Late last year I wrote about Gogo (Nasdaq: GOGO), the monopolist that couldn’t make money. The business was struggling for a number of reasons, and we initiated a short position. Since then GOGO has gone from bad to worse.
As a recap, GOGO is in the business of in-flight connectivity services – they provide the equipment and software to make wi-fi possible whilst on a flight. The company had a monopoly in North America for the last decade, yet did not actually produce positive cash flow or a profit. GOGO has now been expanding into satellite connectivity by virtue of the fact that its legacy air-to-ground (ATG) network is capacity-constrained, and can no longer handle the burgeoning data needs of consumers who are accustomed to a world of rich multimedia consumption (video streaming, a la Netflix).
To satisfy the desire of consumers for (i) inflight connectivity; and (ii) download speeds that permit the streaming of video, GOGO must continually invest in technology to improve its services. The company is bound by a paradox: as GOGO rolls out faster connectivity speeds for its inflight wi-fi service, more consumers elect to take up this service. However, as more consumers choose to use the service, the limited throughput to the airplane must be shared amongst more consumers, throttling the speeds for all those using the service. GOGO must run just to stand still, and its technology is still a while away from achieving both high download speeds, and a high connectivity take rate (that is, the proportion of passengers electing to use the in-flight wi-fi service).
GOGO’s difficulties are compounded by the fact that management decided to invest in an inferior type of technology – the company’s Ku band of technology falls short in performance compared to the Ka band of spectrum used by competitors. In addition, GOGO leases this spectrum, as opposed to its in-flight wi-fi competitors who own the actual satellites and have a lower operating cost. This gives competitors the ability to price their services at a more favorable rate to airlines than GOGO can.
It was probably no real surprise why Michael Small, the then-CEO of GOGO, abruptly resigned in early March 2018. Curiously, Oakleigh Thorne, a substantial shareholder who has an approximately 30% stake in the company, stepped in to take the CEO reins. His first quarterly earnings call was a mess – a litany of operational issues surfaced and management decided to pull prior guidance for a slew of metrics.
Firstly, de-icing fluid leaked into GOGO’s antennas that are installed on aircraft, creating service availability issues and resulting in GOGO incurring costs to rectify this. Secondly, the denial order impacting ZTE, a Chinese company that is a major supplier for GOGO’s next-gen ATG system, has interfered with GOGO’s plans to rollout a next-gen network to alleviate the maxed-out capacity of its ATG business. Finally, the long-awaited de-install of 550 American Airlines aircraft began in 1Q 2018, with the majority of these de-installs expected to occur in FY18. American Airlines switched these aircraft from GOGO to a competitor’s service, and the risk remains that more airlines will similarly break their contracts and defect.
In addition to the above operational mishaps, GOGO pulled disclosure of a number of important metrics: the average revenue per session (this fell off a cliff and was down 24% YoY in Q4), gross passenger opportunity, and the connectivity take rate. This is a big red flag, particularly as these disclosures were removed right after some of these metrics started to plummet. Furthermore, after guiding that adjusted EBITDA would be below the low end of the prior guided range, GOGO pulled its 2018 guidance for adjusted EBITDA, airborne cash capex, airborne equipment inventory purchases, and free cash flow. The new CEO said explicitly that “I also want to make it clear I don’t want to tie the company to old numbers or projections”, suggesting that future guidance could be rebased downward.
If you thought all that was bad, it gets worse. GOGO is highly levered – roughly $700m of net debt on a c.$500m market capitalization – and the company has exhausted its permitted indebtedness. From the 2017 10-K: “As of December 31, 2017, the remaining permitted indebtedness for Gogo Intermediate Holdings LLC (a wholly owned subsidiary of Gogo Inc.) and its subsidiaries was approximately $8 million”. Analyst questions on the earnings call touched on the need to raise further capital, which the new CEO stumbled through, failing to provide the market a reassuring answer it had hoped for.
The facts suggest that GOGO, on its current course, is careening towards a liquidity event. We estimate that the company will be burning through $250m to $275m of cash per year over the next few years, which includes roughly $120m of interest expense per year. When considering this against GOGO’s year-end 2017 cash balance of approximately $400m, the company’s current cash burn suggest liquidity exhaustion within a 12-15 month period. Moody’s took notice and downgraded GOGO’s credit rating to Caa1.
GOGO’s convertible bonds mature in Q1 2020, and there are likely to be significant challenges for management in upcoming quarters in dealing with GOGO’s strained capital structure and refinancing the convertible bonds. I concluded my October-2017 article with “GOGO is stuck between a rock and a hard place, and there is a scenario where the equity becomes worthless.” It would seem that given recent events, the probability of the equity being worthless has since increased*.
*This credit analysis was aided immensely by Amit Nath, who joined Montaka in April this year in our New York office. Amit’s background on the credit side is proving to have great synergies with our research process, particularly on the short side.
Montaka is short the shares of Gogo (Nasdaq: GOGO)
George Hadjia is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.