Eight Capital ReportIn-line FQ4; Lowering Target to $3.50 on More Conservative Outlook and Financing Dilution
We are maintaining our BUY rating on UrtheCast following the company's in-line FQ4 results, but lowering our target from $4.00/share to $3.50/share based on a more conservative outlook heading into F17 and recent financing dilution. While the financial results themselves were largely a non-event, given the update provided in February, the results did shed light on potential for more pronounced seasonality in the EO imagery segment while management remains steadfast that it will be able to convert the remaining two MOUs 'shortly'. From our perspective, investors are waiting for the MOU conversions as the primary catalysts making the OptiSAR constellation a reality with the first plane fully backed and likely financed. Moreover, we anticipate that the UrtheDaily constellation could gain further momentum and management will be in position to look for appropriate funding options as they continue to sign up anchor B2B clients.
We remain bullish on the story and looking for contract conversions to provide us with further confidence of the longer term opportunity.
Revising forecasts for EO ramp and assumptions for OptiSAR
We have updated our model to reflect more seasonality within the EO revenue line and at the same time we have de-risked our model to push out the OptiSAR revenue to the latter part of Q4 (from the beginning of Q3 previously). While our confidence has not waned, there are a lot of moving pieces to this puzzle and even if management is able to convert these MOUs in the next two to three months, we do not have the full timetable to move into build phase and actual milestone billing timelines; hence we have decided to be more conservative at this juncture.
Key Highlights
• Net revenue (non-IFRS), excluding non-cash revenue, was $11.7mm, in-line with our $11.6mm expectation and to consensus at $11.8mm.
• The seasonal decline in Sales of earth observation imagery was better than expected at $3.6mm vs. our $3.1mm estimate.
• Adjusted EBITDA came in at $1.9mm vs. our $1.8mm estimate and consensus of $2.1mm. Adjusted EPS came in at ($0.02) vs. our ($0.01) estimate and consensus expectation at ($0.03).
Maintaining BUY rating but lowering target to $3.50 from $4 per share:
Our new $3.50/share (from $4.00/share) target price is based on 37x (was 20x) our F17E adj. EPS, a slight premium to EO peers, further supported by our DCF analyses. Another supportive valuation methodology is to ascribe $2.40/share in value to the base business and place a $1.10/share NPV to the first three MOU contracts' margin estimate.
Q4/F16 RESULTS OVERVIEW
UrtheCast reported FQ4 results yesterday after market that were in-line with the company’s prior guidance update (2/21) and our and consensus expectations. We highlight key takeaways from the results and the earnings conference call below:
Net revenue in-line with expectations.
UrtheCast reported total gross revenue of $57.7mm, vs. our $16.7mm estimate and Street expectations of $16.9mm, with the significant variance due to accelerated recognition of non-cash barter revenue given the termination of operating agreements with its Russian partner for the HRC/MRC sensors. Net revenue (non-IFRS), excluding this non-cash barter revenue component, was $11.7mm, right in-line with our $11.6mm estimate and the Street's $11.8mm. Outlook wise, the company did not provide detailed guidance but rather simply reaffirmed their view for growing revenue while expanding adjusted EBITDA margins on a y/y basis. The incoming CFO noted he needs time to digest the revenue model and forecast prior to providing the Street with full year outlook. He anticipates being in a better position following the Q1 results in mid-May.
Seasonal decline in EO imagery better than expected.
Sales of earth observation imagery came in at $3.6mm (-50% q/q) vs. our $3.1mm expectation. While the company did not provide an update on the current sales pipeline, management did note a solid pipeline globally with Deimos-2 sales ramping nicely along with a broader, more diversified customer base. Management is also upbeat on a recent hire for new head of Global Sales and Business Development, Jamie Ritchie, who comes to UR with +15 years industry experience across major EO focused firms including Airbus (AIR-P; NR) and ESRI. The company also did reiterate the large opportunity ahead with the PanGeo Alliance partnership in place citing emerging end-customer requirements for multiple providers. As for the HRC/MRC sensors, the company remains engaged in discussions with a number of prospective parties for a potential asset sale but negotiations are still ongoing and management prefers not to comment until something is finalized. UR recognized a further $3.1mm impairment charge this quarter for these sensors.
Engineering services revenue lower this quarter.
Engineering and value-added services revenue was $8.0mm, slightly below our $8.5mm expectation, down 5% q/q as more revenue was recognized as earth imagery data sales due to specific delivery milestones in the contract.
Improved operating model. Total direct costs and opex, less non-cash barter related expenses, share based comp, and D&A, came in at $10.0mm, in-line with our forecast of $9.8mm and a slight improvement over last quarter's $10.8mm, highlighting an improved operating model realized from the company's implementation of cost-saving initiatives over the course of the year.
Earnings in-line. Excluding share-based comp and the impairment charge, adjusted EBITDA came in at $1.9mm vs. the Street's $2.1mm estimate and our $1.8mm. IFRS EPS was reported at ($0.08). Adjusting for stock-based comp, amortization of intangibles, adjusted EPS came in at ($0.02) vs. the Street's ($0.03) estimate and our ($0.01).
Recent financing further bolsters cash position. The company closed the quarter with cash and cash equivalents, and restricted term deposits of $15.6mm (net debt of $15.3mm), down from $21mm (net cash of $16.4mm) last quarter. Post the recent financing (net proceeds of $18.4mm), we estimate the cash position to sit near $34mm, with a net cash position near $3mm. Cash flow from operations was $2.2mm vs. a loss of $7.6mm last quarter.
ESTIMATE REVISIONS
We are updating our model for UrtheCast to incorporate both management's commentary on similar seasonality as the company experienced throughout 2016 as well as push out some of our OptiSAR constellation revenues. While our confidence levels have not changed that UR will successfully convert the remaining two MOUs and bring OptiSAR forward into a funded project, the final timing of contract conversion and furthermore the actual timing from contract signing to the actual build phase and milestone payments remains unknown; hence we have decided to remove OptiSAR from the forecast in Q3 completely and also half way through Q4. In our opinion, by mid-November the company should be closer to generating revenue and if not, then have full visibility into 2018. At that point we will be able to push out this metric, but provide a more fulsome forecast for 2018 with the incremental information.
Due to management`s commentary of similar seasonal patterns in 2017 as 2016, we have decided to trim our Q1 estimates and ramp the seasonal strength into Q2 and peak quarter Q3, but again forecast a seasonal decline in Q4. We will wait until the company`s guidance to further adjust our numbers. Due to seasonality, we are lowering our Q1 estimates from $15.2mm to $12.2mm and dropping our adjusted EBITDA estimate by $1.4mm to $1.1mm. On the bottom line, we are lowering our adjusted EPS to a loss of two pennies, flat sequentially. For the full year, our organic revenue forecast (excluding the OptiSAR build) is approximately $72mm. Including half a quarter of build revenue ($22.5mm) takes our estimate up to $94.5mm, which is significantly lower than our previous estimate of $167.7mm which included approximately $90mm of revenue from the OptiSAR build. On the bottom line, adjusted EBITDA now sits at $26.8mm (or about $25mm excluding build contribution) and adjusted EPS at $0.09 (or $0.08 excl. OptiSAR build).
VALUATION
Comparable Valuation Analysis
Our new $3.50 per share target (from $4.00 per share) implies an F17E EV/Sales multiple of 4.6x, a premium to peers at 3.2x, and EV/EBITDA of 16x, a premium to peers near 12x.
On a P/E basis, our target now implies 37x (was 20x) F17 adj. EPS, a premium to earth observation peers at 19x and comps overall around 20x, justified by the company's significant growth potential as their disruptive business model continues to be de-risked and proven out.
Another way to look at our valuation is to ascribe a $2.40 per share target to the base business, driving an EV/EBITDA multiple of 12x, which is in line with peers, and a P/E multiple of 30x, considering the significant growth levers in the business. From there we add approximately $1.10 per share in NPV for the three MOUs that we have a high conviction will be converted into binding contracts. We used a 25% margin per contract and an 8% annual discount rate, assuming that these contracts will be recognized over a 3.5 year term starting at the beginning of 2018.