Gogo: The Market Doesn’t Get It (NASDAQ:GOGO)

Gogo Inc. (NASDAQ:GOGO) provides inflight connectivity for business aviation. I believe Gogo is undervalued at the current share price as the market is not looking at the subscription business correctly. They have built a near monopoly in their niche, and the financials of their subscription business continue to improve.

Gogo has also made great strides in improving cash flow and provided impressive earnings guidance. Valuation multiples are depressed, and the market keeps overreacting to earnings. While there are risks from the competition and marketing and sales execution, Gogo has enough of a head start to maintain its niche leadership position. I rate this stock a buy, and as a bonus, I believe a dividend is possible within the next few years.

Gogo Has Built A Near-Monopoly In Its Niche

Gogo Inc. is a leading provider of connectivity products and services for business aviation. Since pivoting away from commercial airlines to business aviation, Gogo has created a near monopoly in serving smaller business jets and turboprops. Gogo provides both earth-to-ground services as well as low-earth-orbit satellite services. This means that Gogo can offer lighter, less expensive, and faster-to-install equipment than any of its competitors.

This is especially important when considering Elon Musk’s Starlink. Since Starlink announced they would begin serving business aviation customers, Gogo’s share price has stagnated despite solid revenue growth. However, Starlink’s system is heavy and expensive, and capacity is still restricted. It is an excellent play for larger business jets (like launch customer JSX), but not for smaller jets and turboprops that represent the majority of business aviation fleets

In addition to flexible equipment, Gogo has a leg-up in high-speed internet deployment. Business aviation customers demand faster, higher capacity, and more reliable internet services. They have completed the build-out of the 5G air-to-ground network in the US and will launch the service later this year. While air-to-ground has coverage limits, it offers significantly higher speed and lower latency than satellite.

Gogo also has room to grow in its niche, as inflight connectivity has low penetration for small jets, especially turboprops. From the Q1 2023 earnings call, management noted that 50% of small business jets and 10,000 turboprops are still on the table for future growth. This is in addition to the opportunity to provide global connectivity as they expand further into satellite broadband by 2025.

Ignore Equipment Volatility And Focus On Subscription Business

I believe it is critical to look at Gogo as a subscription-based business versus looking at the entire P&L. As management acknowledged in the Q1 2023 earnings call, equipment revenue is highly variable based on the timing of installs and the actual availability of equipment which supply chain issues have constrained.

Q1 earnings look very different when you evaluate the entire business versus looking at the subscription business. Total revenue was up 6.6% year over year, and EBITDA was down 7% year over year. However, service revenue was up 11.1% year over year and gross profit on the service business was up 10.1%. Double-digit growth on a subscription service is phenomenal, especially compared to other businesses in the wireless sector. Even better, Gogo saw increases in both rate (up 2% year over year) and volume (up 8% year over year).

From a cash flow standpoint, Gogo has really been cleaning things up. In Q1 2023, Gogo increased cash flow from operations (despite lower EBITDA), more than doubled Free Cash Flow, and added $13 million to their cash balance. The cash balance is so strong that management announced they would pay down $100 million of term loans early to save $8.5 million in interest annually.

I feel earnings guidance was equally impressive. Revenue growth of 17% annually through 2027, with global broadband coming online in 2025. Adjusted EBITDA margin in the mid-40 % range by 2027. Most important, free cash flow above $200 million starting in 2025. At that level of free cash flow, on a business with low variable costs, I start to see the possibility of competitive dividends.

The Market Isn’t Looking Correctly At Gogo

I believe that Gogo’s share price is undervalued by the market, driven by two primary factors. First, I do not believe the market treats Gogo as a subscription business. Following Q1 2023 earnings, which I felt were extremely strong, as discussed above, Gogo fell 7%. Second, I believe the market is overreacting to competitors’ announcements. Gogo’s stock has stagnated since Starlink announced an entry into business aviation. As discussed above, Starlink doesn’t have the technology to challenge Gogo in its core niche.

Supporting my theory, key valuation multiples are also depressed from historical averages. EV/EBITDA is down 30% from the 5-year average. Today’s EBITDA is driven by investment in new business and equipment volatility. I believe this multiple reflects that the market is looking at the full P&L, and not diving into the fundamentals of the subscription business. Price/Cash Flow is also down 64% despite strong growth in cash flow and even stronger earnings guidance.

Downside Potential

A few key factors could impact Gogo’s ambitions, and in turn, their share price. First, their closest competitors (Starlink and Viasat) could enter the small jet niche. While this is definitely a risk, every company will look for ways to grow, Gogo would have advance notice since neither competitor has the technology today. They are also a few years ahead of any competitor on network deployment; no competitor has an air-to-ground network that is 5G ready.

The other factor is Gogo’s ability to further penetrate its niche, especially turboprops. Gogo’s 17% revenue growth guidance relies upon market share growth and dominating the small aircraft space. This is a challenge for the marketing and sales team and a potential margin risk as customers become harder and more expensive to acquire.

Verdict

I rate this stock a buy and believe that investing in Gogo at its current valuation presents investors with attractive upside potential over the next 3-5 years. Gogo’s competitive edge, 5G installations, and low market penetration it a good foundation for future growth. The company has an ambitious plan which appears achievable and should drive significant value for shareholders in the long run, potentially including a dividend.