Can you trust Gilat?
27.11.06 | 11:05 By Ami Ginsburg
The stock offering that Gilat Satellite Networks (Nasdaq: GILT) announced last week left Israeli market animals with that feeling of déjà vu. Gilat, issuing shares? They had heard that before.
Indeed, if you know Gilat's history on the stock exchange, you remember that the company had several good years when it began: sales and profits grew nicely. But its success in business evolved into adventurism and aggression, leading it to fail colossally, with debts exceeding $800 million.
With a record like that, it's hard to believe that here it is again, asking for Wall Street's affection.
Gilat first went public on Wall Street in 1993, and was a meteoric success for no less than seven years. The company, which develops satellite communications technologies and terminals (VSATs) at attractive prices grew beautifully. At the height of its success, revenues passed $500 million a year. At the start of 2000, Gilat was worth $4 billion and expectations soared as high as satellites.
Its success enabled Gilat to tap the markets again and again. Between 1993 to 2000, the company raised nearly $300 million by selling shares. In early 2000 it raised $350 million overnight in an offering of convertible bonds. Israel's biggest banks lined up to lend it money, most notably Bank Hapoalim (TASE: POLI) , which lent nearly $150 million.
Gold in them thar webs
The market's faith and its money lulled the Gilat management into complacency. CEO Yoel Gat and chairman Amiram Levinberg adopted a very risky policy. During the bubble years on the Street, Gilat found gold: small Internet companies hungry for satellite equipment. It sold it to them, usually on credit and even invested in some of them, too.
The downfall was awesome. The bubble burst and Gilat was left with gigantic debts, which reduced it to sheltering behind Chapter 11.
From 2001 to 2003, Gilat fired almost 1,000 people. In April 2003 it signed an arrangement with creditors, after which Levinberg and Gat were forced out. The company spent two years treading water. At some point the cash bleed stopped, but sales refused to rebound. Gilat's revenues hovered in the range of $200-240 million a year and operating income crawled around the flatline.
A year and a half ago, Bank Hapoalim passed the controlling interest in Gilat to a group including York Capital Management and Mivtach Shamir Holdings (TASE: MISH) , and Levinberg came back as CEO and chairman.
Come the year 2006 and the company's situation seems to be improving. For the first nine months of 2006 Gilat reported sales of $183 million, an increase of 20% from the year before. But operating income has remained shrunken at just $9.2 million or 5% of revenues, while net profit was just $6 million.
There is a point of light in cash flow, which climbed to $35 million in the first nine months of 2006.
The positive momentum in its business lifted Gilat stock 60% in a year to $8.50, which prices the company at $290 million.
The improvement in its business and share price evidently persuaded Levinberg that the time is ripe to come back to Wall Street hat in hand, and a week ago Gilat filed a prospectus to sell 7 million shares. Of that, 4.6 million would be newly issued shares and 2.3 million would be sold by controlling shareholder York.
So the question is, is Gilat worthy of Wall Street's trust again? Here are some points for thought.
1. Profit remains tiny.
It is usual to demand that high-risk technology companies provide relatively fat gross and operating margins. That shows the company has a technological edge that enables it to demand reasonable prices for its products, and assures that it can keep investing in R&D to preserve its advantage.
Companies selling communications equipment are usually required to present gross margins of 40% to 55%. Gilat, which sells communications equipment and services as well, boasts a gross margin of just 36%. That is relatively feeble, and at the present level of sales, it leaves the company with precious little in hand. The slightest deviation from forecasts, increased costs or intensifying competition, could tip it into the red.
Its operating income, at just 5% of sales, is far from satisfactory. Full recovery from the crisis should leave Gilat at gross margins approaching 40% and operating income climbing to 10-12% of turnover.
2. The controlling shareholder is selling shares.
York invested in Gilat all of a year and a half ago, by buying its debt from Bank Hapoalim. Two months ago York converted most of that debt into shares, at a sweetheart conversion rate, shoring up the company's financial stability.
York presently owns 33% of Gilat's shares, which it bought for an average price of $6.50 each. Assuming it gets the present share price, $8.50, then York's return from this exit alone is 30%.
That's not bad for a year and a half, but it isn't amazing, considering the high risk York undertook to start with. Usually, investment in companies that need to turn around (or die) demands a 50% return, or more. First Israel Mezzanine Investors (FIMI), for instance, which has a line in floundering companies, usually sells its best ones only after having doubled or tripled their value.
The fact that York is selling a quarter of its holding after 18 months is a puzzler. One suspects that the main reason for the offering is that York wants to make a quick profit. It is also possible that on the inside, York sees risks that outsiders miss.
3. Proving his mettle.
At present Levinberg, one of the company's five founders, is back on top of the Gilat pyramid. He deserves much credit for the company's breakthroughs in the early 1990s, and for its recovery in the last year. But he also deserves part of the blame for the mistakes he and the other managers made in the late 1990s and early 2000s, mistakes that brought the company to its knees and halted its development for years.
Managers deserve a second chance and the boom in Gilat stock shows that the capital market is willing to give him one. But three or four good quarters aren't a trend: they could be a statistical blip. Maybe Levinberg should present a few more good quarters before he hits the markets again for money.
Gilat is no startup any more. It has been around 20 years, makes revenues of a quarter-billion dollars a year, and its potential on the market is pretty clear.
To date the company produces operating income of $13-14 million a year and nets $9-10 million. After York's conversion of debt into equity, at full dilution Gilat has 33.8 million shares, of which York owns 11 million. Based on that number of shares, its market cap is $290 million.
We nay assume that Gilat will continue to improve its profitability and sales, rising to earnings of $14-15 million a year, which translates into a profit multiple of about 20. At the ed of the third quarter, 2006, its shareholders' equity amounted to $166 million, which translates into a equity multiple of 1.8.
Those are reasonable pricing levels, but not particularly low for a company that has shown no sales growth in the preceding three years, and whose profits are runway-thin.
Gilat's share price is not astronomical, as it had been in the gay days of the tech bubble. It is a reasonable price that suits its present performance. If the company proves that it has returned to suitable rates of growth and profitability, it's an opportunity, albeit not a risk-free one. Gilat's record on the stock exchange has taught that this is one company that should be viewed with a healthy dose of wariness.