LLAP - Terran Orbital: Rocketing Towards Growth Or Bracing For Zero

2023-07-02 23:52:20 ET

Summary

• Terran Orbital, a company specializing in building small satellites, is a high-risk, high-reward investment opportunity due to its potential to multiply its market capitalization or fail completely.
• The company's partnership with Lockheed Martin and its recent $2.4 billion contract with Rivada Space Networks are significant strengths.
• LLAP also faces challenges such as a highly competitive market and the need for significant capital expenditure funding.
• The company's financial situation is a concern, with $292 million in liabilities and a potential for significant share dilution. However, the company expects to become profitable by the end of 2023.
• I believe Terran Orbital's shares are ready for lift-off due to its proven ability to design and build small satellites, its large-scale production infrastructure, and the potential for profitability and positive cash flows in the near future.

Terran Orbital (LLAP) caught my eye after spotting it on the TIME100 Most Influential Companies 2023 list. After delving into the stock, I reached a simple conclusion: there's a roughly equal chance that this company will either have a bright future, multiplying its market capitalization by at least fivefold, or fail, plummeting its stock value to zero.

This means my analysis and favorable rating are intended for investors seeking an asymmetric bet, where they'd stake a small portion of their capital. The risk is high, but the potential reward is even higher: my view is simply that, when adjusting both risk and reward based on the company's fundamentals, it's worth adding Terran to your portfolio of side-bets.

The Strategy

Terran Orbital specializes in building small satellites. The small satellite market is on the rise for two reasons: first, the world is discovering the potential of constellations of these small satellites, such as in the case of satellite internet services (the most famous being Starlink); second, thanks to companies like Rocket Lab and Astra Space, small satellites now have dedicated carriers offering a significantly better chance of success when it's time to launch them into orbit.

According to a market research by Spherical Insights , the small satellite market is expected to grow from $3 billion in 2022 to $13.2 billion by 2032, growing at a CAGR of 15.9%. This indicates an undeniable market opportunity. Given that this is a high-tech density industry that requires tailored solutions for each client, the potential margin on sales is high. This will become increasingly apparent as small satellite manufacturers begin to scale their production.

At the same time, the market is highly competitive. Among the companies already in the small satellite field, the most important are Airbus, Boeing, L3Harris Technologies, and Thales Alenia . Most of these are established players in the aerospace industry but don't focus exclusively on the production of small satellites.

Strengths and Opportunities

Terran Orbital's main strength lies in its partnership with Lockheed Martin (NYSE: LMT ), which significantly contributes to the company's credibility and helps it secure new contracts regularly. Terran is the trusted partner for Lockheed Martin when it comes to small satellites, and the defense giant directly invested $100 million into the company in October 2022 in exchange for warrants and convertible bonds.

The partnership will last until at least 2035, as per the contract, and Terran has allocated the received funds to expand its manufacturing facility in Irvine, California. Finding sources of capital expenditure funding is one of the key issues for Terran right now, considering the company's backlog grew by 1,300% over the course of 2023.

The second major opportunity is that satellites are becoming increasingly important not only for commercial applications but also for defense. The Biden administration requested $28.5 billion in its 2023 budget for investments in military space funding, up from $21.9 billion in 2021 and $17.7 billion allocated in 2020. Lockheed Martin is one of the main defense sector suppliers, so Terran Orbital will certainly benefit from the budget expansion over time.

Lastly, it's important to note that satellite constellations offer Terran a source of ARR. The company estimates the lifespan of each satellite to be 3-5 years, so about 20% of each constellation needs to be replaced year on year.

Threats and Weaknesses

To find Terran's weaknesses, one simply needs to look at its balance sheet. The company holds $54 million in cash and equivalents, $156 million in assets, and $292 million in liabilities.

I find it extremely unlikely that Terran Orbital could default or go bankrupt, despite the debt. Lockheed Martin is simply too big a partner with too much vested interest in the project, especially considering the over $100 million in warrants and convertible bonds yet to be converted into shares. Moreover, after generating losses since its inception, the company now expects to become profitable in the short term: we should see positive GAAP EPS by the end of 2023.

Having generated this momentum, it would be unthinkable for its investors not to support it just as Terran is ready to soar high. However, a significant dilution of shares should be expected: there are currently 145M in circulation, but before the "bleeding" stops and the company stabilizes its equity base, this could easily triple.

Not only is liquidity needed to meet debts, but there's also a growing need for capex to expand production, research, and development operations.

Disregarding the possibility of issuing new shares to finance core business, there are already 115.9 million shares that could be issued based on agreements already made by the company:

• 20.1 million shares between options and RSUs

• 11.1 million shares linked to the $10 warrants connected to the SPAC

• 12.2 million shares connected to the SPAC's PIPE

• 36.0 million shares connected to Lockheed's convertible bonds

• 19.3 million shares linked to the $11.50 warrants

• 17.3 million shares linked to other Lockheed warrants

One piece of "good" news is that the warrants with a strike price of $10 and $11.50 are far from the stock's current price. Before they become a source of dilution, a performance increase of 650+% over the stock's current price should be achieved.

The Positive Catalyst: A $2.4 Billion Contract

This analysis wouldn't have a buy rating if it weren't for two elements: a strong positive catalyst for Terran Orbital and a virtually nonexistent price reaction.

In February 2023, Terran sealed a $2.4 billion deal with Rivada Space Networks. The contract involves building 300 satellites weighing 500 kg each, intended for a constellation: the first tests should take place in 2024, and Terran has already received a significant payment to finance the initial milestones.

This contract will not only significantly impact Terran Orbital's financials but will also allow the company to develop technologies not yet part of its commercial offering. It will also enable it to achieve the goal that management has always defined as the company's mission: to construct small satellites on a scale, controlling and minimizing both costs and risks, achieving the same result that Ford achieved with cars.

This contract paves the way for others of similar magnitude. Of course, failing to meet the target is not an option, as it could irreparably damage Terran's reputation. However, if the company succeeds in its mission, it would establish itself as the go-to name for designing and building satellites for constellations. The stock should have soared on the back of such news, but for the time being, the market has remained on the sidelines.

How to Evaluate Share Dilution In assessing Terran Orbital, the element that gave me the most concern is precisely share dilution. My analysis is as follows:

• The effect of share dilution can be likened to buying the company at a higher valuation.

• If the company issued $400 million in new shares, it would be able to completely repay its debts and finance $100 million in capex to fully cover the capital requirements needed to complete the new production facility in Irvine.

• If Terran's current market cap were actually $600 million, with no debt and total capex coverage for the next 12-18 months, considering that the company is now close to producing a net profit, I would be happy to buy the stock.

Remember that, as management pointed out at the Jefferies Space Summit , Terran's contracts are designed to make the business model less cash-intensive. When a particular milestone is reached, the company ensures that the payment associated with that result is sufficient to fully cover the development of the next milestone.

Profit and Free Cash Flow

Also during the intervention at the Jefferies Space Summit, J. Siegman - head of investor relations at Terran Orbital - marked two important figures: $400 million and $600 million in revenue.

Once $400 million in annual revenues are reached, the company expects to generate a positive GAAP net profit. By adding $200 million in capex, it would also have the capacity to generate positive cash flows. Considering that 65-80% of the $2.5 billion contract should be translated into revenues by mid-2025, and that the company expects to have a 20% ARR for satellite constellation maintenance, Terran's days as a cash-burning company are numbered. We must remember that the backlog could still increase rather easily over the next 6-12 months.

Regarding existing clients, it's very likely that Terran will secure new contracts from the Space Development Agency. In 2022, Terran delivered 10 satellites for the initial phase of the SDA's satellite constellation project. In 2023, it will start delivering 42 satellites for the second phase of the project. After that, the SDA is expected to launch a third phase, which in total will involve orders for 216 satellites divided between 2-3 suppliers.

Clearly, defense contracts, not only from the US, could also increase: the war in Ukraine has shown how useful and strategic satellite constellations can be.

Conclusions

Over the years, Terran Orbital has proven its ability to successfully design and build small satellites for major projects. It has then shown that it can construct large-scale production infrastructure. Now sales have caught up with production capacity.

What this company lacks is only the stabilization of its financial data: to start producing a net profit in 2023, move towards positive cash flows in 2024, stabilize debts, and stop diluting shareholders' ownership stakes. These are results that can be achieved in the next 2-3 years, especially considering that by 2025, we should witness the ignition of the first large satellite constellation designed and built by Terran Orbital.

When business is booming, management is able to meet client demands, and profits are on the horizon, the most crucial factors for a company's success are aligned. Regardless of the new share issues that will come in the future, I believe that Terran Orbital's shares are ready for lift-off. It will take time to extract maximum value from such an investment, and the risk is high, but I believe there is room for this stock in the growth section of a portfolio.

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