Activist Carronade spots a hidden gem in Viasat’s business. How the firm may unlock value

Company: Viasat Inc (VSAT)

Business: Viasat is a global communications and defense technology company that operates at the intersection of secure communications, global connectivity, as well as aerospace and defense technology. The company operates in two business segments: Communication Services and Defense and Advanced Technologies (DAT). The Communications Services segment encompasses Viasat's fixed broadband, government, maritime and inflight communications services. The DAT segment offers defense-technology platforms for information security and cyber defense, space and mission systems, tactical networking and advanced technologies.

Stock Market Value: $3.44B ($25.62 per share)

Activist: Carronade Capital Management LP

Ownership: 2.60%

Average Cost: n/a

Activist Commentary: Carronade Capital is a multi-strategy investment firm that focuses on process-driven investments in catalyst-rich situations. Carronade was founded in 2019 by Dan Gropper as primarily a credit investor. But, four people on the firm's seven-person investment team, including Gropper, have spent considerable time working at Elliott Management: They have experience with shareholder activism and are not afraid to use it.

What's happening

On July 31, Carronade sent a letter calling on Viasat to separate its Defense and Advanced Technologies (“DAT”) business through a spin-off or initial public offering.

Behind the scenes

Viasat operates in two businesses segments: Communications (73% of revenue and 80% of earnings before interest, taxes, depreciation and amortization) and Defense and Advanced Technologies (“DAT”) (27% of revenue and 20% of EBITDA). Communications is Viasat's legacy satellite business, with offerings of fixed broadband, government, maritime and inflight communications (IFC). DAT offers defense-technology platforms for information security and cyber defense, space and mission systems, tactical networking and other advanced technologies. This is a newer but rapidly growing business, with high to mid-teens revenue growth. Despite the company's strong strategic positioning, prior to Carronade's engagement, Viasat's share price had significantly underperformed, down 21.12%, 51.56%, and 57.98% over the past 1-,3-, and 5-year periods, respectively.

As Carronade describes in its letter, this is a “materially misunderstood” business. Carronade believes that the reason why this company is trading down is simple: Viasat has been treated by the market as a small-cap legacy satellite company that has been marked for death due to new high-profile entrants like Starlink. This narrative is two pronged: (i) that Starlink and similar entrants will make Viasat's Broadband business obsolete and (ii) that they are encroaching on Viasat's IFC market dominance. It is true that the broadband business is declining, as revenue is down over 27% year over year, but this is only a piece of the Communications business and the worst piece with the lowest margins. The Communications segment also has three other businesses: (i) Government, which is growing approximately 25% year over year; (ii) IFC, with 22% growth; and (iii) Maritime, which is growing at 11%. The second part of this narrative – the market threat in IFC – is greatly exaggerated. Viasat's IFC business is not going anywhere. The company's customers have long-term contracts (five to 10 years) and face high switching costs as they would need to replace their entire connectivity systems. Viasat presently has customers with 4,120 planes and a backlog of another 1,600 planes from just those existing customers. And this is a very nascent market with only approximately one third of airplanes globally having Wi-Fi, so there is a huge untapped market, which Viasat should get a large piece of despite competition from Starlink and other competitors. Additionally, Viasat is aware of the Broadband drag and is actively pivoting out of it to double down on the growth businesses with better margins. Exiting the broadband business over time while the other businesses continue to grow could be a plus for the company as it will no longer be viewed as a sleepy broadband communications business.

But that isn't even the biggest misunderstanding of Viasat's business. The DAT business has been buried under the legacy business and its accompanying negative sentiment. DAT is a hidden gem, with best-in-class EBITDA margins of 28%, double-digit revenue growth, and significant exposure to hot button next-generation defense and dual-use technologies such as the Golden Dome, next-generation encryption, drones, device-to-device (D2D) and low Earth orbit. While Carronade highlights how each of these translates into promising growth avenues, perhaps the best illustration of DAT's mis-valuation lies in its D2D platform services, which is designed to enable global connectivity directly to unmodified smartphones and other Internet of Things devices. DAT has $1.22 billion of revenue and $285 million of EBITDA. The peer comps to DAT – companies like AeroVironment, Kratos, Mercury Systems and Redwire all have lower margins and weaker growth profiles, yet trade at multiples ranging between the mid-20s to above 80-times EBITDA. Viasat currently trades at approximately six-times EBITDA.

Carronade's proposed solution is simple but compelling: spin-off or IPO the DAT business to unlock this intrinsic value and eliminate the drag caused by the narratives orbiting the satellite business. Carronade models 20-times to 51-times (comp median) valuations for this business giving it a value of $6.3 billion to $16.2 billion, versus a present enterprise value for the entire company of approximately $8 billion. This leaves the Communications segment with $3.3 billion of revenue and $1.2 billion of EBITDA. Applying a conservative 4-times value to this business creates another $4.9 billion of value, and there is another $1 billion of value from the upfront and long-term annual payments pursuant to a recent legal settlement with Ligado Networks. According to the Carronade analysis, this gives Viasat a total valuation of anywhere from $48.93 per share to $112.49 per share or a 76% to 304% return.

Carronade is a multi-strategy firm that focuses on investing in non-traditional, undervalued debt instruments. Viasat is highly levered, and its investment base is filled with creditors, so we imagine Carronade likely entered its position (currently approximately 2.6% of shares outstanding) in a similar fashion. The firm's analysis almost seems too good to be true, but there is not a lot of focus on small-cap companies in today's market and this lack of focus is exacerbated when you have companies like Starlink greatly winning the PR battle against companies like Viasat. This is how a company can go from $34 per share to $16 per share (prior to Carronade's engagement) over two years despite revenue increasing from $2.6 billion to $4.5 billion and EBITDA growing from $344 million to $1.4 billion. Fortunately for Viasat shareholders, Carronade's involvement should help bring the market's attention to this strong value case. While Carronade is not known for confrontational activism, that is OK, because this is a situation where no more than a nudge should be needed and Carronade's best weapon is the power of the argument. Moreover, management has already signaled that they have been considering selling some of the DAT business, suggesting that they may already recognize Carronade's value proposition and are headed in the right direction.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Viasat is owned in the fund.