Description

Summary

Gogo is the leading broadband provider to the business aviation industry (i.e., private jets).

Gogo is a high-quality, recurring-revenue business with a meaningful growth runway that is grossly undervalued due to a) misplaced competitive fears per Starlink's entry into the market; b) recent company-specific execution issues in launching its 5G service that are being resolved; and c) residual investor association with the low-quality commercial aviation business that was divested in 2020. As cash flows ramp post-normalization of growth investments that support 5G and a competing LEO service to counter Starlink, we think the stock could triple in value by 2026, assuming strong execution.

With an undemanding entry valuation on near-term cash flow (7x-8x), a sticky customer base that supports a multi-decade annuity stream, and durable competitive advantages, we believe the fundamental downside risks are quite low.

In-Depth Thesis:

Gogo is the leading broadband provider to the business aviation industry (i.e., private jets) with an installed base of over 7,000 aircraft – 10x larger than its closest competitor, which translates to approximately 85% market share in North America.

Foundational to Gogo’s dominant market position is its exclusive rights to air-to-ground (ATG) spectrum that supports a terrestrial network of 150 cell towers spanning the continental U.S. and Canada. This terrestrial ATG network offers a highly efficient means of broadcasting the internet in comparison to competitive alternatives such as satellite systems, making Gogo the lowest-cost provider in the industry. In addition to its cost efficiency, a terrestrial network provides for close proximity between the aircraft and cell tower at all times, which reduces latency and allows for a compact form factor antenna that fits on all aircraft body types.

As a comparison, geosynchronous (GEO) satellites, which offer global coverage, are up to 5-10x more expensive than Gogo. This price gap is explained by the multi-billion-dollar expenditure required to launch a satellite that only has a 15-year useful life. In contrast, Gogo’s terrestrial network is already built out and only requires $20 million in annual maintenance capital. Further, due to their distance from the Earth (20k miles), GEOs require large, tail-mounted antennas that only fit on super-mid to large jets and are less performant in regard to latency. With <20% of all business aircraft being super-mid or larger, Gogo’s low-cost, low-latency, and performant network offers an unrivaled value proposition for the majority of business aircraft owners that predominately fly domestically.

Broadband penetration of business jets is only 30% in North America and <10% internationally. This low penetration is largely attributable to the average age of aircraft in circulation being nearly 20 years old. Further, aftermarket installation of broadband equipment is an intensive process that often occurs in parallel with large maintenance events (5-6 years), slowing the pace of adoption. Nonetheless, the trend of increasing broadband connectivity is unmistakable. The vast majority of OEM deliveries are now line-fit with broadband. Further, consumer demand is increasing due to a generational shift in aircraft owners who place greater value on the accessibility and performance of in-flight connectivity. Gogo has grown its service revenue by 17% annually from 2015 to 2022. Industry experts anticipate broadband penetration to approach 100% over the next 10 to 15 years. If this projection is directionally correct, the global addressable market could quadruple in size, creating a massive growth tailwind for Gogo for years to come.

In addition to industry tailwinds, Gogo’s growth will be catalyzed by two network upgrades. First, after several years of investment, Gogo will turn on 5G at its existing cell towers in 3Q 2024. The 5G upgrade will quintuple the average speed consumers receive and is priced 20% higher than 4G. Second, Gogo will launch a low-earth-orbit (LEO) satellite service that will provide high-speed connectivity globally via a partnership with OneWeb in 2H 2024. This satellite offering will enable Gogo to prosecute the international business aviation market where there are 14,000 jets largely without internet, as well as provide global coverage optionality to large-jet owners based in North America.

The combination of secular tailwinds and product launches is expected to more than double Gogo’s revenue to nearly $900 million by 2027, according to management guidance. In addition to rapid growth, Gogo’s unit economics are highly attractive. Earning a 30% gross margin on upfront equipment sales, Gogo earns an 80% gross margin on monthly service fees.  This is a classic razor-razorblade business model. Importantly, this recurring revenue stream is highly durable as churn is less than 5% annually. Essentially, after onboarding internet connectivity to their plane, a customer would have to incur tremendous costs and downtime to the aircraft if they elected to switch broadband providers. These friction points attach Gogo to its customers throughout the aircraft’s useful life and create a meaningful barrier to entry for competitors.

Gogo is very profitable, having generated a 35% EBIT margin in 2022. With an estimated +60% operating margin on every incremental dollar of revenue, we believe EBIT margins can expand by more than 10% as revenue compounds over a largely fixed cost base by 2027.  Notably, the cost to run the ATG network is largely fixed at only $20 million annually. Since the network has the capacity to support 3x growth in broadband consumption without substantial capital improvements, the returns to scale are profound with additional growth.

We estimate EBITDA can compound at 20% annually through 2027. Notably, with growth investments underpinning the launch of 5G and LEO rolling off, FCF is poised to significantly increase over the next 18 months. We project close to $200mm in FCF by 2025 with cash flows compounding at over 30% annually thereafter. At the current valuation, investors participate in the business at 7x-8x 2025 FCF. For what we view as a competitively dominant, recurring revenue, high-ROIC business capable of growing profits rapidly for many years, this valuation multiple appears exceedingly attractive.

Finally, Gogo is run by an aligned management team with a strong track record. Oak Thorne, appointed CEO in 2018, successfully turned around the company by divesting the unprofitable commercial airline business to focus on business aviation in 2020. Thorne owns 22% of the company and is the second largest shareholder behind private equity firm GTCR. As background, this is Thorne’s third time running a public company after having successfully turned around and sold Commerce Clearinghouse and eCollege in what were highly profitable transactions.

We believe Gogo’s equity is mispriced as most investors associate the company with the struggling legacy commercial business and overestimate competitive threats posed by Elon Musk’s Starlink. Regarding the latter, we note that while Starlink’s commercial prospects are strong in many verticals, this is not the case for business aviation, in our view. To begin with, Starlink’s tail-mounted antenna is too large to fit the vast majority of private aircraft (85% of the market is non-applicable today). Even if it could miniaturize its antenna, a process that would take several years per our discussions with Starlink, the company would need to overcome numerous regulatory and distribution barriers to entry.

From a regulatory perspective, Starlink would need to secure Supplemental Type Certificates (STCs) for every single model aircraft (19 major models), a process that takes 6-12 months per model. This process can only begin after Starlink has created a smaller antenna, which we believe is two years out.  From a distribution standpoint, Starlink’s business model, which has been designed to sell products directly to millions of consumers over the internet, would need to be adapted. First, Starlink would need to form relationships with maintenance repair organizations (MROs), which are entities that interface with the jet owner and actually install the broadband equipment. Up until now, Starlink’s direct-to-consumer approach towards distribution has reduced goodwill with the MROs who rely on this high-margin installation service.  Second, Starlink would need to invest in a technical customer support team that would be capable of servicing plane owners on the ground globally with high levels of care. Plane owners are highly sensitive to service levels and require immediate attention when issues arise. While these barriers are surmountable, it remains to be seen how serious Starlink will be in going after what is a complicated, niche market in business aviation ($500mm annual revenue) when it could more easily allocate its resources to significantly larger and more penetrable markets.

Further, Starlink’s business aviation product is marketed at $25k per month, which is over 5x more expensive than Gogo at $4k per month. For the vast majority of plane owners that fly domestically and thus do not need global coverage (85% of all jet hours globally take place over North America), Starlink’s pricing premium will likely not make sense, especially for more price-sensitive owners, compared to Gogo’s 5G network (launching mid-2024). Included in this bucket of price-sensitive customers are not just owners of smaller jets, but also fractional fleet and charter companies. These entities, unlike personal jet owners, manage their aircraft for profit. If Gogo can upsell these enterprise customers (i.e., Net Jets) to 5G or LEO before Starlink is able to service the market, it would make it exceedingly difficult for Starlink to achieve scale without having to sell to individual plane owners one by one, especially since it has no salesforce. For customers that are price insensitive and want a highly performant network with global coverage, Gogo’s LEO product will offer competitive service levels at 50% of the cost relative to Starlink and will fit on all plane types from the get-go starting in 2H 2024.

Given there is no marginal cost in distributing broadband, it is possible that Starlink could choose to drastically lower its price to compete with Gogo once its LEO product hits the market. However, by doing so, this would shrink the addressable market, requiring Starlink to achieve more share, all else equal, to achieve an equal economic return against what is already a tens-of-billion-dollar cost basis that continues to grow every day to maintain its 8,000+ satellite system with an estimate 5-year useful. Considering Starlink has already raised its prices by nearly 40% despite having yet to launch, it would appear it is behaving as a rational actor and is seemingly intent on undercutting the GEO providers at the upper end of the market who are charging $30-$40k per month.

We would not be surprised if Starlink enjoyed success in the large jet section of the market that is predominantly served by GEOs and, to a lesser extent, Gogo – provided it makes changes to its business model. However, after upgrading its network to 5G and onboarding LEO connectivity, Gogo will be more than competitive in both price and performance for all customer types from turboprops to large jets relative to any competitor in the market, including Starlink. Given its compelling product suite and value proposition, entrenched customer relationships that facilitate ease of product upgrade, and its unparalleled distribution/service network, we believe it is highly likely that Gogo will be able to maintain its leading market share in the years to come.

Contact

Jordan Fox

[email protected]

Catalyst

Earnings trajectory over the next 24-36 months.