VORB - Virgin Orbit Holdings: Crash And Burn

2023-03-20 04:21:06 ET

Summary

• The management team at Virgin Orbit Holdings announced plans to immediately stop operations for a week in order to preserve their capital.
• The most recent data made available by the firm suggests that cash is certainly in short supply.
• Current economic conditions have impacted the firm's ability to raise cash and there could be additional pain for investors right ahead.

20 years ago, the thought that there would be any significant market opportunity in the foreseeable future when it came to outer space would have been doubted by many. High costs made any sort of space activities largely the realm of governments that could afford to invest tremendous amounts of capital while receiving little to no financial return in the process. But since then, innovation has brought the cost of getting to space down significantly and has opened up the door for many opportunities, ranging from activities regarding satellites, to tourism, to resource extraction, and more. Some estimates peg the market opportunity at around $400 billion. Some of them forecast that by 2040, the market opportunity will climb to $1 trillion.

This has created something of a space race in private industry. But it's also important to keep in mind that as economic conditions here on earth change, the ability of companies to fund their operations off this planet can be impacted materially. The first major wake-up call for the investment community when it comes to this involves Virgin Orbit Holdings ( VORB ), an entity dedicated to providing launch services for companies and governments alike. In particular, it provides customers with both dedicated and rideshare small-satellite launch capabilities. On March 15th, the management team at the company announced that it was initiating a company-wide operational pause effective March 16th with the aim of conserving capital as it seeks out additional funding sources. In the few days that followed, this sent shares plunging as much as 39.6%. Not only does this serve as a highly irregular move for a company, it also is a sign that the firm is facing a true existential crisis. Given these recent developments, investors would be wise to consider looking for opportunities elsewhere.

Crash from orbit

In another article that has nothing to do with Virgin Orbit or the space industry, I discussed the impact that rising interest rates and economic uncertainty has had on funding for the most vulnerable companies. These are companies that could be considered ‘startups’, which I define as any business that is technology oriented and that is somewhere between just raising its first serious round of capital and becoming a publicly traded enterprise. These businesses have been hit hard because higher interest rates make it more difficult and risky for investors to allocate capital to them. The same sentiment can be applied to even publicly traded firms that are trying to grow rapidly and that are exhibiting tremendous cash outflows.

In my opinion, Virgin Orbit falls under this group. But up until March 15th, it's highly likely that the investment community did not think that management would temporarily cease operations altogether. In the regulatory filing the company made public, it mentioned that it was initiating a companywide operational pause that would last one week with the goal of conserving capital while it conducted discussions with potential funding sources and while it explored strategic alternatives. Management went so far as to say that there could be no assurance that the discussions it's engaged in will result in any transaction. Beyond that, the company has been silent regarding this matter.

Most companies, by their very nature, can't just stop their operations. But given the fact that most of the firm’s work toward preparing and launching satellites has been years in the making and, as such, does not necessarily require consistent functioning like a factory would, this kind of maneuver can make sense. At the same time, it's a last-ditch effort to avoid a scenario Where bills cannot be paid. At that moment, the firm essentially ceases to exist. For those who are bullish about the company, this maneuver may have come out of left field. After all, the company has had a lot going for it that has been positive over the past year.

Consider data from the most recent quarter, which would be the third quarter of the 2022 fiscal year. Revenue for that time was $30.9 million. That compared to virtually nothing in revenue that was reported for the same time one year earlier. In addition to this, the company reported binding backlog of $143.1 million. This meant that additional revenue would be coming in the future. At first glance, this makes the company look like a rapidly growing business that has the opportunity to capture a piece of a large and growing market.

The downside to this is that this industry requires a tremendous amount of capital in order to operate. In the first nine months of its 2022 fiscal year, for instance, the company generated a net loss of $139.5 million off of $33 million of revenue. Operating cash flow was even worse, with a net outflow of $158 million. Even if we adjust for changes in working capital, we would have seen a net outflow of $127.5 million. Free cash flow for the company was worse than this, coming in negative to the tune of $175.1 million for the first nine months of 2022. And according to management , overall free cash flow for 2022 as a whole would be negative by between $220 million and $230 million.

The business hoped that it could grow into its cash flow needs. Their goal for 2023 was to double their launch rate, effectively spreading out their fixed costs across additional revenue that would come in. But growth alone also comes with additional variable costs, plus any additional investments that need to be made in order to facilitate growth. For this, the company needed a tremendous amount of cash. And that is something that has disappeared over the past year. At the end of the fourth quarter of the 2021 fiscal year, the company had about $195 million in cash and was completely debt free. Over the ensuing four quarters, cash plunged to $71.2 million despite the company successfully raising $50 million in June of last year in the form of a convertible debenture. In November, management explored the possibility of a securities offering, but quickly realized that market conditions made such a move impossible or would have subjected the company to rather onerous terms.

To further dash hopes for the company's future, it had something of a failed mission in January of this year. This was the 5th launch in the company's history and the first that involved launching from British soil. That particular launch made it to space with its payload, but ultimately fell short of achieving orbit. Though nothing is perfect when dealing with space travel, that does obviously elevate the risk for potential investors. There have been other questionable developments as well. For instance, the $143.1 million in backlog I mentioned previously was actually a decrease compared to the $163.2 million reported one quarter earlier. On top of that, management no longer mentions the non-binding backlog that they did mention through the second quarter of the 2022 fiscal year. This number was $418.7 million at that time. Today, the actual amount is a mystery.

Another major problem for the company involves the aforementioned convertible debenture. This came with some rather interesting terms. Namely, it brought with it a right in which any portion of the principal amount of the debenture, combined with any accrued but unpaid interest, may be converted into common stock of the company at the discretion of the holder of the debenture. The original agreement called for this to be equal to the lower of A) $4.64 per share or B) 95% of the average of the two lowest daily volume weighted average price of the stock during a three-day window prior to the date that conversion is ultimately set. As of March 15th, the price floor on this debenture has been set at $1.01. And with the stock now below $0.70 per share, it's very likely that the floor price could be pushed even lower.

According to the terms of the debenture, the holder may not receive more than 9.99% of all common shares of the company outstanding. However, given 65 days prior notice to Virgin Orbit, this can be waived by the investor in question. In this case, Virgin Orbit would have the ability to redeem the debenture. But the firm does not realistically have the capital to do this. Given the most recent price for established, and if said notice by the investor was given, the end result for shareholders could be dilution of 12.9%. So even if the company can find funding to weather this storm, it will have to deal not only with what would likely be stringent and heavily dilutive terms, it will also have to deal with the possibility of this debenture taking a portion of the pie that's larger than what investors might otherwise have anticipated.

Takeaway

When I analyzed Virgin Orbit last year, I felt as though the company might have an opportunity to grow out of its cash flow problems. But as economic conditions have changed, and as management has been unable to raise additional capital, it has become abundantly clear that the end result for investors might not be all that positive. All the changes seen that I detailed in this article suggests to me that, at best, investors might come out of this owning a much smaller slice of the pie than what they had even a few months ago. And at worst, the company could be facing a scenario where its entire existence might cease. Given these concerns and in spite of the rapid decline in share price, I do believe that a ‘strong sell’ rating is now appropriate for this particular firm.

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