On February 22nd, 2019, Virgin Galactic, a subsidiary of billionaire Richard Branson’s Virgin Group, launched its first passenger into space on the spacecraft Unity, peaking at an altitude just above 50 miles at a speed of Mach 3.04, or three times the speed of sound. Virgin, however, is far from the only company targeting the space economy, with the most famous competitors in Jeff Bezos’ Blue Origin’s development of New Shepard, a fully reusable, vertical takeoff, vertical landing (VTVL) space vehicle and in Elon Musk’s SpaceX, which marked the first launch to the space station of a commercially built and operated American rocket, as American Astronaut Anne McClain gathered supplies from SpaceX’s Crew Dragon spacecraft.
The purpose of this post is twofold:
- First, what is the business model of space travel? What are the trends and competitive landscape, who are the customers, and what is the value proposition?
- Second, what are the unit economics of building and launching a rocket into space? How is the market changing and is this a worthwhile investment?
How it All Got Started
On July 21st, 2011, NASA retired its Space Shuttle program that had been responsible for 135 missions including Columbia, Challenger, Discovery, Atlantis, and Endeavor. The International Space Station remained in use, with Russian Soyuz rockets used to ferry astronauts to and from the space station at an expense of about $80 million per seat, and the prices continued to rise year-over-year, reflecting a tightly knit international competitive landscape.
This all changed on March 30th, 2017, when SpaceX successfully launched the first used rocket into space and successfully landed it on back on Earth. The significance of this event was that a once prohibitively expensive journey into space, costing $450 million in 2011, could now be substantially cheaper as the orbital class booster, the most expensive part of the rocket, could be re-used for multiple trips. The price tag for a seat on a re-used rocket can fall anywhere from 30% off the usual $62 million to 50% off, per executives from SpaceX and SES.
The private market interest in space launches stems predominantly from the opportunity to leverage the lower cost structure and extremely high contract value to generate returns, and both the space launch market size of $27.18 billion and the projected compound annual growth rate (CAGR) of 15% from 2017 to 2025 provide considerable tailwinds for investments in the space. In many instances, space launch expense is the bottleneck in the value chain for the space industry, but declining costs will positively reinforce commercial investment previously unviable to continue to grow demand, and the space launch end market is significant in size and growth.
Behind Human Astronauts, the Multi-Billion Dollar Launch Service Industry
The $300+ billion commercial market dwarfs the $1.1 billion of human spaceflight and serves as the impetus for considerable investment over the last decade. The largest contributor to this market’s size is the satellite market, ranging from communications satellites used for radio, television, and telephone transmission to reconnaissance satellites used by governments for the gathering of visual and audio intelligence.
The future of demand for these satellites is increasingly attractive as lowered cost of transportation will increase viability for nanosatellites, which provide everything from crop imagery data to farmers to internet access to rural areas (for instance the AMOS-6 satellite sent by Faceboook via SpaceX that exploded along with the Falcon 9 rocket in late 2016). In 2017 alone, more than 250 small satellites were launched into space, the vast majority of which were nanosatellites. More broadly, the increased demand for space satellites can be broadly attributed to data dependence and communication infrastructure.
In 2016, Bryce Space and Technology published a report citing the Global Space Economy size of $344.5 billion, with ~$130 billion in various industries associated with satellites. As this data becomes modularized through the licensing of imagery software and tailwinds continue in declining costs for Original Equipment Manufacturers (OEMs), the cost for end consumers of satellite imagery will decline considerably and demand for this data will increase as it becomes more affordable. The launch services component of the value chain will continue to grow to accommodate this.
On the telecommunications side of the equation, the advent of 5G networks may pose challenges to the growth of satellite providers and the resulting demand for space launch services. Integration of satellite transport conduits with 5G communication maps for automatic traffic transfer between terrestrial and satellite has been proposed; however, the one-millisecond latency requirement will create a considerable strain on the viability of satellites in the new telecommunication world. Satellites in Low-Earth Orbit (LEO) orbiting from 100 to 1,250 miles above earth can cut latency to 20 milliseconds, but this is both too slow for the constant communication stream that is required for self-driving cars and factory automation and considerably more expensive due to low coverage. Hundreds or even thousands of satellites will be required to cover the same expanse as that of one Geosynchronous-Earth Orbit (GEO) satellite.
In short, investments into space launch services are underwriting to growth in demand for satellite data more than for telecommunications, and this growth is projected to reach 11,631 satellites in annual launches due predominantly to earth observation (42.9%) and Internet-of-Things (IOT) (21.4%).
When looking into the economics of the space launch industry, there are broadly two revenue channels for launch service providers. First, governmental revenue including contracts from government agencies such as NASA and the National Reconnaissance Organization (NRO) which have been providing the majority of revenue to service providers. Second, commercial demand stemming from launch and maintenance of satellites.
Because the government contractual budgets are constant or declining, the growth in the industry is much more likely to stem from commercial activities than from government activities; thus, the following unit economic analysis comprises only the revenue stream from commercial contracts. Additionally, the illustrative analysis centered around SpaceX’s Falcon Heavy because of the relatively greater availability of financial information, significant progress in the commercial reusable rocket market (with 21 launches in 2018), and the more attractive economics of the larger rocket.
The Cost Structure
The primary costs associated with building, launching, and re-launching rocket ships can be broadly broken down into three categories: initial development costs, launch costs, and fuel costs.
For the initial all-in cost of developing and building the first rocket, CEO of United Launch Alliance (ULA), the spacecraft launch services joint venture between Lockheed Martin and Boeing, Tory Bruno guides to a value of $2 billion for new rockets. A 30% discount to this value was built into the analysis given the nature of the entirely reusable rocket that they are building and the 30% discount to competitors that SpaceX provides.
The Revenue Model
On the revenue side, SpaceX charges $90 million for 8.0 tons of storage in the Falcon Heavy with an additional capacity of 42,860 pounds. SpaceX has an ancillary revenue stream comprising an additional $2,800 per pound. For the purpose of the analysis, the run-rate load factor was assumed to be 80%, in line with that of the airline industry in 2017.
Useful life- the number of times a reusable rocket can be launched before becoming inoperative- is the last variable that determines return for reusable rockets. While SpaceX has guided to everything from “dozens” to 100 uses, Jeffries ran their analysis at 15 uses, which was incorporated into the analysis.
Unit Economics- How Much Money Can be Made from Building a Billion Dollar Plus Rocket
Above, the total return from building a spaceship and operating it through 15 launches is ~$550 million in profit; however, this attractiveness to investors of developing this technology depends greatly on the frequency with which rockets are launched. On a $1.4 billion investment, if the rocket could only be launched once a year then the intrinsic rate of return (IRR) would only be 2%, which is not commensurate with the risk associated with such an endeavor and would not invite investment.
Demand for space launches is the primary contributor to how frequently launches occur, and this value can be backed out through analyzing the number of satellites launched in 2018 * average weight of each satellite / capacity on a heavy rocket. The resulting value of 1.86 total demanded launches in 2018 illuminates why current rocket providers are particularly reliant on government contracts rather than commercial contracts today; however, projected satellite launches are expected to reach 11,631 in 2030 at a 26.2% CAGR. At this 2030 level, 395 satellite launches will be demanded at current capacity, which is considerably more than necessary for all players in the current space market to generate attractive returns and enough for new entrants that can match the scale to enter.
Billionaires are launching rockets into space because there is significant economic upside associated with occupying the space launch provider niche in the commercial satellite market value chain. With a considerably lower cost structure resulting from reusable rockets and substantial growth tailwinds in end markets from demand for satellite data in digital imagery and IoT use cases, private investment into rockets has become financial viable with the potential to become lucrative.
It should be noted, however, that subtle changes in the underlying assumptions justifying the economics can have a substantial impact on returns.
- In this case, the rocket cost is the largest contributor to returns. Legacy players in the space that have not fully mastered the recyclable build and launch process are at substantial disadvantages as Airbus’ Ariane 6 costs of 3.6 billion euros turns the entire return profile negative within the context of the sensitivity.
- The next most important variable is revenue per pound, which clearly shows that ancillary revenue makes the investment. This variable is particularly interesting because it is likely to come down considerably.
- The third and more minor contributor to returns is gross margin, which decides variable costs but, given operating leverage, largely doesn’t make or break the investment.
In the Hands of the Billionaires- Competitive Strategy and Future of the Industry
Lower launch prices are a result of what may be the single most important characteristic of this nascent market- competition. We have already discussed how new entrants are driving legacy players like Airbus and the ULA out of business with an entirely new business model; however, within this context, the minimum efficient scale is low enough and delivered service commoditized enough to not grant a significant competitive advantage.
For example, the comparison can be made to the airline industry, which is widely analyzed for its inability to generate sustainably attractive returns despite creating substantial value for customers. Airlines are highly capital intensive and sell a commoditized good; indeed, the vast majority of flights are booked predominantly if not exclusively on price. In theory this should drive entrants out of the market, decrease supply, and result in a higher price, but the considerable operating leverage leads to airlines finding it more economically viable to continue to operate than shut down entirely. Frequent flyer miles and loyalty programs were introduced to drive differentiation, but those were both capable of being matched and applied predominantly to business and luxury passengers. Finally, liability and regulations further hinder flexibility and profitability.
Space launch services exhibit the same characteristics, except instead of hundreds of millions of dollars in investment, the requirement is in the billions. Additionally, quality of service is initially a critical decision making criteria as the satellites have value in the millions as well, but similar to airlines, as the technology is mastered and best practices shared throughout the market, this decision-making criteria will shift once again to price (without the benefit of loyalty programs given infrequence of space launches). Additionally, the same aspects of liability for cargo and regulations from multiple international bodies will be a continual drag on the performance of the business.
In short, unless the incumbent service providers can build barriers to entry in the industry or develop truly proprietary technology for advantageous cost structures, individuals will run the math above and see the imbalance between substantial demand and limited capacity, and capital will follow suit. Prices associated with launching space crafts will be pressured to marginal cost and returns will suffer.
There is, however, one way for incumbent providers to create barriers to entry and maintain attractive economics- creating excess capacity. At a 15 year useful life and 10 launches per year, the IRR is 24.9% with ancillary revenue priced around $2,800 per pound. This is of course a general estimate, but if current providers were to first lower the price/lb for ancillary revenue to the point that it is no longer profitable for previous players like ULA, government space launch providers, and Airbus, then eventually the market will only support the most cost effective players. The remaining cost-optimized providers can increase costs to generate attractive economics but bring on considerably more capacity than necessary to deter competition.
As a result of the few players with optimized cost structure, the significant capital investment required to enter the industry, and the relatively small size of the market (commercial airlines suffered as a result of the market being too large), the competitive playing field becomes similar to that of a collaborative oligopoly. As of now, there are no viable substitutes to launching satellites into orbit outside of space launch providers, and the coordinated excess capacity will enable all players to capture the organic growth of the industry without engaging in a price war.
The market in 2030 is projected to support 395 launches valued at the $184 million per launch. This comes out to ~$73 billion in value for the market, which could be fully captured by the current players in the competitive landscape provided incumbents invest in sufficient capacity. Potential new entrants know that the fixed infrastructure to capture growth has already been purchased and, resulting from the high operating leverage, will be profitable on a variable basis down to prices that are prohibitively low for justifying entrance.
The spoils for the remaining players are 20%+ IRR compounding on the tailwinds of declining fixed and variable costs and 20%+ organic growth with limited competitive threat.