2023-08-02 14:52:13 ET
Summary
- Virgin Galactic's financial health, operational challenges, and strategic decisions raise significant concerns for investors.
- The development of the Delta fleet faces timeline risks and ongoing dilution risks, making it a strong sell for me.
- The company's cash burn rate, reliance on equity financing, and lack of aerospace R&D expertise in management further contribute to the concerns.
Virgin Galactic ( SPCE ) has been a topic of fascination among investors, given its groundbreaking foray into the realm of commercial space tourism. However, an examination of the company's financial health, operational challenges, and strategic decisions reveals significant concerns. These concerns, in particular the timeline risk associated with the development of the Delta fleet and the ongoing dilution risk, lead us to rate Virgin Galactic as a strong sell. With no revenue-generating abilities for the foreseeable future this is a bet on engineering and not a bet on a business.
Q2 '23 Results
Despite Virgin Galactic's historic milestones and ambitious plans, it faces significant financial challenges. The company reported a meager revenue of $2 million in Q2 2023, far from sufficient in my view given the rising operating expenses of $141 million. The GAAP net loss deepened to $134 million, primarily due to escalating R&D costs. Furthermore, the Adjusted EBITDA was negative at $116 million, with free cash flow also reported to be in the red at $135 million for Q2 2023. With a high burn rate and increasing capital expenditure, the cash position, despite a sequential increase, might not be sustainable in the long term. Management's narrative is one that is supposed to reassure investors on the development of the Delta fleet and that they are marching towards a profitable business with massive upticks in flights just around the corner.
This narrative has become all too familiar over the years . The promise of revenue-generating flights is perpetually just over the horizon, always seemingly a few years away. Meanwhile, the company says that it is making unprecedented progress and is going to hit industry milestones at a breakneck speed that is practically unheard of in the aerospace industry. Going from design to production and operation in 3 years while having minimal involvement in the manufacturing of the aircraft. Management continues to emphasize the strength of their balance sheet, encouraging shareholders to focus on the robust financial position. However, I think this facade masks the less favorable reality. There's an elephant in the room that's hard to ignore: the ongoing dilution of shares. Thus, despite the rosy outlook painted by the management, the underlying risks and challenges persist, warranting a more cautious approach from investors.
A Long Road to the Delta Fleet
Virgin Galactic has a very ambitious roadmap, with plans hinging on the launch of commercial services for its Delta fleet by 2026. However, the timeline for developing, testing, and certifying a new spacecraft, even if it's just a variant, is extensive and fraught with uncertainties.
The design phase for the Delta fleet is expected to last until 2024. After this, the fleet will have to undergo rigorous quality assurance tests to ensure the jets' performance aligns with the design specifications and safety standards set out by aviation authorities. According to their latest earnings call they have "Copper" and "Iron" prototype systems that are focused on electronics and flight hardware. These being prototypes shows they are far from final designs and more experimentation is needed. Following the final designs being submitted they still have to create tooling and then pass the designs to subassembly contractors such as Bell and Carbon who will in turn also have to design and manufacture tooling.
Following this, the manufacturing and assembly phase is next, where intricate pieces developed from various manufacturing techniques and providers come together to form a complete aircraft. This process will be done in Arizona by Virgin themselves. In a typical aerospace setting this process alone averages between two to three years, depending on the complexity and size of the aircraft.
The certification stage is the final hurdle before the aircraft can become operational. This process, which involves detailed flight testing and documentation, can take between three to five years for amended aircraft certifications and up to nine years for new aircraft . Given the Delta fleet's unique and experimental nature, it's likely that the certification process could take much longer than anticipated. We believe that the certification phase here will be an underestimated long poll in the implementation of the fleet. These stages of aircraft development are not just time-consuming; they are also subject to potential setbacks and delays, which could push the launch of commercial services even further out. With this factored in we expect ongoing and regular commercial operations to begin no sooner than 2027 and likely 2028.
Also, this is extremely "nitpicky" but in my view if you have a massive and instrumental ongoing development project maybe focus more of your presentation on its development than one blank slide that isn't even a Delta variant. As investors we want to see images of updates, engineering simulations etc.
The only slide on Delta (SPCE)
Cash Burn
Virgin Galactic's ambitious goal of launching a commercial service for their Delta fleet by 2026 faces significant challenges, primarily due to their substantial cash burn rate. A dive into the company's finances reveals a troubling picture.
Virgin Galactic's primary sources of revenue, at least in the short term, are expected to come from commercial flights and research flights. The announcement of 2 flights in Q3 and 3 flights in Q4 are projected to drive revenue for each quarter of around $1 million. With VSS Unity only having the capability of 1 flight per month we can assume that these abysmal quarterly revenue figures will continue until the Delta fleet is operational.
These anticipated earnings are dwarfed by the company's staggering cash burn rate. Virgin Galactic has reported $416 million in long-term debt as a result, the company has had to resort to equity markets to finance the Delta fleet.
Furthermore, Virgin Galactic's external suppliers, Bell and Carbon, contribute to their cash burn. The company is expected to assemble 4-6 ships per year by 2026, with a cash burn of $50-60 million per ship, excluding the first batch Non-Recurring Engineering expenses. This presents a significant ongoing cost and a significant portion of cash reserves.
In addition to their development costs, Virgin Galactic's operational expenses are also considerable. To mitigate some of these financial pressures, Virgin Galactic has been trying to smooth spending through strategic push outs. One of their operational strategies includes using pushing out the construction of more mother ships and to use EVE, which can fly more frequently than Unity, as the primary vehicle for the test series for Delta which again presents a single-point failure. If anything delays the use of EVE not only is their limited revenue at risk but so is their Delta Fleet. This single-point failure should be cause for concern for investors.
The Financing Problem
Virgin Galactic's financial strategy is a topic of growing concern, mainly due to its consistent reliance on equity financing. As a result of its limited income, the company has been unable to tap into conventional debt markets to fund its operations. This hurdle has pushed Virgin Galactic to continually issue new shares, a strategy that inevitably leads to the dilution of its stock.
To fully comprehend the extent of this issue, we need to delve into the numbers. Virgin Galactic has been consistently selling its shares for cash. From March 31, 2023, through their latest June the company sold a total of 37.4 million shares for gross proceeds of $164.6 million, in addition to 22.0 million shares sold for $135.4 million sold earlier in the year. This strategy continued in June when the company managed to raise $241 million from a $300 million offering, issuing an additional 55 million shares at an average price of $4.38 per share.
The pace of equity financing did not slow down even after these rounds. Immediately after the June offering, Virgin Galactic announced another round aiming to raise $400 million. If this offering sells at approximately $4.00 per share, it implies an additional 100 million shares entering the market. When combined with the previous offerings, the total number of shares will have the ability to be an increased by an alarming 55% in the first 7 months of this year alone.
In their Q2 earnings call , Virgin Galactic stated that they "fully intend to keep the balance sheet strong during this phase" with no specific minimum cash balance, and a plan to maintain a balance of $900 million plus. This statement suggests to me that more open market sales are imminent, and the dilution of shares is not expected to stop anytime soon.
Assuming Virgin Galactic successfully closes its $400 million round at a similar 80% rate, it will add $320 million to its cash reserves. This infusion will increase its pre-burn cash holdings to approximately $1.3 billion. After accounting for an estimated quarterly burn rate of $130 million, the company's post-burn cash balance would stand at around $1.1 billion.
Based off of Virgin Galactic's recent comments on their commitment to maintaining a robust balance sheet, the company will likely aim to uphold a cash balance in the range of $800-$900 million. With no significant revenue in sight, we can anticipate the company's burn rate to remain high until at least the end of the year, although it may potentially decrease as engineering costs start to reduce.
Assuming an average quarterly negative cash flow of $120-$130 million for the next year, as suggested in their recent earnings report, we can anticipate that Virgin Galactic may need to initiate another round of capital raising within the next 3-4 quarters depending on what management believes is a strong balance sheet.
Any difference between their target cash balance will be covered through share issuance, which will lead to further dilution of existing shares. With the stock becoming less and less appealing we would not be surprised if preferred shares are issues in the next 8-12 months. This dilution poses a significant risk, as the current timeline lacks sufficient catalysts to support the stock price. The continuous cycle of share issuance resulting in lower share prices and increased dilution is a major concern that investors should be aware of.
Questionable Management Team
The management team of Virgin Galactic comprises individuals with diverse backgrounds, but there are some potential weaknesses, particularly in the area of aerospace research and development (R&D). While some team members have aerospace experience, including the Chief Pilot, the CEO, Michael Colglazier, lacks a specific background in the aerospace industry. This raises concerns in my view about the depth of expertise in crucial areas such as spacecraft development and operations. The overemphasis on executives from non-aerospace industries may divert attention from the core challenges of spaceflight development. The lack of a strong aerospace R&D background in the CEO and some other key positions may hinder the company's ability to navigate the complex certification process for the Delta fleet and meet regulatory requirements effectively. Investors should carefully consider these potential weaknesses in evaluating Virgin Galactic's ability to deliver on its ambitious space tourism goals. As most of the senior team's experience seems to be focused on the customer experience and not on the development of aircraft.
Valuation
Seeking Alpha
With minimal sales and non-existent earnings the company is trading at valuations that far and above exceed valuations of other companies in the sector. With no definite earnings in the next few years the stock will continue to struggle against emerging new transportation companies such as Rocket Lab ( RKLB ), Blue Origin, SpaceX, and even EVTOL companies such as Joby ( JOBY ) and Archer ( ACHR ).
I think the leading reason that Virgin Galactic is trading at a valuation over $1 Billion is due to their Cash and Net Cash Positions of $980 Million and $504 Million respectively. This large cash position is the main support of any value of the company and as they continue to burn through that cash it is likely that support level will continue to drop as well.
Conclusion
Virgin Galactic faces significant hurdles that warrant a strong sell rating. The company's ambitious timeline for the Delta fleet's development may experience delays due to its complex nature. The high cash burn rate and reliance on equity financing pose financial risks, including significant stock dilution. The management team, particularly the CEO, lacks strong aerospace R&D expertise, potentially impacting the company's ability to meet regulatory requirements effectively. Given these challenges, investors are advised to stay away from Virgin Galactic's stock until their timeline and dilution risks and begin to edge away.
For further details see:
Virgin Galactic: Lost In Space