September 27, 2020

Virgin Galactic: Valuing The Company’s Commercial Spaceflight Business (NYSE:SPCE)

Investment Thesis

Virgin Galactic (SPCE) is one of the most exciting stock currently with investors waiting anxiously in anticipation of commercial launch. With the stock cooling off from its March highs of $42, I believe current prices present a good opportunity for investors to begin accumulating shares. However, expect extreme volatility in the stock as the company ramps up towards commercialization. Buckle up.

Company Overview

Virgin Galactic is a vertically-integrated aerospace company with an aim to provide private individuals and researchers access to space through its commercial suborbital spaceflight offering. SPCE was founded in 2004 by none other than billionaire entrepreneur Sir Richard Branson, also the founder of British venture capital conglomerate Virgin Group. In 2019, SPCE went public through a special purpose acquisition company, or SPAC, deal with Social Capital Hedosophia. The IPO not only raised capital for SPCE but also provide a meaningful opportunity for the company to market its service offering given how widely covered the world of investing is.

The company’s main value proposition is to offer individuals a suborbital space experience through its cutting-edge technology and unique aircraft. Customers first undergo a three-day training and preparation at Spaceport America, the company’s “airport.” On flight day, Future Astronauts will board SpaceShipTwo, which is attached to the carrier aircraft, WhiteKnightTwo. After ascending to an altitude of 50,000 feet, SpaceShipTwo will be released into a free-fall. Within seconds, its hybrid rocket motor will blast the spaceship into space where the crew will be able to experience microgravity and a spectacular view of Earth. After a brief moment, the pilot will configure the spaceship for reentry into Earth using its “wing-feathering” feature. The spaceship will then glide back to Spaceport America where customers first began their mission.

(Source: Virgin Galactic Website)

After 16 years since its inception, SPCE has conducted numerous test flights and perfected its suborbital spaceflight offering. As of Q2 2020, the company has cleared 27 out of 29 elements for FAA Verification and Validation, leaving just two left before commercial launch. Although SPCE currently focuses on commercial spaceship flights, the company has the expertise and technological capabilities to expand into other segments such as point-to-point hypersonic travel and orbital spaceflights.

(Source: Second Quarter 2020 Investor Update)

(Source: Second Quarter 2020 Investor Update)

Valuation and Assumptions

Since SPCE’s current main value proposition is to offer commercial spaceflights to high-net-worth individuals I will attempt to value its commercial spaceflight business, exclusive of any potential growth from other business offerings such as hypersonic P2P travel and private orbital spaceflight. I will use a 10-year discounted cash flow model. Below, I lay out key assumptions and drivers for my valuation model. In its 2019 Investor Presentation, management provided financial projections through 2023. Due to delays and COVID-19 disruptions, I will delay all of management’s projections by a year.

(Source: 2019 Investor Presentation)

Revenue – Revenue will be a function of the number of vehicles, flights, and passengers, as well as ticket prices. Based on management’s projection, they are implying a ticket price of over $300,000 even though a price of $250,000 has been mentioned numerous times. In my valuation model, I will keep prices constant at the lower end at $300,000 per ticket. Management also expects 5 vehicles by year-end 2023 and total flights of 270, implying 54 flights per vehicle. I will gradually increase flights per vehicle to 80 by 2029. Projected total flights of 270 and projected total passengers of 1,565 also imply an average of 5.8 customers per flight. For my projections, I will keep passengers per flight constant at 5.8. Finally, I expect the total number of vehicles to grow to 10 by year-end 2029. Below shows the breakdown of my revenue projections.

(Source: Author’s Analysis)

Operating Income – Based on management’s projections, gross margin and EBITDA margin in 2023 are expected to be 73% and 46%, respectively – overly optimistic numbers in my opinion. SPCE has historically burned more cash than anticipated and thus, I expect margins to be compressed in the near future. For gross margin, I will project it to be close to management’s contribution margin projection, at 66%, by year-end 2024.

(Source: 2019 Investor Presentation)

As of Q2 2020, the trailing 12-month operating expenses is about $250 million. As such, I expect operating expenses to increase thereafter. Chamath Palihapitiya, the CEO of Social Capital, claimed that SPCE can achieve a 70% operating margin. However, I think this number is too rosy. Therefore, I will use a 40% operating margin by 2029 instead. Below shows the projections for operating income.

(Source: Author’s Analysis)

Capital Expenditures – I used management’s capital expenditures projections and stabilized it at 5% of revenue by 2029.

(Source: Author’s Analysis)

DCF Assumptions – I assume a 10% discount rate and a terminal growth rate of 4%. Based on my valuation model, I arrive at an intrinsic value per share of close to $20, slightly higher than what the stock is trading at currently, at $17 a share (as of 09/10/2020).

(Source: Author’s Analysis)

Keep in mind that my valuation model does not include revenue from other sources, only SPCE’s commercial spaceflight business. Also, I have used relatively pessimistic assumptions to drive my model, instead of the numbers given by management. If SPCE can achieve the 70% operating margin that Mr. Palihapitiya claimed, its share price might easily spike. However, I believe such claims were only used to entice investors and analysts to drive SPCE’s valuations higher. Mr. Palihapitiya may be right, but investing in SPCE comes with extraordinary risks, and therefore, requires a more cautious valuation approach.

Highly Speculative, But Massive Potential

One of the reasons why SPCE is very speculative is because of the fact that the company has not launched commercial operations, and thus has no revenue other than cash received from collaborations with researchers and the U.S. government, as well as sponsorship agreements. Furthermore, commercial launch will depend on the Federal Aviation Administration’s approval and the timing and cost of the verification process may drag further, increasing the company’s cash burn. Speaking about cash burn, SPCE is currently burning over $200 million per year. While the company still has about $360 million in cash, further delays in commercial launch will force the company to issue additional shares, diluting shareholder value.

Another major risk is safety. Due to the recent Boeing (BA) 737 Max crashes, the FAA has become extra stringent when it comes to aviation safety. In addition, there are still uncertainties to whether SPCE can complete a voyage with six non-pilot crew members – the best progress so far was in 2019, where the company completed a test flight with one non-pilot crew member. Additionally, accidents are bound to happen, which may not only destroy consumer confidence in SPCE but also delay any progress towards commercialization. In 2014, for example, SPCE’s VSS Enterprise crashed, killing one of its pilots.

(Source: Google Image of VSS Enterprise Crash in 2014)

Lastly, space tourism is an emerging market and while there’s a lot of excitement and hype towards the industry, such service offering is not proven yet. Space tourism will be a reality in the future, but the timing and success of the industry are still uncertain. Also, SPCE may face intense competition from other space exploration companies such as Blue Origin (BORGN) and SpaceX (SPACE), two juggernauts who have substantial resources and the expertise to launch their own commercial spaceflight programs, thus posing as major headwinds for SPCE.

Not all is dark and gloomy for SPCE – there are massive opportunities if the SPCE management team can pull this off. Firstly, while Blue Origin and SpaceX pose a major threat for SPCE, SPCE has the first-mover advantage in the commercial spaceflight business. In addition, SPCE has the technological capabilities to execute a horizontal take-off to space, something that the other two companies have yet to achieve. Horizontal take-off may also be deemed safer for passengers.

(Source: Second Quarter 2020 Investor Update)

As mentioned earlier, my valuation model is only based on SPCE’s commercial spaceflight business – successful expansion towards hypersonic travel and orbital spaceflight may juice company valuations. With its proprietary technologies, SPCE has the potential to expand into adjacent markets such as those shown in the picture below. Additionally, fleet size expansion and geographic expansion to make the offering more accessible for future astronauts will be key in the company’s growth. Modifying its pricing structure such as introducing customization and tiered pricing may also present an opportunity to squeeze out extra dollars from high-net-worth passengers.

(Source: Fourth Quarter and Fiscal 2019 Investor Update)

Conclusion

Valuing a company with no track record of generating consistent revenue is difficult and using management’s financial projections may prove to be too optimistic – it’s better to take the more cautious approach. All in all, I value SPCE’s commercial spaceflight business at $20 per share. As you can see, my assumptions are relatively pessimistic compared to management’s expectations as I do not believe the company can achieve such impressive margins in such a short period of time. However, even with the high risks involved, I do believe in the long-term prospect of the company and the industry. The company also has a very strong management team that can turn the dream of commercializing space tourism into reality.

With its recent pullback below $20 after a run up towards $42 in March and $27 in July, SPCE presents a great speculative buy for those who believe in the long-term potential of the space tourism industry and for those who are interested in holding the first space tourism company ever to publicly trade in the stock market. However, just like launching into space, holding SPCE stock is not for the faint of heart. A successful flight test with Sir Richard Branson in the cabin may potentially launch the stock into orbit while accidents (God forbid) may see its stock price crash. The stock is extremely volatile – moonshot upside potential as well as headwinds that could crater the stock. Buckle up.

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Disclosure: I am/we are long SPCE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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