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Lynx illustration
Companies like XCOR Aerospace, currently developing the Lynx spaceplane (above), offer great potential payoffs but also considerable risks for unwary investors. (credit: XCOR Aerospace)

Financial risk analysis and the space industry revisited

Last week we looked at the different risks that exist in different parts of the space industry (see “Financial risk analysis for the space industry”, The Space Review, June 16, 2008). Roughly speaking they divide into two groups. One is the conventional space industry, which includes both the military and civil space sectors as well as the conventional commercial space sector. In these sectors risk is well understood and can be managed by conventional means. This is also the sector where risk has been bought down by ample and sustained government investments.

Then there is the NewSpace sector: entrepreneurial and visionary, but full of technological and financial unknowns. This is the area where the greatest potential profits exist and where there are excellent chances for unwary investors to lose their proverbial shirts. However, one must recognize that these dangers have been reduced over the past decade. The NewSpace firms that have survived are agile, thick-skinned beasts who either have very rich patrons or have become exceptionally good at scavenging the landscape for contracts and investors.

NewSpace is the area where the greatest potential profits exist and where there are excellent chances for unwary investors to lose their proverbial shirts.

Companies like SpaceDev, TGV Rockets, and XCOR Aerospace are not going away anytime soon. They have all gotten beyond the “viewgraph engineering” stage and are cutting metal and building products. By itself this may not be enough to secure their future profitability, but it’s a long way from where they were eight or nine years ago. SpaceDev, for example, has latched onto a successful niche making actuators and similar small components at its facility in North Carolina while still working on more ambitious systems in California. The firm may be making a small profit, but it still has a ways to go before it can compete with better-established ventures.

One thing that the NewSpace firms all have in common is that they share big ambitions. They may have different visions of what they want to do, but none of them are thinking small. They all believe that one way or another their ultimate success will transform the way the space industry operates and will open up the solar system for human exploitation. Those who dream big dreams can often be their own worst enemies when it comes to dealing with the day-to-day world of equity and finance. Smart investors do not simply put their money into good ideas, they invest in people. If the CEO and other leaders in a firm appear to have their heads stuck in the clouds, their chances of raising risk capital will remain earthbound.

Investors and business leaders are ready to take risks, but they are not willing to take stupid risks, at least not normally (anyone remember the “New Coke”?) Mitigating risk by spreading it around is a basic principle of money management. Yet as the techniques of risk mitigation become more and more sophisticated, so do the opportunities for systemic failure: we have all seen what happened to the financial engineers who helped create the subprime mortgage disaster. The success of Western capitalism is due in large part to the inventions of the joint stock company and the insurance industry. Entrepreneurs who make it big are ones who know how to use these institutions rather than those who spend time and effort fighting them.

The next phase of the NewSpace industry will logically result in the emergence of one or two major new companies that will take their places amongst the so-called “big boys”. Virgin Galactic and Scaled Composites are part of large conglomerates, and while they may behave like small, independent firms, they have the kind of support needed to carry though with their plans without the need to raise new capital or to win new government contracts. The independent companies are the ones that will either grow or go under. This is where investors will have to take real risks.

However one or more of these firms could make the kind of technological breakthrough that would turn them into a giant of the 21st century. They simply have to come up with the right product at the right time for the right price. This usually requires a divine miracle.

The history of capitalism is full of such miracles, yet as we all know there are far more failures than successes. What is happening is the convergence of various technologies with the demand for low cost access to, and operations in, space. The basic science of rocketry is now better understood than it was fifty or sixty years ago when it was much more of an “art”. The NewSpace firms are free to try and use combinations of new products and ideas to build their products. Some or most are sure to fail, but those who do not may have their hands on a gold mine. For example, a firm that comes up with a genuine new two-stage-to-orbit RLV that can dramatically cut launch costs will instantly change to economics of the commercial launch industry.

Technology may be taking some of the “art” out of rocket science, but it cannot help much with the “art” of risk management in the space industry.

Imagine what would happen if, in say, 2011 or 2012, a NewSpace firm were to put into service a launch vehicle that could put a two-ton payload into geosynchronous orbit for two million dollars. Would this hurt the market for the Ariane 5, the Proton and for Sea Launch? Probably, but only if there were satellites available in that class that could provide services roughly comparable to the heavy ones that are now being designed and built. To truly disrupt the market, the new satellite would have to combine lower manufacturing costs and lower operating costs with the lower launch costs. The launcher would have to be shown to be at least moderately safe and reliable.

Some of these factors could be met by turning an orbital space tourism vehicle into a satellite launcher. If a vehicle designed to safely carry passengers into orbit works as planned, then modifying it to profitably carry satellites is only logical. This may be why the European conglomerate EADS is looking to build its own suborbital space tourism vehicle.

For everyone involved in the space industry their are risks and dangers involved in staying with today’s tried and true expendable rocket technology and even greater ones in investing in the next generation of reusable launchers. The only way to avoid these risks is to get out of the industry altogether.

Technology may be taking some of the “art” out of rocket science, but it cannot help much with the “art” of risk management in the space industry. It takes men and women with years of experience and considerable investing skill to understand this emerging industry. It is evident that investors must place their bets on people, rather than on hardware that may or may not work as well as planned.