GSAT - Rocket Lab: The Downside Risk Profile Is Reassuring

2023-07-21 10:29:55 ET

Summary

• This article discusses some reasons why downside risk for Rocket Lab investors may be relatively limited, by the standards of the space sector.
• Rocket Lab's downside risk is mitigated by its current monopoly in dedicated small launch, its diversified set of revenue stream, its increasing significance in defense, and its strong balance sheet.
• Hence, Rocket Lab may not warrant the same degree of investor unease as other space stocks, and may be currently undervalued due to industry-wide turbulence.

The space industry has been experiencing a period of consolidation over the last few quarters. This has resulted in some players, such as Virgin Orbit, declaring bankruptcy, while many others are grappling with serious challenges. Understandably, this uncertainty in the space sector has led to a considerable decline in space stocks. However, this widespread decline implies that there could be long-term winners that are currently undervalued due to the industry-wide turbulence.

I think that Rocket Lab (RKLB) may be one such potential winner. One reason for this view is that Rocket Lab's downside risk appears relatively limited compared to many other players in the space sector. In this article, I will elaborate on the reasons behind this assessment.

However, it is important to note that, of course, Rocket Lab is a risky investment. We are dealing with rocket science, and the company is not yet profitable. My view is simply that Rocket Lab's downside risk is relatively limited within the overall high-risk context of the space sector . With this caveat in mind, let's delve into the reasons why I believe Rocket Lab has a favorable downside risk profile and stands a good chance of long-term success.

The Electron Monopoly

I have previously written in detail about the Electron launch business in an article titled " Rocket Lab: Electron Launch Business Set To Grow. " I encourage readers to refer to that piece.

Recently, Virgin Orbit went out of business, and other small launch startups like Astra continue to face difficulties. As a result, at least to my knowledge, Electron currently enjoys a monopoly in the dedicated small launch market, with orders from struggling competitors being redirected to Rocket Lab, as noted in their Q1 earnings report .

CEO Peter Beck also expressed optimism on this front during the earnings call, stating:

On small launch, I think my personal view is it's pretty tough to enter that market at this point. I mean, Electron has demonstrated just such great reliability and a good service that that becomes harder and harder to break into that, not being as arrogant to think that, nobody can do that, but certainly, it will be difficult. So, I'm - we've seen a failure of a lot of - lots more launch vehicles or failure to deliver over the years and even more recently, in more dramatic ways. So, I think on the small launch side, it's a great market. It's a nice little niche market and Electron will probably continue to do well there. And I'm not sure if I really see too many small launch vehicles coming online in the future.

While the Electron is not yet profitable, its profitability should improve as launch cadence increases (allowing high fixed costs to be spread over more launches) and the reusability program progresses (reducing the cost of each launch). Having a monopoly may also contribute to better margins in time. Therefore, the Electron is in a fairly secure position and has the potential to soon become a successful business. If it does, that should help limit Rocket Lab's downside risk by providing stability to one part of the company.

Diversified Revenue Streams

Small launch is only one aspect of Rocket Lab's operations.

The space systems division is already significantly larger and continues to grow. And even within space systems, Rocket Lab operates a variety of businesses. The company designs and manufactures a range of satellite and spacecraft components, including solar panels, reaction wheels, star trackers, radios, and software. They also build entire satellites and spacecraft, including Rocket Lab's Photon spacecraft. One of the largest orders in Rocket Lab's backlog is a $143 million contract to build 17 custom spacecraft for Globalstar.

Rocket Lab also plans to enter the medium launch market with the Neutron rocket, which is expected to debut in late 2024.

Furthermore, Rocket Lab aims to become a space services company that manages satellites and constellations, although this is still in the early stages. However, it is worth noting that there has been some progress on this front. As an extension of the contract with Globalstar, Rocket Lab is also building a Satellite Operations Control Center ((SOCC)) intended to provide 24/7 monitoring and management of Globalstar’s constellation including:

• Continuous satellite control and monitoring using Rocket Lab’s MAX GDS, a constellation-class ground software solution that provides complete spacecraft command and control.
• Satellite orbit determination, maneuver planning, collision avoidance, orbit maintenance, and propellant management.
• Satellite health analysis and reporting, anomaly resolution, performance trending, payload monitoring, management, and reconfiguration.

Given the variety of businesses that Rocket Lab is involved in, it seems reasonable to think that there will be some long-term successes here. For instance, it may be possible that even if the Neutron fails, Rocket Lab could still succeed as a small launch provider, or as a space systems company (and vice versa). This is just classic diversification.

Since Rocket Lab has several different pathways to long-term success, this mitigates overall downside risk for investors. There is a decent chance that Rocket Lab will find success, one way or another.

The Defense Angle

As space becomes increasingly critical in defense applications, defense spending on space continues to rise. This could significantly help Rocket Lab.

Rocket Lab has been performing well in the defense sector. The Electron has been used for defense-related launches, and a modified version of the Electron was recently selected for suborbital testing and applications by the US government. This is part of Rocket Lab's recently-debuted HASTE (Hypersonic Accelerator Suborbital Test Electron) program .

The Neutron could also perform well in the defense sector. The Space Force is contributing $24 million to its development—almost 10% of the projected total development cost of $250 million. This suggests that there is interest in the Neutron from a defense perspective.

The US government has also been keen to prevent the launch market from becoming a monopoly and to support multiple launch providers, which should benefit Rocket Lab.

Rocket Lab's growing involvement in the defense sector, coupled with the prospects of government orders and backing, should instill some degree of confidence in the company's future. As Rocket Lab becomes increasingly integral to defense operations, the likelihood of it being allowed to fail decreases, thereby limiting the downside risk. This is a journey, of course, and Rocket Lab may not be indispensable yet, but there is certainly good progress on this front.

Strong Balance Sheet

Finally, Rocket Lab boasts a strong balance sheet that should see it through the development of the Neutron. I have previously written about this, and my assessment remains unchanged:

Rocket Lab has almost $400m in "cash" and a book value of $640m. The cash alone is more than all of Rocket Lab's liabilities (both short- and long-term), and Rocket Lab has negligible interest expense. The cash is, of course, being burned through while Rocket Lab progresses on the runway to profitability, although much of the burn is going towards R&D for the upcoming Neutron rocket... Rocket Lab is investing a total of about $250 million into Neutron, a sizable portion of which will accrue between now and 2024 or 2025 (some has already accrued). But at the current burn rate (Rocket Lab posted a net loss of $46m in Q1), and even adjusted for further spending on Neutron, Rocket Lab should comfortably make it through Neutron's debut, at least financially.

Conclusion

In light of these considerations, I think that Rocket Lab is reasonably likely to succeed in the long term in some form or another. Nothing is certain, of course, and space is an extremely difficult industry. Still, Rocket Lab may not be as risky as many other "new space" companies. As I have discussed, Rocket Lab has quite a few advantages that limit its downside risk by comparison. Hence, Rocket Lab may not warrant the same degree of investor unease, and may currently be undervalued due to industry-wide turbulence.

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