% to 25% range’ then based on the Q1 2016 revenue of $13.6m at the current pricing the maximum theoretical revenue…

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Edward Croft

20th Nov '15

DS - great analysis ! I'm surprised nobody else has commented here.

I had a friend call me up back in 2012 saying:

"Ed what do you think of Avanti Communications?".

We'd just launched the data on the site, and a quick glance showed me Avanti was clearly a sucker stock - red lights everywhere, massive dilution... ugly. I said:

"run a mile"...

He said:

"but my friend Johnny is one of London's top bond traders and he's in large and gave me a wink".

I said

"if he's a smart trader, he's in large and he gave you a wink... he needs someone to sell to... run a mile!"

Kelvin Prescott

top quality analysis, thanks. short a miracle, it seems to me that the equity is worthless.

Mark Carter

Loads of debt, no free cashflow.

John Chew runs an excellent free blog: http://csinvesting.org/author/csinvesting/ . if you're not aware of it, then you really should take a look at it. A few years back he ran a discussion on Whitney Tilson's purchase of sateliitle company Iridium http://csinvesting.org/?s=iridium . The basic conclusion seemed to be that satellite companies never made any money. They're all very exciting and high tech, but they aren't really that good as investments.

Stockopedia's ranks really paint a good picture, I think. Value 26, so not that cheap. Quality 16, which makes it a pretty attrocious company, actually. Momentum is 52, a little above average, but I think coupled with poor quality and value, it's doubly difficult to see how a purchase could be justified.

monzo

21st Nov '15

The bondholders and the directors are the only ones to benefit from Avanti Communications (LON:AVN). Little to no shareholder value. They were one of the first investments I made a few years back. I was suckered into the story and potential. I learnt from my mistake and moved on. There was a bit of a Facebook rumour sometime in the last year about wanting to increase internet coverage in Africa which sounded remotely interesting. Not even on the watchlist anymore.GL

Richard Goodwin

22nd Nov '15

Could it not be that much cost of sales is non-cash amortisation of investment? A cost of sales assumption significantly lower than 60% would make a big difference to the investment case.

Having said this, my general view is the same as that of everyone else who has posted here!

Mark Simpson

23rd Nov '15

Ed,

Thanks for the feedback. Your story reminds me of the Buffett quote 'If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy.'!

Mark,

Thanks for the link to the blog - looks an interesting read.

It wasn't the low StockRanks that initially concerned me about Avanti - although they certainly help confirm what I think - it was the change of comparatives in the results/trading statements. If you read just the narrative for 2015 you would see a rapidly growing company acheiving it's goals:

It's only when you graph the results you see declining revenue. Every company tries to put it's best foot forward so Avanti Communications (LON:AVN) isn't alone in choosing it's comparatives but it does seem particularly adept at doing so.

The other thing that alerted me that things may not be going as well as they would like is booking all the revenue of the spectrum 'sale' in Q4 2015. Maybe their accounting policies demanded it but it definitely looks like a company struggling for growth when a large amount of revenue get's booked and then comes straight out again in the notes to the cash flow statement without appearing as a receivable on the balance sheet.

Richard,

Could it not be that much cost of sales is non-cash amortisation of investment?

No I don't believe that is the case. I have excluded 'Space Asset Depreciation' from the analysis as non-cash. There is a small amount ($2.1m) of other asset depreciation included in operating expenses but this is insignificant. Note 3 to the 2015 annual report & accounts shows the breakdown of COS (although strangely not the complete breakdown since the figures don't fully add up to the totals in the income statement):

You are right to focus on the gross margin though. What my analysis shows is that although rapid utilisation & revenue growth are a necessary condition for success they are not a sufficient one. Only the combination of revenue growth and improved gross margin will see Avanti Communications (LON:AVN) be able to generate any return for shareholders.

When I did this analysis I had expected to see some kind of efficiencies of scale so I was surprised that the COS as a percentage of revenue remains the same whether they did $7m of revenue or $40m in the HY. Given how stable this has been I would think the onus should now be on the company to explain how and show it can generate higher margins rather than an improvement being automatically assumed.

Of course this is also the risk to any short position. Rapid revenue growth alone (particularly of the kind that appears in the results narrative but not in the results!) would not cause me to reconsider my position but any significant improvement in gross margin would.

Cheers,

Mark

4th Aug '16

Just a heads up that I'm now completely out of my short position on this.

It pretty much played out as expected although things came to a head earlier than I thought cash flow wise which is nice. The high debt interest combined with the failure of management to raise enough money to see them through to cash flow break even or control costs caught up with them in the end and no amount of gloss on the results or accounting gimmicks could prevent that.

With a sale of some point on the cards the risk is probably now to the upside. As a separate entity and without a highly dilutive placing I think their liabilities exceed their assets. But a larger player who have a much lower cost of capital could make a case for paying something for the equity. I still think the smart play could be to pick up the space assets from the administrator and bin the failed management but that has risks in itself.

The upside isn't clear enough for me to go long but enough to close out my short.

VegPatch

Should this rise much further I would short it again. The cash flow is terrible, the debt is terminal and the CEO is always overoptimistic. Great analysis Dangersimpson. Thanks.

Re Eds story on bond holders, as a equity PM in one of Londons largest fund management houses a few years ago, I explained my thesis to my bond colleagues on why there was real danger to UK Food retail bonds (Tesco etc) from the Internet and discounters taking mkt share. There were a few stunned looks when the penny dropped. Moral : we all miss things and just because the bond trader is in 'large' doesn't mean he is right. Good story Ed!

Thanks for the update DS. It was an excellent original article and an interesting follow up from both VegPatch and yourself

mercury61

17th Nov '16

A really good analysis and responses!. Very helpful. Thank you. I'm holding hoping for a miracle....

Can Avanti Communications break even?

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Mark Simpson

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