EchoStar: Dangerous Debt Comes With Massive Spectrum Potential

Summary

• EchoStar faces severe financial challenges, including a "going concern" warning and declining cash flow, jeopardizing its 5G network construction and spectrum licenses worth $20 billion.
• The company's strategy to use pay-TV cash flows to fund 5G network construction is faltering due to losses in the Retail Wireless and Broadband segments.
• EchoStar's immediate survival hinges on securing new financing to cover $1.98 billion in debt maturing in November 2024, with uncertain prospects.
• Despite the risks, a successful 5G network build out could significantly boost EchoStar's market cap, offering substantial upside potential if the company can overcome its hurdles.

enot-poloskun

With the announcement of EchoStar’s (NASDAQ:SATS) Q2 earnings report earlier this month, the scope of the challenges facing the company is coming into ever greater, and grimmer, focus. The company once again issued a “going concern” warning, legalese for “we might go bankrupt soon,” and reported another net loss. Operating income was down across all divisions of the company, and the dramatic decline in cash flow has begun to severely restrict spending on the construction of the 5G Network which must be completed if EchoStar is to avoid forfeiting over $20 billion of spectrum licenses and ever return to profitability.

It wasn’t all grim, there are a few bright spots and EchoStar’s spectrum holdings remain a potential ace-in-the-hole. But regardless of whether it pulls out of this nose dive or not, the strategies and two key mergers of the past few years have been a complete failure, undermining confidence in management and making it harder for EchoStar to obtain the financing it needs.

Star's Dimming Light Leaves Networks In The Cold

EchoStar today comprises four operating segments, with three of them being the inheritance of the merger with the former DISH Network. The fourth, Broadband and Satellite Services, is the original EchoStar. Well, I say original - DISH Network actually spun off EchoStar back in 2008, so this is more of a reunion than a marriage.

The idea behind the merger, which is only a year old, was that EchoStar’s cash hoard and free cash flow would help fund DISH Network’s wireless network build out. Essentially, EchoStar was the past and DISH Network was supposed to be the future, but DISH needed bridge financing to get to the future, hence the merger.

Less than a year after the deal closed, that plan may be shot. Broadband and Satellite segment operating profit has swung into negative territory for the past two quarters. Far from being a reliable source of cash, it threatens to become a deadweight, which is potentially catastrophic for EchoStar since every dollar of losses slows the construction of the 5G network which is its only long-term path to profit, or even survival.

To be sure, the losses in the Broadband Satellite segment are net income losses. Cash flow, which is arguably more important at this point, is still just barely profitable - the segment recorded $117 million of depreciation but only $57 million of actual capital outlays, so a $35 million net loss was actually about a $25 million cash generation. But this same metric is down 75% from the year before.

The Turnaround Plan

DISH Network has spent the better part of the last decade trying to transform itself from a satellite TV company into a wireless network company. In that pursuit it has acquired almost $30 billion of FCC spectrum licenses. This for a company with a current Enterprise Value of…$30 billion.

The plan was to turn DISH’s hoard of spectrum into a viable wireless phone operator, to rival or at least challenge T-Mobile, AT&T (T) and Verizon (VZ) Wireless. Indeed, when the government approved the Sprint merger with T-Mobile (TMUS) a few years ago, it made its approval contingent upon the sale of certain assets to then-independent DISH Network.

In order to monetize the spectrum, however, EchoStar needs to build a network. In fact, FCC regulations require much of the spectrum to be forfeited if it can’t build the network by next year. Roughly $10 billion of licenses is subject to forfeiture if not completed by June 2025, and another $9.9 billion has an October 2025 deadline.

For the past few years, DISH was pouring all available funds into network construction. The problem is, “all available” is coming to mean less and less. And as EchoStar’s creditors get more and more nervous, they are refusing to roll its debts, making the cash drain that much worse and completion of the network that much harder.

November Deadline Looming

After redeeming roughly $1 billion in debts earlier this year, EchoStar’s cash position has fallen below $500 million. This makes this statement, lifted straight out of the 10-Q, particularly ominous:

“As reflected in the condensed consolidated financial statements as of June 30, 2024, we have $1.983 billion of debt maturing in November 2024, and we are forecasting negative cash flows for the remainder of the calendar year 2024”

Obviously, $500 million and a negative cash flow is not going to cover $1.98 billion, so EchoStar needs to secure new financing if it wishes to remain afloat. The prospects for this are, frankly, somewhat unclear. In the Q2 earnings call, management indicated that all of its spectrum except for its 600 MHz holdings were unencumbered and available as collateral, which should make $2 billion a cinch since DISH has spent almost $30 billion acquiring licenses.

However, it may not be so simple. In order to get its spectrum “unencumbered,” EchoStar engaged in a series of transactions to transfer licenses between subsidiaries, potentially asset-stripping the ones to which bondholders thought they had recourse. A lawsuit is currently underway to assess the various claims and counterclaims; it may yet turn out that EchoStar doesn’t have as much unencumbered as it thinks.

This is obviously a critical issue, but without knowing what’s behind all the redactions and sealed filings, it's hard to express a more solid opinion on it. EchoStar needs the financing and insists it can get the financing; if they’re wrong, the equity has a value of zero.

Assuming for the moment, however, that they’re right, we can do an operational analysis on what the company can look forward to in 2025 and beyond, so that is what I’m going to focus on now.

Cord Cutting Isn't Cutting Too Deep Yet

The common refrain is to talk about the looming insolvency of EchoStar as a reflection of the collapse of the pay-TV bundle. It is certainly true that cord cutting is proceeding apace, with roughly 5 million net subscriber losses each of the last five years, and 2024 certainly appears likely to keep the streak going for a sixth.

However, EchoStar’s recent earnings report makes clear that isn’t really the most pressing concern. Yes, subscribers are declining and operating income is following it down. However, DISH TV and Sling TV, EchoStar’s satellite and streaming linear bundle services respectively, are being managed for cash generation and are not currently showing leverage loss. That is, the decline is operating income is, in percentage terms, less than the decline in revenue, not more; in the past two quarters, each time pay-TV revenue has declined 10% while operating income has declined only 6%.

Obviously, it’s never good to have operating income decline at all, but such a performance is rather impressive considering that pay-TV, especially satellite TV, is an inherently high fixed-cost business where each subscriber loss should see its lost dollars coming straight out of the bottom line.

The success likely owes to the performance of Sling TV. EchoStar’s streaming linear bundle remains the only service to offer a bifurcated linear offering, with the NBC, ABC and FOX broadcast nets on one service and the ESPN family of networks on the other. The ability to pick and choose which one to take, and to add and drop month to month, is unique to Sling among streaming video providers. This led to a truly astonishing result last quarter: Sling TV reported a Q2 net subscriber addition of 78,000.

Even the top-performing streaming services regularly report losing subscribers, not gaining them, in the second quarter, which is the only quarter that ends with neither the NBA, the NFL nor college football in action. fuboTV (FUBO) lost subscribers and so, we think, did YouTube TV, although Alphabet (GOOG) (GOOGL) does not regularly update that subscriber number. For Sling to achieve this result is truly remarkable.

DISH TV also seems to have had a better quarter than expected, though in its case this amounts to losing fewer subscribers, not gaining them. In fact, when adjusting for the smaller subscriber base compared to last year, DISH TV’s 182,000 subscriber losses actually reflect a higher percentage than the 197,000 a year ago. However, DISH TV saw a decline in churn rate, which allowed it to reduce spending on subscriber acquisition costs. In fact, EchoStar’s pay-TV segmented saw SG&A costs decline $116 million Y/Y in Q2, although I doubt that all of that number is attributable to DISH TV’s lower churn and SAC.

We shouldn’t set too much store in this yet. Sling TV’s performance is out of character for a service which has already fumbled its first mover advantage and yielded the growth and size leadership categories to fuboTV and YouTube TV, respectively. It is not clear exactly how Sling TV managed this growth or whether it is sustainable.

But even so, the more general takeaway is that while cord cutting certainly isn’t stopping, pay-TV is not the segment that threatens to bankrupt the company. In 1H2024, pay-TV represented over 2/3 of revenue and over 100% of OIBDA (OP Income before Depreciation & Amortization) at EchoStar. While pay-TV OIBDA did decline by $87 million over the past six months Y/Y, that is barely 20% of the OIBDA decline at the company overall that is causing EchoStar to flirt with bankruptcy.

Network Construction Remains Expensive

Roughly another 30% of that decline is represented by the 5G Network segment. That’s not surprising considering that building the nation’s first nationwide open-RAN wireless network from scratch has been the business strategy at DISH, and now EchoStar, for the past decade. In Q2, 5G Network represented roughly 85% of the Purchases of Property and Equipment at EchoStar, as the company works frantically to try to get a finished network up and running before the music stops.

Looking at overall numbers instead of Y/Y changes, 5G Networks has a negative segment operating income of $579 million in Q2. The primary reason for this is that even though 5G Networks is spending a lot of money, it is generating almost no revenue - only $35.5 million last quarter. While EchoStar is open to partnerships to get utilization of its network up, it’s always been known that one of the biggest users of the network would be DISH’s own wireless service - without that service at scale, it is difficult to imagine the 5G segment ever generating meaningful profit.

This is especially true in the early stages of development; EchoStar’s CEO has already admitted that right now, private 5G is “a nascent market” that isn’t generating meaningful revenue. This is the key point. It’s not that the 5G Network’s costs are so high - it’s that its revenues are so low. Right now, its consumer mobile or bust.

Retail Wireless Is The Killer

That brings us to the Retail Wireless segment. This is the segment that was created entirely out of the Sprint/T-Mobile/DISH three-way deal a few years ago - Sprint sold its Boost Mobile prepaid division and its 9.3 million subscribers to DISH as a condition of the deal. The justification for this was that it would give DISH a running start in creating a viable wireless business, as well as a little more cash that could help fund network buildout.

Instead, it now threatens to capsize the whole company. Retail Wireless is not only reporting negative OIBDA, but its operating losses have tripled Y/Y in 1H2024. The company has lost 2 million subscribers since the time of sale, and this is not a short-term hiccup; the segment also reported negative operating income in 2023 and 2022.

A full analysis of everything that has gone wrong with Retail Wireless could be an article, or indeed a novel, unto itself. But the key point now is this: regardless of what may have capsized the wireless ship in 2022, it shouldn’t be this hard to right size it. Because so little of EchoStar’s own network is up and running at this point, Retail Wireless buys virtually all its network capacity from other companies.

The absence of owner economics in the Retail Wireless segment limits upside, but it should also be limiting downside; a business which pays for data by the gigabyte should always be able to turn a profit simply by structuring its pricing plans to attract relative data sippers who don’t need the bells and whistles of an unlimited data plan. Comcast (CMCSA) and Charter (CHTR) each have fewer wireless subscribers than EchoStar - though with these trend lines that won’t last much longer - and yet they manage to turn an operating profit from their wireless operations. Management hasn’t really explained why they can’t, and even worse is that when asked point blank when the losses would end on the earnings call, EchoStar’s CEO admitted he wasn’t sure yet - though he insisted it was outperforming his expectations.

Stop Helping, Already!!

The original plan to use pay-TV cash flows to fund a network build out wasn’t necessarily flawed. Yes, a $579 million Networks loss in a single quarter is bad, but it’s still less than the $667 million of operating profit pay-TV generated. Even now, pay-TV operating profit is enough to cover the build out costs of the 5G Network segment.

Admittedly, that’s with EchoStar chopping back network spending almost 50% from last year, but the cash hoard at the old DISH Network pre-Sprint and pre-remarriage should have covered that remaining gap.

The issue for EchoStar is that the two new segments that have been added by the last two merger deals, and which should be completely unaffected by cord cutting, are barely contributing at all and, even more alarmingly, decaying rapidly.

The attempts to “help” DISH/EchoStar complete the 5G build out may very well turn out to be what prevents the completion and pushes the company into bankruptcy.

The Upside Scenario Is Long Odds, But Big Payoff

There is only one piece of good news here: if EchoStar does bounce back, it will bounce very, very high.

Analysts estimate that a functioning 5G Network would increase the value of EchoStar's spectrum holdings to anywhere from $57 to $91 billion. That is capitalizing the cash flows from operating the network, but even if TV went all the way to zero and the satellite broadband business shut down, subtracting $25 billion of debt leaves a potential market cap of $32 to $66 billion. With EchoStar's current market cap at $5 billion, that is an awful lot of upside, if EchoStar can finish the network.

Other Industry Players Affected

If EchoStar really has found a way to beat the Q2 slump and Sling TV is returning to permanent growth, that would definitely have implications for Fubo and YouTube TV, but I am highly skeptical of that claim at the moment. Likewise, while a successful wireless offering could conceivably impact Charter and Comcast's own mobile efforts, the fact that each TV provider largely sticks to its own customers for mobile means that they probably aren't sweating too much either.

The real industry story here is probably AT&T, T-Mobile and Verizon. If EchoStar does beat the odds and get its network up and running, an open-RAN competitor could conceivably produce real pricing pressure in an industry that has largely been able to hose consumers since Sprint was taken off the board. EchoStar's gain could certainly be Ma Bell's and Verizon's loss, but first EchoStar must deliver the goods.

Investment Summary

EchoStar is not struggling because of pay-TV. Before the merger, DISH Network wasn’t really struggling because of pay-TV, either, at least not in the immediate sense. The issue here is that while the plan was always to use cash flow from pay-TV to fund 5G Network construction, the pay-TV segment is now also carrying the load of a cash-burning wireless segment. To fix this, supposedly, the merger was undertaken; only now the Broadband segment’s OIBDA is also collapsing, threatening to saddle what may soon be the company’s only profitable segment with yet more dead weight.

In the immediate term, the question is whether EchoStar can obtain financing. Past that, the question is whether it can reverse losses in the Retail Wireless segment and get that business generating cash instead of burning it. That is absolutely critical to finishing the construction of the 5G Network; pay-TV is holding for now but cord cutting means that this is a business in decline. At some point, Retail Wireless is going to have to help carry the load.

If it can be turned around, EchoStar just might yet have a happy ending. But this stock is extremely risky, and I rate Avoid.