Space signals spell trouble for NewSat

Space can be a dark place. Shareholders of Australia’s only listed satellite operator are already experiencing the feeling after watching NewSat’s (NWT) value nearly halve this year.

There are a number of drivers behind NewSat’s recent fall from grace, and these factors cast a long enough shadow over the stock for me to decide against re-initiating coverage.

I first highlighted NewSat’s unique story a little over a year ago when the stock was trading at 40 cents, only to see it surge to 57 cents in October before taking a dive last month on the back of a troubling company update. The stock is currently trading around 25 cents.

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I put the stock under review earlier this year and the latest market update and restructure plan have deepened earlier doubts I had on the company.

To be sure, it isn’t NewSat’s business model that is causing consternation. The company is still on track to launch its own satellite, called Jabiru-1, next year. A successful launch will mark a golden milestone for the market junior.

The issue is more around questions regarding management and the nearer-term outlook for the company. I believe many would be better off channelling valuable resources into other “lower hanging” opportunities in the small cap sector. Frankly, shareholders in NewSat will have to wait until at least 2015-16 to see management turn a profit – and that’s under a bullish scenario.

This leaves investors exposed to “temporal risk” – where the longer one needs to hold an investment to realise its potential (profitability is the goal here), the riskier the asset. To justify investing in stocks that take longer to hit their straps, investors must have greater than normal confidence in management’s ability to deliver future profits and the stock must have a higher comparative potential return to offset the risk.

I have three areas of concern that make me think the risks do not justify the reward, particularly in relation to management’s ability.

Management & governance

Some of the headwinds may be outside NewSat’s control, but I believe management has not done a good enough job in managing the business and controlling costs. The fact that it needed to form an expenditure review committee to trim costs and “restructure company processes and policies” is telling of how standards are not be up to the level I would expect.

If this wasn’t worrying enough, NewSat also appointed a corporate governance expert to help reshape company practices. While this initiative is commendable, it can often indicate troubling behavioural issues – and this in itself is a big red flag in my book.

The bad news on the management and governance front doesn’t stop there. Three independent non-executive directors, Mark Fishwick, Andrew Plympton and Brendan Fleiter, walked out of the company on the same day last month.

A spokesperson for NewSat downplayed the sudden departures by claiming it was part of the restructure, but it’s still a bad look – especially when all the above points are considered together and given how close NewSat is to its single biggest milestone in the company’s more than 15-year history.

Our sister publication, The Australian, also reported on July 25 that NewSat has “lost the support of broker Baillieu Holst, which has suspended coverage of the stock”, even though the firm played a key role in NewSat’s capital raising in 2013.

The big dump

NewSat has issued a lot of options and convertible warrants. I am normally not overly fussed about such issues, but I did mention there were a lot. What’s more, most of them can be exercised at next to nothing or have a strike price that is below today’s already depressed share price.

Retail shareholders could soon know what “getting dumped on” means as there are around 260 million warrants and options that can convert into ordinary shares over the following few years. This represents 44% of shares on issue at December 31, 2013.

The composition comprises of 107.9 million warrants that can be converted into ordinary shares for free and 152.5 million performance options with a weighted average exercise price (WAEP) of just 10 cents a share.

The low WAEP is largely driven by performance options with a zero exercise price, and these are primarily given to reward senior managers. That’s a whole lot of options for very little performance.

Earnings expectations

The dilution would be a little less of an issue if management could deliver a big step-up in near-term earnings but NewSat’s latest update, weak first-half result and cautious outlook has thrown doubt on management’s mantra: “If we launch it, customers will come”.

The sign-up rate has been slower than I had anticipated with less than 50% of Jabiru-1’s capacity sold. Management is aiming to achieve 60% to 70% utilisation, which wouldn’t be too hard to achieve except for the fact that market demand for satellite communications is weakening.

NewSat warned that revenue and profit will deteriorate in 2013-14 after it lost a contract with the US government because the country was withdrawing troops from Afghanistan. Further, weak economic activity is dragging on demand from military, mining and oil & gas customers ahead of NewSat’s crucial satellite launch next year.

Management expects to deliver sales of $30 million to $33 million and a net loss of between $5 million to $6 million for 2013-14. In contrast, NewSat posted revenue of $39.3 million and net profit of $10.5 million in the previous financial year.

NewSat is one of the riskiest stocks under our coverage and I have mentioned in previous articles that its fortunes hinges on Jabiru-1. While the company’s risk profile is not unlike Mint Wireless (MNW), there is a very distinct difference between the two.

Speculative small caps need to be building investor confidence as they head towards company-making milestones. But the issue now is whether NewSat’s management, led by chief executive Adrian Ballintine, really can carry the weight of investor expectations to the summit.