New Space De-Orbiting
Share Prices Have Come Back to Earth as Market Volatility Increases
If you had been in an investing competition with my mom over the last 2 months, my mom probably would have won.
No, she isn’t an investment guru, she’s more of a Bogle-head who preaches ETF investing, but you—the reader—I assume you invest in (or are at least interested in) New Space stocks, which have struggled over the last two months.
Executive Summary
New Space stocks have greatly underperformed the market since the end of October—$SPY is +1.8% through 12/22, while the market cap-weighted return for New Space is -20.6% (see the footnote below for constituents). This is slightly worse than the performance of Cathy Wood’s ARK Innovation ETF (a proxy for non-New Space growth stocks), which has declined -19.0% over the same time period.
Here is what I see going on:
The Federal Reserve’s recent shift in policy triggered a sell-off in growth stocks in November and December, including New Space companies. Further investigation reveals investor bias towards launchers vs earth observation (EO), manufacturing, or satcom. This pullback is probably healthy given valuation concerns surrounding New Space companies, particularly those having gone public via SPAC (i.e. all but $TSAT, $SIDU, $MAXR). Going forward, the key to New Space stocks working is execution of forecasted business/operational plans + meeting financial guidance on time. The stock market rewards consistent, incremental progress which is not necessarily how many of these New Space companies grew up before going public.
Money Printer No Longer Going Brrrrr
Traders and investors indicate that recent growth stock underperformance + increased market volatility has in-part been driven by repositioning into 2022 as investors digest the Federal Reserve’s pivot in November/December from dovish (focus on economic growth) to hawkish (focus on controlling inflation).
This change in policy matters because dovish policy (low interest rates, bond purchases to infuse capital into the economy) is generally good for stocks, while hawkish policy (no bond purchases, higher interest rates) generally creates a more challenging environment for stocks.
Key Changes in Federal Reserve Policy:
Change of Stance on Inflation: Earlier this year the majority of Federal Reserve officials had the opinion that higher prices were driven by supply-chain bottlenecks and would resolve themselves in time. However in November Chairman Powell said “it’s probably a good time to retire” the word “transitory” when describing inflation, and in December he stated that “inflation may be more persistent and…the risk of higher inflation becoming entrenched has increased.” Laurence Meyer, a former Fed governor who is now president of research-advisory firm Monetary Policy Analytics said the change in tone towards inflation is because “…they want to make sure…that they haven’t let the situation get out of hand, where once the supply-based inflation has come down, demand-based inflation tells them they should have gone sooner or faster.”
Faster Bond Purchase Tapering: As a result of this new perspective on inflation, in December Fed officials agreed to reduce their bond purchases at a rate that would end the current program in March vs prior expectations of ending the program in June. Bond purchases are the Fed’s method of infusing capital into the economy—they buy bonds from banks in exchange for cash, which increases the money supply. So ending this program cuts off an inflow of cash in the economy, which many argue is not needed at this point in the recovery from COVID.
Interest Rate Hikes: Additionally, Fed officials projected that they would raise rates 3x next year—this is a more aggressive outlook versus September when their projections were for 1-2 rate hikes in 2022. These three interest rate hikes would only increase the Federal Funds Rate by 0.75% (which compares to near-term peaks of 2.4% in 2019 pre-pandemic, 5% in 2007 pre ‘07-’09 financial crisis, and 6.5% in 2000 pre-dotcom bubble), and interest rate increases beginning in mid-2022 only brings forward the expected timeline by ~3 months.
However, I believe it was the change of outlook (versus the magnitude of change) that triggered investors to more closely evaluate growth companies whose valuations and projections may have gotten a pass in the equity-friendly low interest rate environment of late 2020 and 2021 which is when most New Space stocks went public.
Why Should New Space Investors Care About Interest Rates?
Image Source: Financetrain.com
Rising interest rates matter for growth stocks (aka New Space companies) because investors measure the present day value of a company’s future profits by using some form of the above formula for Net Present Value (NPV), the basic premise being that $100 today is worth more than $100 in the future (if you don’t already understand the time value of money, check it out straight from the mouth of a valuation OG, NYU professor Aswath Damodaran).
When calculating the NPV of a company’s future cash flows, changes in interest rates impact the variable “r,” or the discount rate, in the above equation. So if The Fed is raising interest rates, this means the denominator in the NPV calculation becomes greater (all else equal), which means a smaller present day value of the company’s future cash flows.
Given that most New Space companies are not profitable in the near-term, rising interest rates are more meaningfully negative for New Space than it is for businesses that are already cash/profit-generative because most of new space’s value is in their future cash flows.
Additionally, New Space in particular is at risk in a higher interest rate environment given the capital intensive nature of their businesses:
If New Space companies can’t self-fund (which is harder to do if input costs are going up due to inflation), then they must raise debt that no longer has bottom-of-the-barrel interest rates, OR they must dilute equity shareholders via equity.
For reference, Maxar raised $150M of debt with a 7.54% interest rate (~$11M interest/yr) in mid-2020—it’s safe to assume other New Space companies would have higher interest rates.
Virgin Galactic raised $500M via an equity raise in mid-2021 and its share price dropped >10% following the announcement.
Lastly, the longer that de-SPAC’d companies hold onto their piles of cash after merger completion, the less valuable the money becomes due to inflation.
Launchers vs The World
Since the end of October, launchers have declined only (lol) -15.6%, outperforming EO, satcom, and manufacturing.
However, I will note that Maxar is +15.0% over this same time period, and EO performance ex-Maxar is nearly -39% vs -22% including Maxar
I assume Maxar’s performance is due to the company’s superior profitability relative to the rest of the companies in the above list ($MAXR’s FY20 Adj. EBITDA margin was 47.5%, though the company burned $65M of FCF in 2020 as well).
Telesat is also profitable (TTM as of 1Q21, 80% EBITDA margin), but the company’s revenue and operating income have been declining y/y every year since 2016, so $TSAT shares have not experienced the same trend of outperformance.
Additionally, I looked at the timeline for when SPAC management teams projected their companies to breakeven—it doesn’t seem like launchers have an advantage here, as profitability timelines would actually seem to favor Spire Global and Redwire.
As simplistic as this may seem, I believe the bias towards launchers is due to investors’ lack of familiarity with the New Space industry. To a generalist investor or someone very new to covering the industry, it is easier to measure progress of launchers (rocket goes into sky = big headlines), relative to EO (lumpy contract acquisition), satcom (next-gen LEO constellations are still pre-launch), and manufacturing (progress overshadowed by Redwire’s accounting issues). While Astra and Rocket Lab have successfully launched fire-spewing and headline-grabbing rockets since going public, EO, satcom, and manufacturing companies have all stumbled out of the starting blocks in their early days of trading on the stock market, including multiple downward revenue guidance revisions from EO companies, and lingering investor uncertainty regarding AST SpaceMobile and Redwire’s respective issues (launch delays and Audit Committee investigation).
For New Space stock share prices to appreciate going forward we need to see the following, as I highlighted in my note on 3Q21 New Space Earnings Key Themes:
Space is an industry that is literally pushing the forefront of what is possible for mankind, but the stock market is an area that requires a tempering of expectations—to see share price appreciation, it is often better to set expectations low and exceed them than it is to promise the world (the moon?) and end up short, even if progress made is material.
I’m not saying this balance should be easy (because let me tell you, it is not), but this concept is something public New Space management teams will have to consider as they grapple with how to communicate their results and outlook—even if they view themselves to be long-term oriented and not concerned with day-to-day movement of their stock.
Disclosure/Disclaimer: This post is not investment advice and represents Case’s opinions only. Do your own research before making investment decisions. While Case aims to write with an unbiased opinion, he has long stock positions in $ASTS, $RDW, $PL, and $RKLB, which are all mentioned in this post. Please (respectfully) yell at Case if you think his bias is showing in an unprofessional manner, and he will take your feedback into account in the future.