NOC - Mynaric: High Risk Low Reward Space Business

Summary

• MYNA has landed some contract wins, but not at large enough scale to generate profit.
• MYNA cash-burn each quarter is accelerating to new heights, requiring significant financing via debt and/or capital raise.
• MYNA shareholders unlikely to be rewarded appropriately for risk given upside is capped based on poor economic scaling. Strong Sell.

Investment Summary

Mynaric ( MYNA ) (hereto referred to as "MYNA", "Mynaric", or "the company") is a German-based Aerospace and Defense micro-cap that manufactures laser terminals for space-based, air-based, and ground-based platforms. The company went public with a $70 million dual-listing on U.S. exchanges end of 2021. The technology involves optical-link, free-space (i.e., not restrained by cabling or lines) communications, which is an extremely young, low heritage technology that is still squarely in the research and development maturity stage. This article focuses only on the space business simply because the air and ground businesses currently produce $0 in revenue.

The company's business model relies on operating at production capacity of 2000 terminals annually , but currently only has backlog of 40 units in FY 2021 and 243 units in FY 2022 . Though this growth in backlog is encouraging, it is a far cry from the necessary inflection to profitability. To that point, management have forecasted their operating loss to " significantly increase " from FY 2021 loss levels of €(42.4) million with flat revenue of €2.4 million. MYNA raised liquidity as part of their U.S. IPO at the end of 2021, but cash levels have already fallen from €48.14 million to €25.51 million by 2022H1. Free cash flow was €(47.04) million in FY 2021 and €(32.17) million in 2022H1. MYNA had to take on €10 million in debt in 2022H1 and expects similar free cash flow deficit in the second half of 2022, which necessitates further debt financing or, more likely, a capital raise to maintain sufficient capital for operations. An extremely generous business outlook stipulates inflection to profitability occurs around 415 units produced and sold annually, with still generous, but more realistic outlooks requiring around 600 - 900 units produced and sold - targets unlikely to be reached in the next 3-5 years. Given the extreme likelihood for more than one capital raise at these depressed share price levels, debt financing, increased competition, and unclear profitability for several years, we advocate remaining on the sidelines for MYNA and waiting to see how things develop. This article concludes with a Bearish/Strong Sell rating.

Note to the reader : MYNA is a micro-cap with material risk due to its current financing and business operations requiring further financing that could result in significant capital loss. The stock is extremely low float with 5 million shares outstanding, and likely to experience severe volatility. Readers are encouraged to take extreme caution should they choose to be interested in this company.

Business Model

In the last few years, space-based communications and data companies have stormed the market by going public (mostly via SPAC), including BlackSky ( BKSY ), Planet Labs ( PL ), Spire Global ( SPIR ), Mynaric ( MYNA ), Redwire Corporation ( RDW ) and AST SpaceMobile ( ASTS ). Apart from short-term trading around contract catalysts, we are not bullish on any of these companies due to poor unit economics, several questions to profitability, established incumbent players, and unproven business models.

Unlike the other space IPOs, Mynaric is "pick and shovel" play to provide optical-link terminals to support inter-satellite communications within a constellation, regardless of their mission. Eventually, the data collected in space is sent to the ground, traditionally accomplished through radio wave emitters to ground stations unlikely to be supplanted by optical links due to Earth atmosphere and line-of-sight obstruction causing significant technical difficulty for optical space-to-ground links. The business thesis for Mynaric is that an increase in dense low earth orbit ((LEO)) satellite constellations will eventually transition to optical-link technologies to support large data transfers.

The only customer with any real weight regarding space capabilities remains the U.S. Government, particularly the Department of Defense. The company's business case relies on mass producing low-cost laser terminals, which requires a consistent proliferation of satellite constellations that heavily rely on laser terminals. We agree that the direction of communication technology is moving away from radio wave technology and toward optical links, but this is a trend that will be followed by competitors and developed in-house by satellite manufacturers. This article will first consider the market and customers for Mynaric before investigating the business economics.

Market Potential and Customer Base

For this decade, we strongly believe the U.S. Government will remain the primary customer within the space domain, currently custodians of 400 of the 5500 active satellites in space. Mynaric expects there to be 100K orbiting satellites by 2030 , largely due to the proliferation of space by the commercial sector. This seems to be a common narrative, evidenced by the flurry of recent space-related IPOs mentioned earlier. However, we do not share this viewpoint due to: (1) increased regulations making it increasingly difficult for new players and (2) poor scalability and unit economics unable to support huge numbers of players in the space data market. Instead, we believe this decade will see space remain dominated by the U.S. Government and only a few successful companies.

Consider first, space-based internet servicing. Out of the 5500 active satellites in orbit, a whopping 3271 of them are from one source as of November 2022: Starlink (a SpaceX business). SpaceX has themselves marketed Starlink as a service for remote and rural areas, marine, and aviation. At $110 a month, it is extremely unlikely the typical non-rural consumer can't find a better priced internet service provider in their area. Couple this with the fact that only 17% of the U.S. population lives in rural areas (we set aside a global figure due to the prohibitive cost for consumers in most countries ex-USA), and there simply isn't a market to support dozens of companies each with thousands of satellites in constellations providing similar services. Further saturating the market are other up-and-coming space data constellation competitors such as Project Kuiper ( AMZN ) and OneWeb.

Next, consider space-based intelligence, reconnaissance, and surveillance ((ISR)) businesses such as Maxar ( MAXR ), BKSY, and PL. Maxar satellites are in geostationary orbit ((GEO)), which only requires a handful of satellites to sustain earth viewing ISR operations. BlackSky is primarily LEO based but only with 14 satellites in their constellation . Planet Labs has a much larger network of 200 satellites, but their data is transmitted over X-band radio , not optical links. Recently, the U.S. National Reconnaissance Office awarded MAXR, BKSY, and PL up to around $5.5 billion altogether for data products and services on a 10-yr contract. Since the U.S. NRO is by far the biggest customer for these types of businesses, there is little room for further constellations in this space.

Lastly, consider the largest customer base that is the U.S. Department of Defense. The primary program Mynaric and its competitors are involved in is the Space Development Agency Transport Layer, part of a larger program to support missile warning/missile tracking. Northrop Grumman ( NOC ) and L3Harris ( LHX ) were winners of the next phase contract, and Mynaric is the supplier to NOC's solution bid. Each satellite is equipped with three terminals, with the number of satellites for this particular portion of the program amounting to 28 (14 per vendor) . Ultimately, the entire network will involve 144 satellites across different orbital altitudes and planes, sourced from various vendors. Even if MYNA were the sole supplier to every single one of these satellites, that brings the total unit count to 432 terminals, which would be a one-and-done deal excepting replacements. This scenario will never materialize, however, due to the U.S. DoD's risk-adverse strategy and preference for vendor diversification (as evidenced by the spread of ISR contract winners in the previous paragraph).

Altogether, we find it difficult to arrive at Mynaric's expected 100K satellites or operation of their high fixed-cost plants at full production of 2000 terminals a year by 2030. Furthermore, vertical integration and competition will limit Mynaric's addressable market. For example, Starlink is pursuing its own purpose-built laser terminal for its constellation; OneWeb is tightly partnered with Airbus , who owns Mynaric-competitor and incumbent laser terminal producer Tesat; SA Photonics - recently acquired by CACI International ( CACI ) - is also ramping up production for defense customers. Though this article focuses on the space market, the company is also pushing into the air-based market by equipping UAVs with laser terminals. No units have been sold and this business currently has $0 in sales, but the reader should be made aware of this additional potential, which we believe is the only way the company can ultimately produce at full capacity annually. That said, AeroVironment ( AVAV ) has been in the business of flying high-altitude, long-duration UAVs for several years with limited market success, so basing MYNA's profitability on this market will require significant time to realize.

Mynaric Business Economics

A discussion on the business economics will be based on two considerations: (1) U.S. Space BACN research program aims for technology transition within the industrial base to reach unit cost of laser terminals of $100K or less, and (2) Mynaric's current fixed-cost assets are designed for full capacity of 2000 units.

The recent report for the company's earnings showed that SG&A expenses are at €17 million for 2022H1 , driven by hiring 100 additional personnel. The majority of these hires are in Germany. Depreciation and amortization came in at €3 million for 2022H1, and we will eschew 2022 "other operating costs" since it's skewed by one-time costs from the recent U.S. dual listing. Cost of materials came in at €8.3 million in 2022H1, which when annualized will be generously assumed to be associated with the cost of all 243 units in the backlog. Aggregating together on an annual basis to assume operating costs and gross margin will result in:

Assume that Mynaric is able to sell each unit at $150K, above the target set by the U.S. Government customer base, then the gross margins in Scenario A using the COGS assumed above are 55%. The above computation is extremely forgiving by assuming operating costs never rise from 2022 levels, essentially acting as fixed costs regardless of the scaled number of units sold.

The Northrop Grumman supply contract , running through 2025 and worth $36 million, states Mynaric is to deliver 126 units for 42 satellites. The contract would put each unit price at $285K. Even with the parameters in Scenario A , this contract would not be enough to break-even on an operating income basis for Mynaric.

Scenario A is of course ridiculous as the U.S. Department of Defense wouldn't let its industrial vendors sustainably undercut them to such a degree as to allow 55% gross margins. One would be hard-pressed to find a primarily defense-based contractor or supplier with such margins; most are within 20 - 30%. BWX Technologies ( BWXT ), for example, has a monopoly and operates at 25% gross margins. nLIGHT ( LASR ) is a company focused on laser products and fiber optics with a large defense customer base and also operates at 25% gross margins. Even CACI, which has most of its revenues derived from IT, research, and consulting for its defense and intelligence customers - not hardware manufacturing - operates at 35% gross margins. With that said, using more realistic gross margins results in the following unit economics:

Once again, this assumes current operating costs remain fixed regardless of number of units sold. This means no additional hiring required for 900 individuals (an especially non-trivial cost is being ignored here considering expensive German labor). Management's own guidance states a "significant increase" in operating losses this year. Finally, recall that the price per unit was set to $150K, which does not align with the cost requirements of the U.S. Government customer, further exemplifying the great liberty taken to arrive at production targets beneficial to Mynaric.

The more realistic Scenario B and Scenario C computations require a number of units produced and sold annually that seem unachievable within five years given the market outlook and customer base discussed earlier. It would not be surprising to see other programs adopting a "wait and see" approach and letting the SDA Transport Layer program act as the avant-garde before choosing to adopt Mynaric's technologies. This would suggest any sizeable deliveries aside from the current Northrop Grumman supply contract wouldn't materialize until after FY24-FY25 when the products have been delivered to Northrop and integrated.

It is important to determine when Mynaric may be able to achieve break-even operating income due to its limited financial reserves. The company currently holds $25.51 million in cash, $10 million of which was obtained by debt financing. Shares outstanding are at 5.24 million, an increase from 4.09 million a year earlier. In the first half of 2022, the company operated with €(32.2) million in free cash flow, indicating that the end of this year and next year will require significantly further share dilution or debt financing.

Risk and Conclusion

The primary risk to the company is financing, with material risk to shareholder capital due to significant dilution or debt financing. Tangible book value is at €33.82 million against a market capitalization of €84 million. This is still too expensive, despite the share price deterioration over 2022, considering €64 million is required each year as things currently stand and with losses expected to ramp up. There is too much risk surrounding Mynaric, and until there is clarity on their financing situation and backlog outlook, this article concludes with an uninvestable Bearish/Strong Sell rating.

The technological aspects of Mynaric are promising and the future of space technology is trending toward the capabilities Mynaric has to offer. However, the unit economics are poor, with limited scalability for profitability. The company may not go bankrupt, given obvious interest by institutions and customers, but there remains material shareholder risk. Rather than take this unnecessary risk, this article suggests a more prudent idea to remain on the sidelines and watch for further developments before jumping in - primarily to look for (1) financing clarity and (2) an increasing, sustainable customer order backlog. We do not believe point (2) will materialize for several years and are thus in no rush to jump in at this time.

For other small/mid-cap ideas in the defense sector, the reader is encouraged instead to explore Leonardo DRS ( DRS ), BWX Technologies ( BWXT ), Huntington Ingalls ( HII ), and Leidos ( LDOS ) for high-quality companies with different moats.

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