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The Final Frontier: Our Top Stock for the New-Age Space Race

Jared George|February 12, 2021

Fellow Fools,

When most investors think of Elon Musk, they think of the companies he's founded or led that they could invest in directly.

For me, however, his true genius has been the successful founding and dramatic expansion of his still-private company, SpaceX. By developing reusable rockets, he and his team have truly changed the economics of space travel...forever.

Unfortunately for most of us, we can't profit directly from SpaceX's success because there's no publicly available way to invest in it.

And that's why I've been so excited about a company we first recommended back in April 2017...

At the time, it went by the name MacDonald, Dettwiler and Associates. Since then, it's been through a lot:

- Completed a transformational acquisition of DigitalGlobe, making it the premier "commercial vendor of space imagery and geospatial content, and operator of civilian remote sensing spacecraft."

- Changed its name to Maxar Technologies.

- And, moved its headquarters to Denver, Colorado.

It's also experienced some operational hiccups (thanks to a faulty part from a vendor) and been the subject ofan opportunistic short reportin August 2018 stemming from worries about its ability to service its elevated debt load.

Having survived all of that, the company decided to shed some weight.

To close out 2019, Maxar announced that it would be selling "all of MDA's Canadian businesses, encompassing ground stations, radar satellite products, robotics, defense, and satellite components, representing approximately 1,900 employees." This left SSL as the remaining portion of the Space Systems segment.

All told, those businesses generated roughly US$370 million and US$85 million in revenue and Adjusted EBITDA in 2019. While that meant selling a higher margin part of its business, it also maintained the two segments with the best growth prospects: Imagery (i.e. DigitalGlobe and its high margins) and Services.

Examining what the debt picture looked like after this deal, we saw a much less bloated business creating ample separation from the debt covenants that bears were so quick to latch onto. Using the proceeds from the sale, along with the closing of its Palo Alto real estate deal, Maxar has been much more capable of navigating its existing capital structure.

Coming out of Fiscal 2019, long-term investors had suffered some losses. However, since closing on December 31, 2019, Maxar shares have returned more than 200%!

In my honest opinion (and as a shareholder), I think the competition among the likes of SpaceX, Jeff Bezos' Blue Origin, and others, will mean that satellite launches will become economically feasible for many, many more companies.

This bodes well for the "new" Maxar, giving it a lot more upside if it can begin to capture some of the Low-Earth Orbit (LEO) market or if the Geostationary Equatorial Orbit (GEO) can regain some life. In the meantime, Imagery and Services have ample opportunity to see the stock higher.

Foolish Bottom Line

Following a transformational couple of years, Maxar has become leaner, while retaining most of the features we like about the company. Further debt reduction will help on the cost-side and will get us to late FY2021 when the new Worldview Legion is expected to begin contributing to revenue and EBITDA growth.

For those of you interested in more backstory, our original recommendation can be found, below.

Onward!

Buy MacDonald, Dettwiler & Associates Ltd. (Now Maxar Technologies)

A unique company in the Canadian market, MacDonald, Dettwiler & Associates (MDA) offers tremendous value to long-term shareholders following a transformative acquisition and obtainment of U.S. Security Control Agreement.

Why Buy:

• Its acquisition of DigitalGlobe is a potential game-changer, positioning MDA as the market leader in multiple industry verticals.
• Competition within the satellite delivery industry (e.g., rockets) is heating up, which could lower the overall cost of sending satellites into space, providing a boost to overall activity.
• Across several trading multiples, MDA shares have traded well below historical averages since 2010, leading us to believe significant downside risk is rather mitigated.

2,000 Kilometre Overview

Even before the company announced that it was acquiring Colorado-basedDigitalGlobe(NYSE:DGI)back in February,MacDonald, Dettwiler & Associates(TSX:MDA) was a clear global leader in the commercial communication satellite industry, along with space robotics, space-based and airborne surveillance solutions, satellite ground stations, and associated geospatial information services.

Speaking to MDA's leadership position, in an article published byThe Financial Postin March, Ian Hardacre, Empire Life's chief investment officer and manager of $15 billion in funds, called MDA Canada's best technology company.

With a roughly 30% market share of the commercial communication satellite market, it supplies its customers with "solutions for cost-efficient global delivery of a broad range of services, including television and radio distribution, broadband internet, and mobile communications." These solutions are tailor-made for satellite operators, manufacturers, and government agencies. Customers in this segment include Intelsat, DirecTV, SiriusXM, and many more.

Just like its Communication business unit, its Surveillance and Intelligence business unit serves the needs of both governments and commercial customers, only it enables them to "monitor changes and activities around the globe" to support their needs. Space and terrestrial robots also fall under this business unit.

From these business units, the company was able to generate $2.1 billion in revenue during 2016roughly flat versus 2015. However, it was able to turn a much larger portion of those sales into operating cash flow (8.4% vs. 6.4%) and generated a more attractive free cash flow yield (5.8% vs. 4.9%).

Peering into its Commercial Communication segment, we see slight declines in revenue in both 2015 and 2016; however, MDA has been able to maintain its market share. This is a rather lumpy and short-term, unpredictable business, and this slight decline has been shared industry wide. Management expects the business to turn, but it's admittedly hard to say when. Operationally though, this segment is still performing at a high level; a record 11 geostationary satellites it manufactured reached their assigned altitude of 35,786 kilometres above the earth.

Perhaps more exciting than MDA's record launches is its growing Surveillance and Intelligence unit. Throughout 2016, MDA landed several contracts with both NASA and the Defense Advanced Research Projects Agency (DARPA). Of particular interest were contracts for "space tugs," or small unmanned spaceships that NASA and DARPA hope will, in the future, act as tow trucks in space, capable of servicing satellites currently in orbit. Several other companies, likeLockheed MartinandOrbital AK, have been working on their own models, so the fact that MDA received NASA and DARPA's votes of confidence makes us, well, confident.

Adding to this momentum was the company's announcement in January of this year that it had signed a Security Control Agreement with the U.S. Department of Defense. This advancement should open even more U.S. government work moving forward, a key to the company's strategy, and an area where management has been seeing robust proposal activity.

Transformation 2.0

Now that you know where MDA has been, it's time to discuss where it's headed.

Roughly a month after our team discussed the companyinternallyback in January 2017, MDA announced a transformational acquisition in DigitalGlobe. All told, the transaction values DigitalGlobe at an equity value of $3.1 billion and an enterprise value of $4.7 billion, which includes assumption of $1.6 billion in DigitalGlobe's net debt. For perspective, MDA's current enterprise value (the deal has to close) is $3.5 billion.

The basic sales pitch for the combined entity includes expanded capabilities, greater scale, a more diversified portfolio, stronger financials, and no acquisition is complete without the mention of synergies.

If we look at it more closely, though, there areplentyof details to get excited about! DigitalGlobe's founder and chief technology officer considered the deal "hitting the 'go fast' button" for the company, allowing it to "move faster and go bigger than ever before."

One area where things could pick up the pace would be in the Earth Observation Services business, where DigitalGlobe is the unquestioned leader. This segment of the satellite industry accounted for 14% of all satellites in operation, by function, at the end of 2015. That share tied it with Civil/Military Communications and placed it behind only Commercial Communications (37%). Taking what you learned earlier about MDA, you can see that the combined entity will betheleader in two of the three largest segments of satellite end use.

Now, in terms of revenue, Earth Observation Services is a rather small fish, but it's also been the fastest-growing revenue segment for the industry. Again, DigitalGlobe is the leader here with its +15-year image library and unrivaled satellite constellations. On top of this, by 2020, it will more than double its imaging capacity with its Scout and WorldView Legion constellations. This should make current customers such asFacebookand Uber more than happy to stick around.

DigitalGlobe won't be doingallof the heavy lifting here, either. It's been working withGoogleon 13 imaging satellites for its Skybox business, which has helped power Google Maps. And last year, MDA signed another order for six imaging satellites.

All of this success bodes fairly well when you consider projections for the satellite imagery business to grow from US$2 billion in 2015 to US$5 billion by 2025.

Remaining areas where the combined entity could experience growth would be as companies around the world, in industries like airlines and car manufacturers, along with remote and developing countries, seek to expand bandwidth. In fact,Bloombergreported last year that rocket liftoffs supporting communications satellites could rise by 30% over the next five years.

Another reason why liftoffs may become more frequent is that companies like SpaceX and Blue Origin are working hard to make space travel much, much cheaper. Elon Musk's stated goal is to reduce the cost of sending a rocket into orbit by a hundredfold by re-using rockets over and over again. Already, MDA has had success working with SpaceX, sending three satellites it built for EchoStar into orbit since June 2016 aboard SpaceX Falcon 9 rockets. (If you haven't yet watcheda videoof a SpaceX rocket landing back on a floating barge,I highly recommend it.)

Finally, for an idea of how MDA is trying to stay ahead of the competition, it has lately been experimenting with 3D-manufactured parts (think an internalStratasysor current BBNProtoLabs). While not fully certified yet, the group MDA is associated with will be sending its first 3D-printed part to space later this year. And, according to Joanna Boshouwers, a MDA vice president, once certified, many more parts will be experimented with. If expanded at a meaningful scale, this could certainly improve the cost side of the equation for MDA.

What's it Worth?

As was mentioned in our three "Why Buy" points, MDA appears tantalizingly undervalued when compared to the last six years.

Based on the spreads we're seeing, we are left with an implied price between $113.10 and $184.60. Now, let's not gettoocarried away here. I'd certainly lean more towards the lower end of that spectrum ... for now. Though, with the acquisition of DigitalGlobe and the prospects of an increased number of satellites being sent to space, I can't argue against the lower bound being achievable over the next year or two (plusa tidy 2.1% yield to boot).

On top of this valuation exercise, MDA is hoping to get its shares listed on the New York Stock Exchange, which would most certainly raise its awareness among a large pool of U.S. investors. As long as it's positive awareness, shares could receive a bit of a one-time boost due to demand.

Some Thoughts on Management

Any time a big acquisition like this is part of the mix, the people pulling the trigger warrant consideration. Less than a year ago, a rather dramatic change on this front occurred. Out was long-time (20 years) CEO Dan Friedmann, who has more recently resigned from the board as well, and in is Howard Lance. Prior to joining MDA in May 2016, Lance was working a private equity gig within Blackstone. But prior to that, he was CEO ofHarris Corp.from 2003 to 2011. Harris is a leading global provider of communications and information technology products, software, systems and services to government, defence, and commercial markets. During Lance's tenure, Harris grew earnings at a 22% annualized clip, and the stock went up five times. He's no doubt made a splash with the DigitalGlobe transaction, but it's hard to argue with that track record.

Risks and What to Watch Out for

Outside of a satellite malfunction (or, most likely, more would be necessary to do reputational harm), the biggest risk we can see for MDA is its increased exposure to the U.S. government following its merger with DigitalGlobe. Now, to be sure, the U.S. government is of vast importance to the entire satellite industry, as it's the largest market in the world for such wares. However, for the new (and believed-to-be improved) MDA, reduced spending by the U.S. here could dampen future returns. Overall, its top-line exposure to the U.S. government will move from roughly 6.3% to roughly 25%, overtaking the Canadian government (14% in 2016) as its largest individual customer. As always, we will keep a close on this activity, as we believe it will a positive growth-driver for the business in the coming years.

Foolish Bottom Line

We've yet to recommend a company in the mold of MacDonald, Dettwiler & Associates, mostly because there aren't many like it, and certainly nothing compares in the Canadian market. MDA is a world-class company, leading an industry at the forefront of technology and connectivity. That combination, together with its valuation, was just too tough to ignore this month. We're happy to recommend shares and think your portfolio will benefit handsomely from the tech exposure this company provides.

Onward!