September 26, 2019

Communication Satellites 101


What are Electromagnetic Waves?

Mechanical waves and electromagnetic waves are two important ways that energy is transported in the world around us.
Waves in water and sound waves in air are two examples of mechanical waves. These mechanical waves travel through a medium by causing the molecules to bump into each other, like falling dominoes transferring energy from one to the next.
Electromagnetic waves differ from mechanical waves in that they do not require a medium to propagate. This means that they can travel not only through air and solid materials, but also through the vacuum of space.
Electromagnetic waves have crests and troughs similar to those of ocean waves. The distance between crests is the wavelength. The shortest wavelengths are just fractions of the size of an atom, while the longest wavelengths scientists currently study can be larger than the diameter of our planet!
The number of crests that pass a given point within one second is described as the frequency of the wave. One wave—or cycle—per second is called a Hertz (Hz). A wave with two cycles that pass a point in one second has a frequency of 2 Hz.
An electromagnetic wave can also be described in terms of its energy—in units of measure called electron volts (eV). An electron volt is the amount of kinetic energy needed to move an electron through one volt potential. Moving along the spectrum from long to short wavelengths, energy increases as the wavelength shortens.
Consider a jump rope with its ends being pulled up and down. More energy is needed to make the rope have more waves.
Depending on which range of frequencies Electromagnetic Waves are moving, there are several types: Radio, Microwaves, Infrared, Visible Light, Ultraviolet, X-ray and Gamma Ray.
What is a Communication Satellite?


A communication satellite is a device used to receive, amplifies and transmit radio & micro waves in space. The satellite has communications equipment including receive and transmit antennas, power, and electronic components which enable to receive a radio signal from a terminal, and then transmit that same radio signal to another terminal.


The radio waves used for telecommunications links travel by “line of sight” and so are obstructed by the curve of the Earth. The purpose of satellites is to relay the signal around the curve of the Earth allowing communication between widely separated geographical points.

There are many functions and services which satellites are designed and used for: telephone communications, internet, video and TV distribution, etc

A vast array of satellites exist with various Frequencies (C Band, Ku Band, L Band, etc), Altitudes (LEO, MEO, GEO) and Orbital Planes (Equatorial, Circular, Inclined, Polar, etc)
Frequencies Used for Satellite Communications

Life of a Staellite
The design life of geostationary satellites is approximatly 10-15 years.
Orbital Location and Footprint
The location of a satellite is referred to its orbital position. All Geostationary Satellites are located in a single ring above the equator. The requirement to space these satellites apart means that there are a limited number “slots” available, thus only limited number of satellites can be placed in geostationary orbit.
The location of a satellite is normally measured in terms of longitudinal degrees East or West from the prime Meridian of 0 degrees.

The area of Earth’s surface for coverage of transmit to or receive from is called the footprint which can be tailored for different frequencies and power levels.
Uplink and Downlink
Signals transmitted from Earth to Satellite are referred to as uplink signals, and signals received from the Satellite are downlink signals.
The satellite, through the transponder, converts the signal before it retransmits back to earth.
The signals going up to the satellite are at one frequency range (band of frequencies) and the satellite changes them to a different frequency range coming down so they won´t interfere with the signals going up.
As an example: “C Band” uplinks at 6 GHz and downlinks at 4 GHz and “Ku Band” uplinks at 14 GHz and downlinks at 12 GHz.
Throughput rates (Mbps) say us how much data actually is sent/received to/from a Satellite. Of course, throughput rates depends on “Uplink/Downlink” signals and the frequencies assigned.
Satellites and Orbits
Geosynchronous Orbit (GEO) are located 35,786 km above Earth. A single satellite can view approximately 1/3 of Earth´s surface. They travel in the same direction and speed as Earths´s rotation so they appear “stationary” and Earth station do not need to track the satellite.

Medium Earth Orbit (MEO) are located 8,000-20,000 Km above Earth. Typically, they have an elliptical (oval-shaped) orbit, but some travel in near perfect circles. The orbital period is anywhere from 2 to 12 hours. The most common use for satellites in this region is for navigation, communication, and geodetic/space environment science. They are used by GPS satellites. Communications satellites that cover the North and South Pole use MEO satellites.
Low Earth Orbit (LEO) are located 500-2,000 Km above Earth. LEOs are much closer to earth and travel at high speed to avoid being pulled out of orbit by Earth’s gravity. They orbit Earth about every 90 minutes. The international space station is a LEO.
What is Installed on the Ground?
All communications with a geostationary satellite requires the use of Earth stations. They may be fixed or mobile, from small to very large antennas.
The Earth station typically consists of an antenna, RF (radio frequency) equipment to Transmit&Receive, indoor unit and the final communications devices. Final communications devices could be local or off site via terrestrial network.
A teleport or super hub is essentially a large version of a typical Earth station. Teleports have similar equipment to a remotes but the equipment will be hub centric since it is looking at many remotes, rather than the remote just looking at the hub.

As well teleports will also have extra reliability by means of backup power, redundancy of equipment, and sometimes the ability to counteract the effects of fading (uplink power control).
Types of Satellite Services
There are several defined types of satellite service.
Fixed Satellites Services (FSS), so-called because the terminals on the ground are in fixed locations

Mobile Satellite Services (MSS) , where the terminals can be fixed, or in motion such as on a vehicle, a ship or even an airplane.
The worldwide market for fixed satellite services (FSS) is now over $10 billion annually and is significantly larger than the worldwide market for mobile satellite services (MSS).
Historically, Fixed systems have higher throughput and lower operating costs than Mobile systems as a rule. But Fixed Satellite Services (FSS) hardware is more expensive and features larger antennas. They are often susceptible to damage from sand, snow or rain.
Mobile systems have smaller antennas, lower hardware costs and broader coverage. But the cost per minute of use is much higher than Fixed systems, and the throughput rates are far lower than those for Fixed systems.
Demand for both FSS and MSS is growing rapidly and the distinction between the two is becoming blurred as fixed antennas get smaller and mobile terminals accommodate higher throughput speeds.
A third class is “broadcast satellite service” (BSS). Signals are transmitted or retransmitted by space stations are intented for direct reception by the general public. Subscribers receive signals directly from geostationary satellites. Signals are broadcast in digital format at microwave frequencies.
A subscriber needs an installation of a dish antenna, a conventional TV set, a signal converter placed next to the TV set, and a length of coaxial cable between the dish and the converter.
The dish intercepts microwave signals directly from the satellite. The converter produces output that can be viewed on the TV receiver.
What is a Backhaul?
A backhaul (or local loop) is the intermediate link between a core network (teleport or hub) to smaller networks or devices at the edge of the network. It is the physical link or circuit that connects the customers premises to an Earth station.


A backhaul is usually more cost-effective than a customer having their own hub or teleport.
Fading
Satellite Services are subject to fading.
The higher the frequency the more the signal may be affected. C Band is less affected than Ku. Ku is less affected than Ka.
Fading can severely affect service when heavy rain or snow is present.
Tolerances are built into the power levels of the transmitted services to minimize the effect. These tolerances are referred to as fade margins.
That means we transmit more power than what is needed during clear sky conditions and the amount of this power is determined by the link budget analysis.
System design will include a margin to accommodate some signal reduction by precipitation. How much fade margin is used will be determined by the customer’s service availability requirements.
Even with fade margin there still will be some instances where the density of clouds and rain reduces the signal enough that it affects data with errors, or a voice call gets noisy, or it affects a TV channel.

July 01, 2019

HONMA Golf, Governance and Corporate Finance

In this post I will try to give the big picture of HONMA Golf, that is to say, an analysis of Corporate Governance and Corporate Finance and what this analysis would recommend to the management which could be sound arrogance, but this is a part of the analysis exercise, no more, no less.

It could be said that this post should have been posted before valuation, but I have two reasons why I didn’t it, the first one is that Corporate Finance is a tedious work and sometimes could distract from the main story of the company, and the second reason is simple: link stories and numbers are much more fun.

Let´s start...

Corporate Governance (Ownership & Board)

At March 30th, 2019, HONMA had 609.05 millions of outstanding shares and the significant investors in HONMA are:

  • Kouun Holding Ltd (53.2%): Private holding controlled by the founder Mr. Jian Guo Liu, (Individual Large Hdg)
  • Charoen Pokphand Group Company Ltd (15%): Thai private company controlled by “Chearavanont” family, (Individual Large Hdg)
  • Itochu Corp (6.29%): Japanese public company trading in Tokyo Stock Exchange, (Individual Large Hdg)
  • Fosun International Ltd (5.85%): Chinese public company trading in Shangai Stock Exchange and controlled by Mr. Guo Guangchang (Institutional Large Hdg)


These four major investors represent 80.2% of the company, leaving a free float of around 20% available to other holders (private investors, institutional investors and banks with less than 5% of the outstanding shares).

The firm has significant individual holdings and small institutional holding, therefore the marginal investor is “Kouunn Holding Ltd” controlled by Mr. Jian Guo Liu, and I will assume that “Kounn” is diversified.

The board is composed of the 8 members described as follow:


Some conclusions of the table above:
  • Majority of directors are insiders
  • President and Chairman are the same person
  • Not all committees are entirely of outsiders


With all these conclusions above I can´t consider that the board of HONMA is effective in acting as a counterweight to a powerful Chairman/President, Mr Liu Jianguo. Consequently I would recommend to revert these 3 points.

Risk (Cost of equity, Cost of debt & Cost of capital)

As a risk free rate, I used the 10 year Japan government bond rate of -0.157% less Default Spread for Japan of 0.68%, resulting -0.84%.


The average global unlevered beta is 0.83 for Recreation business, as HONMA operates in only one business, I will take an unlevered beta for HONMA  of 0.83. Taking into account debt/equity ratio -lease commitments adjustments- gives me the levered beta of 0.87.

To estimate the equity risk premium of HONMA, I looked at HONMA's revenues by regions and applied the equity risk premiums for each of these countries. This results in a weighted ERP for HONMA of 6.67%. 

Based on the above risk free rate, beta and ERP, HONMA´s cost of equity in JPY is 4.99%.

The company provides with information about its pre-tax cost of debt between 0.33% and 0.51%, averaging  0.42%.

The market value of debt outstanding is Ұ4,986 million and the market value of equity is Ұ61,581 million.

Based on a cost of equity of  4.99% and a cost of debt of 0.42%, the cost of capital of HONMA is 4.64% and HONMA should only undertake investments that return at least 4.64%, the minimum acceptable hurdle rate.

Capital Structure

HONMA´s debt to capital ratio is 9.11%, lower than average global industry (23.12%) and probably underlevered.


All debt is short-term debt with maturity less than one year. The debt is mainly in USD (62%) and JPY (23%), the rest of debt (14%) is distributed in HKD, TWD, RMB and others. All HONMA debt has a floating rate between 0.33%-0.51%.

A certain level of debt for HONMA has the following advantages and disadvantages:


Optimal Capital Structure & Financing Changes

HONMA´s current debt-capital ratio is 9.19%.


Simulating across various debt-to-capital ratios, and taking to account changes in the levered beta, cost of equity, interest payments, interest coverage ratios, cost of equity, etc, the following is revealed:

Optimal debt-capital ratio (60.00%) is greater than current, and it seems that HONMA is underlevered.

Given its shareholder structure (Mr. Liu Guo hold 53.2% of common shares) and its market capitalization (over HK$4.2 billion), HONMA seems an unlikely target for a takeover.

An EVA to equity and EVA to capital positives (see previous post), could indicate that HONMA has good projects and I would recommend to the company, take additional suitable projects with returns above its hurdle rate, and finances them with additional debt.
I would advise HONMA to align the debt maturities with the durations of those projects (and the respective assets generating cash flows).

For all projects, I would assume lifecycles around 3 years, and thus recommend financing them with longer-term debt and with a mix of currencies related to the project costs and expected revenues.

The more uncertainty HONMA sees in the future and in its newly started projects, the more it should use floating-rate debt. 

By raising its debt-to-capital ratio up to around 60%, HONMA could increase its firm value from Ұ52,475 million to Ұ53,053 million, and its stock price from Ұ99.43 to Ұ100.37 (+1%). By doing this, HONMA’s cost of capital would drop to 4.48%, really not too much. Thus I don´t see any significant reduction in the cost of capital to justify any increment on debt.

Dividend Policy

HONMA has returned Ұ6,874 million to stockholders in the last three fiscal years (analyzed from 2016/2017 to 2018/2019) having generated Ұ3,250 million of FCFE in that period.


The reduction of debt and the big increment in working capital in period 2016/2017 explain a negative FCFEE for that fiscal year and the reduction of the aggregate. There isn’t any indication that HONMA plans to stop its dividends, therefore the dividend policy in fiscal year 2016/2017 should not occur again.

June 30, 2019

HONMA Golf, expanding premium niches in the market

Overview
HONMA Golf Ltd –incorporated in Cayman Islands, listed on Hong Kong Stock Exchange with ticker 6858 and headquartered in Tokyo– is a prestigious and iconic brand in the golf industry.
The company utilizes innovative technologies and traditional Japanese craftsmanship to provide golfers across the globe with premium, high tech and the best performing golf clubs, balls and accessories.
The Group’s sales and distribution network consists of HONMA-branded self-operated stores as well as distributors, and develops and manages its sales and distribution network on a country-by-country basis to cater for the specific retail landscape and consumer demographics.
As the only vertically integrated golf company with in-house design, development and manufacturing capabilities, a strong retail footprint in Asia and diverse range of golf clubs and golf related products, HONMA is positioned to grow its business in Asia and beyond, benefitting from the return of golfers in mature golf markets such as US and Japan and from increased participation in golf´s new markets such as Korea and China.
As of Jun 17th, 2019, HONMA´s market capitalization was HK$4,263 million with 609 million shares outstanding at a value of HK$7.00 each.
Back and Current Story
Founded in 1959, HONMA fell on hard times with the collapse of Japan´s bubble economy in the 1990s. It had overinvested in golf courses and made other missteps. In 2005, it filed for bankruptcy protection, and in 2010 – in what many Japanese viewed as a painful indignity – it was bought by a Chinese fund run by businessman Liu Jianguo who also operates a Shanghai company that makes hair dryers and rice cookers. Yet Liu Jianguo became Chairman and President of HONMA since then.

In October 2016, the company went public at HK$10 without fanfare and Liu Jianguo turned HONMA around by revamping its sales strategy since then –Ұ18,525 millions revenues in period 2014-2015 and Ұ27,770 millions revenues in period 2018-2019, so a CAGR 4 Years of 10%–.
Although revenues has been decelerated from 21% in 2016 down to 6% in 2019, EBIT margin has maintained around 20% which makes sense, as I will describe later, with the strategy of the company.

The charts below set forth the breakdown by region and product of the total sales in 30mar19.
As we see HONMA have a strong presence in its home markets of Japan, Korea and China (including Hong Kong and Macau), while clubs represents by product the most important source of revenues.
Global Golf Products Industry Overview and where fit HONMA
Golf is a sport which boasts worldwide popularity and is enjoyed by millions globally. The sport involves players using various types of clubs to hit balls into a series of holes with the aim of minimizing the number of strokes required. To play golf, a golfer needs a set of clubs of various lengths and sizes, a set of golf balls and related accessories such as gloves and bags. These products make up the core of the global golf products market. Golf apparel includes clothing and shoes targeted at the golf lifestyle market and forms another important segment of the golf products market.
Key market players supporting the market expansion significantly include Callaway Golf Company, Amer Sports Corporation, MIZUNO Corporation, TaylorMade Golf Company, Inc., Acushnet Holdings Corp., Roger Cleveland Golf Company, Inc., Parsons Xtreme Golf, LLC, Bridgestone Sports Co., Ltd., Honma Golf Co., Ltd., and Epon Golf.
Although global retail sales has been stagnated since 2014 (US$13.4B), HONMA has been able to increase its market share from 1.5% at 2015/2016 to 1.9% at 2018/2019.
The following factors are expected to be key drivers of growth for the golf products industry over the next several years:
  • New Markets and Demographics. Golf has traditionally been under-penetrated in emerging markets. In recent years, more people in emerging markets, especially in Asia, have started to play the sport, driven by increasing disposable income, higher standards of living and greater emphasis on leisure activities. Meanwhile, golf has also gained greater popularity among women and the younger generation worldwide, as a result of the increasing perception of golf as a “lifestyle sport”, a new generation of young golfers coming to prominence on the professional circuit, and additional marketing efforts by golf brands towards these demographics.
  • “Lifestyle Sport” Proposition. Positioned as a “lifestyle sport” with an element of prestige that accommodates competition, entertainment and physical exercise, golf appeals to modern consumers who pursue a higher quality lifestyle with an increasing awareness for health and wellness.
  • Golf ’s Return to the Olympic Games. The reinstatement of golf at the 2016 Olympic Games significantly raised the profile of the sport worldwide. As we edge closer to the 2020 Tokyo Olympic Games, global attention is slowly starting to focus on Olympic qualification. With Japan hosting the 2020 Olympics, the golf markets in Japan and other parts of Asia are expected to receive a significant boost in the build-up to the Olympics.
  • Digitalization of Retail Channels. Digital retail channels such as e-commerce, mobile commerce and social commerce now address consumers’ purchase preferences, which were predominantly restricted to brick and mortar stores in the past. These emerging channels play vital roles in penetrating different consumer segments.
  • Technological Innovation. Golf products development has always been driven by technological innovations over the years. Further developments in clubs, balls and related products are expected to make the game more accessible, enjoyable and exciting, while continuing to attract new players.

According to HONMA Golf, consumer preferences for golf clubs can be classified under two key dimensions:
  • the willingness to spend, or acceptable price of clubs; and
  • the degree of enthusiasm for golf. The degree of enthusiasm can be measured by the consumer’s skill and participation level, which is score for playing one round of golf, as well as number of rounds played within a particular time period.

Based on the two key dimensions described above, the golf clubs market can be segmented into the 9 Key Segments, each consisting of a unique type of golf club consumer.
HONMA currently offers golf clubs mainly under three major product families, namely BERES, TOUR WORLD and BeZeal, each targeting specific consumer segments:
  • BERES golf clubs target consumers in Segment 2, which is the Group’s traditional customer base and comprises affluent consumers willing to pay a premium price for golf clubs
  • TOUR WORLD golf clubs target consumers in Segment 6, which comprises golf enthusiasts who place a higher emphasis on performance
  • Be ZEAL golf clubs target consumers in Segment 5, which comprises beginner golfers who are looking to improve their performance.

Segments 5 and 6 are experiencing faster growth rates compared to the overall growth rates of major golf markets.
How good are the existing investments
On March 30th, 2019, HONMA presented its results for the last fiscal year. The company earned  ¥4,732.0 million as after‐tax operating income on a book value of capital invested of ¥16,357.6 million, while the net income was ¥4,127.5 million on a book value of equity of ¥28,050.0 million.
The after‐tax return on capital based upon these numbers is 29% and the return on equity is 15%.
With after tax return on capital of 29% and relative to the cost of capital of 4.64%, HONMA seems to be earning an excess return of 24.29%. With a return on equity of 15% and relative to the cost of equity of 4.99%, HONMA earns an excess return of 9.72%.

Therefore  HONMA has a positive amount Economic Value Added both to capital and equity:
Since IPO in 2016, HONMA has focused in targeting niches of golf market which are willing to pay a premium for golf clubs. In order to increase sales in these segments, the company has launched several golf clubs families in the last 3 years to align with its target consumer´s preferences. This growth strategy can explain both high ROC and ROE.
Valuation
A plausible story for the future of HONMA could be an exclusive golf company, with low production and medium/high prices. The benefits of this strategy are high operating margins partly because of the high prices, and partly because the company does not have to spend much more on expensive ad campaigns or selling than it is doing now (currently 11% of revenues). It also will keep reinvestment needs to a minimum, since capacity expansion will not be necessary, though the company will continue spending on R&D to preserve its edge (currently 1% of revenues). In addition, by focusing on people with more purchasing power around the world, HONMA may be less affected by macroeconomic forces than other golf companies.

The inputs into my valuation reflect the story, with low revenue growth, high margins and low reinvestment, driving value:
  1. Revenues growth of 5% a year for next 5 years, scaling down to the current risk free rate -0.84% in year 10
  2. HONMA´s EBIT Margin stays at 20%, the current margin in last year
  3. Sales/Invested Capital stays at 1.52 reflecting the little need for capacity expansion
  4. Cost of capital of 4.67%, scaling down to global industry average

Other relevant inputs to be assumed:
  1. Many growth companies fail, especially if they have trouble raising cash. In case of HONMA, I will give a 10% probability of failure with a distress proceeds of 0% if assets are worth nothing in case the firm would fail.
  2. HONMA will earn a ROC equal to 15%, greater than its Cost of Capital. I am assuming that the firm will maintain its alleged competitive advantage (given by its incremental market share and high ROC & ROE) in the long run.

With all these inputs and others not described on this post, the resulting value is shown below:
The value for equity give us Ұ91,856 million which dividing to number of shares 613.26 million, give us Ұ149.78 per share (or HK$10.34) well above the stock price of HK$6.78. 

May 12, 2019

Valuing Caixabank (Spanish Bank) with FCFE Model


1.Story

Caixabank is a spanish retail bank, has a very strong focus on serving clients in Spain 90% and 10% in Portugal thanks to the recent purchase of 100% of the Portuguese bank BPI. The bank provides traditional banking services to Individuals, Small-Businesses, Private Corporations and Public Sector. In 2018 the firm generated a gross income of 8,767 millions and an income before taxes of 2,806 millions.

Caixabank has completed the first strategic plan launched four years ago and have begun a new plan for 2019-2021 horizon.  During the period 2015-2018 (first strategic plan), the company has improved ratios, margins, and market presence as we see in the tables below:



Thanks to the effort of restructuration, Caixabank is running a simple commercial banking system combining physical branches and the digital world, a business model that covers all financial and insurance needs, and that will get more market presence for the company.

2.Valuation

The valuation I proposed is based on a Free Cash Flow to Equity (FCFE) Model. The FCFE are projected and planned in detail for the next 5 years. After 5th year, the bank is assumed to be in a steady state.

The absolute level of the FCFE is a function of Caixabank’s Risk Adjusted Assets (RWA), their growth (g), its Common Equity Tier 1 Capital in terms of RWA (CET1 ratio), and its expected return on equity (ROE). To estimate present values for these FCFEs, we also need to estimate the cost of equity for next years and beyond. For all of these parameters I make the following assumptions:

1. RWA will grow at expected inflation of Euro Zone (+1.80%) forever.

2. The Common Equity Tier 1 Capital Ratio (CET1 Ratio) of Caixabank is 11.80% and the firm revealed its objective for the next 3 years at 12% plus 1% to absorb any potential regulatory impact. After year 3, I assume the ratio will stay around 12%.

3. The firm expect to achieve a return on tangible equity (ROTE) over 12% in 2021 and the current ROTE is 9.3%, it means an increment of 270 basis points. I assume for ROE the same proportional increment, passing from current 8.26% up to 10.66% in 2021. The following years ROE will be at level of 10.66% and, in the steady state, the ROE is assumed to amount to the current average cost of equity of European Banks (estimated in the next point 5).

4. To arrive at the current cost of equity, I use the average beta for the European banking industry (1.16) that reflects Caixabank´s exposure in the retail banking business, in conjunction with the euro risk-free rate of -1.85% and an equity risk premium of 7.90%.

5. To estimate the cost of equity at end of year 5, I will adopt a different way. To illustrate the process, consider the median bank at start of 2019, trading at a price to book ratio of 0.65 and generating a return on equity of 6.68%. Since the median bank is likely to be mature, I will use a stable growth model to derive its price to book ratio:

Plugging in the median bank´s numbers into this equation and using a growth rate equal to the expected inflation (+1.80%), I estimate a cost of equity for the median banks to be 9.31%
So the proxy for the cost of equity in stable steady for Caixabank will be 9.31%, and the Cost of equity will increase progressively since an initial 7.31% up to 9.31%.

The following table summarizes the estimates of net income, FCFEs, Terminal Value, Cost of Equity, and present values, over next five years and beyond:
The sum of all present values give us a value of equity of 29,181 millions, and dividing by the current number of shares outstanding (5,981 million), I can obtain the value of equity per share:

In May 2019, Caixabank was trading at 2.77 and looked undervalued