Elon Musk Is A True Genius, As SpaceX's Increasing Share Of Government Spend Shows

Aug. 08, 2019 10:35 AM ETSpaceX (SPACE)BA, BORGN, LMT, TSLA61 Comments9 Likes

Summary

  • Everyone knows of Elon Musk's entrepreneurial achievements.
  • His companies' technology achievements are similarly startling.
  • But his true genius is, we believe, yet to be lauded.  It's that he is probably the best government-sector sales guy that ever lived.
  • We explore this below as we talk about SpaceX's ongoing market share gain.
  • Looking for more? I update all of my investing ideas and strategies to members of The Fundamentals. Get started today »

DISCLAIMER: This article is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this article is not an offer to sell or buy any securities. Nothing in it is intended to be investment advice and it should not be relied upon to make investment decisions. Cestrian Capital Research Inc or its employees or the author of this article or related persons may have a position in any investments mentioned in this article. Any opinions or probabilities expressed in this report are those of the author as of the article date of publication and are subject to change without notice.

Two years ago (Space 2.0 - A Small Step For Tech Investors) we wrote that space was going to be the next big market for tech investors. That’s playing out nicely. We claim no credit for this forecast. It was signalled loud and clear by the prior move of tech entrepreneurs into the space market. As everybody knows, the two most prominent are Elon Musk, formerly of Paypal and currently of Tesla, now also founder-CEO of SpaceX (SPACE); and Jeff Bezos, CEO of Amazon and founder-CEO of Blue Origin (BORGN).

Bear with us for a moment whilst we go off on a detour away from space and back towards tech. You’ll see the point in a few moments’ time.

We’ve written separately (see Timing The Temporary Monopoly - Initiating Coverage On Iridium) about one of the reasons tech and telecom can be such fabulous sectors in which to invest. Temporary monopolies. Meaning, in tech and telecom, entrepreneurs have found many ways to create highly defensible market positions for their companies, with wide, deep moats around them. So wide and so deep that for a while at least, those positions are unassailable.

In telecom, the capex-intensive nature of the business means the industry tends naturally toward monopoly. That’s why AT&T and Verizon pay such wonderful dividend yields. (We think Iridium (NASDAQ:IRDM) may soon follow suit, as we wrote recently - see Fundamentals Of Telecom, Part I - If You Love Dividends, Time The Capex Cycle ). Now, every ten or twenty years or so, regulators around the world become indignant at this state of affairs in telecom, they pay consultants many millions of taxpayer dollars to prove that incumbent operators are making too much money, then create a regulated pricing environment that ought to allow new entrants to flourish in a particular geography or market segment. Whereupon risk capital rushes into the sector, new entrants start up, and competition increases for a while. Then the immutable forces of capitalism and the wily ways of incumbents’ regulatory affairs departments combine to slowly extinguish the new entrants. They usually end up as M&A fodder. This doesn’t happen quickly. Nothing in telecom happens quickly. But cast your mind back to the names that have come and gone. MCI. Intermedia. ICG. Level3. Qwest. The list goes on. All now defunct, damaged, or swallowed up by the incumbents.

Tech – by which for these purposes we really mean internet-delivered services, be they consumer or enterprise - works a little differently. There aren’t really any hard barriers to entry. Server-side compute power costs pennies, coding can be purchased by the hour in any number of low-labor-rate countries, marketing no longer requires the help of Madison Ave., and sales happen in large part as a result of successful inbound online marketing. We’re simplifying for effect, of course – but this is directionally correct when compared to the vast efforts that had to be undertaken when IBM were hawking mainframe systems, software & services, or even when Oracle was young. It costs little to start a tech business; it costs an awful lot to start a telecom business.

Tech folk figured out early on that network effects could lead to temporary monopolies akin to those occupied by the Baby Bells in telecom. Created a document in Microsoft Word in the early 1990s? Somebody better read it in Microsoft Word too. Because it was illegible in most other apps at the time. Presto. Two Word – or, better – Office – licenses sold. Want to use instant messaging in the 2000s? Choose your provider – MSN, AOL. Don’t even think about seamless interoperability. Bingo. A group of friends signed up. Want to share news in the 2010s? Facebook and Twitter are your go-to places. Even Google got squeezed out of the social market. Bingo. 45% operating margins at FB even whilst maintaining high revenue growth. Again – this is why MSFT, FB, TWTR and others can continue to provide such fantastic risk-adjusted returns to the savvy investor.

The benefit of network effects were known and used in tech well before the internet ate the world. But when the internet came along – specifically Internet 2.0 when it actually worked as promised – along came the most wonderful of capitalism’s tools. Deflation. That’s right, deflation.

Why does everybody love Amazon? Deflation. Your stuff is cheaper than it used to be, it’s shipped in a day for almost nothing, and if you don’t like it, you can send it back for almost nothing too. It’s retail, perfected. Which is why the whole retail sector other than Amazon is drying up.

Why does everybody love Office365? Deflation. At home or at your own mom’n’pop shop you can have enterprise-class email with no need to employ an administrator or pay for your own server or backup system, for a few dollars per user per month. Oh and that includes all your old Office apps too. Which are now always up to date.

Tech has learned to deliver fantastic products, cheaply, using network effects, to build itself highly profitable temporary monopolies that will last as long as regulators let them. And the ‘cheap’ point is key. It’s awfully hard to build an antitrust case against a company with huge market share that is lower cost than the competition. This is where tech is a lot smarter than telco. Telco waves a big flag with a dollar sign on it saying “huge market share, 7% dividend yield, frequent buyback campaigns” which translates as “Dear Federal Government. We are making too much money. Please pay attention”. Tech doesn’t do that. It passes on its monopoly rents to shareholders in the form of capital gains. Super smart. Low cost, so no antitrust. Network effects benefit all, so not unpopular. Huge share price appreciation, so happy 401ks and happy institutions (and happy government too, from capital gains tax receipts when they arise). Genius. And lest you think we are being ironic or sarcastic, we aren’t. We’ve been in tech and telecom for a very long time and we love it. And we salute it – particularly internet-delivered deflationary business models – as the absolute epitome of pure capitalism.

Now, back to space. The two leaders in the commercial space sector are graduates of the deflationary school of modern capitalism. Amazon we talked about above; PayPal, though long in the tooth now, was a wonder when it was young. Not only were its fees lower than your credit card at the time, you could use it to pay for Pez dispensers that you bought on eBay from a guy in Santiago. (Yes, people did this in the 90s. No, we don’t know why.)

We haven’t really seen BlueOrigin get to work yet. It is working on all manner of projects from space tourism to lunar landers. That it has taken longer to get to market than SpaceX doesn’t mean it won’t be at least as successful. Betting against Bezos is rarely a winning strategy for long. We expect to be giving BORGN a very positive writeup in years to come as it successfully creates new market segments, expands into others and conquers its competitors.

SpaceX on the other hand is a known entity. It’s hard to get financials because it’s still a private company. It doesn’t appear to generate reusable cashflows yet, because it is often on the fundraising trail. Its investors have morphed from out-there-angels and apparently crazy VCs in the 2000s, to your grandpa’s pension fund this year - see Success For Cestrian's Crystal Ball! - Cestrian Capital Research . That tells you it’s now a grownup business run by grownups. Unlike Tesla (TSLA), its PR is relentlessly positive. Just like TSLA, the company inspires widespread love and admiration – without much of the hate that comes free with every TSLA unit shipped.

Now look very closely at a few numbers as to what SpaceX is achieving in launch cost reduction, and let’s see if this looks familiar.

  • Space Shuttle cost per launch: $450M (2011)
  • SpaceX cost per launch, Falcon 9: $62M (2016), $50M (est. for 2018)

So nearly a 10x reduction in cost per launch in seven years. That looks a lot like tech to us.

By comparison, the incumbent, ULA (United Launch Alliance, a JV between Boeing (BA) and Lockheed Martin (LMT)) is thought to cost in excess of $200m per launch.

We don’t suppose these figures are dot accurate, there isn’t a DRAM Exchange website for space launch costs, but they’re more or less right.

There’s more. This month, SpaceX announced it was becoming the Uber of satellite deployment, offering ‘rocket rideshares’ to smallsat deployment missions. See SpaceX will now offer rocket ride-shares tailored solely to small satellites. Commercial, application-specific – not military or high throughput telecom – satellites these days are much lower cost to produce than ever, in smaller form factor than ever. You don’t need a whole payload bay to carry one towards orbit. And you can put a whole phalanx of them on orbit from one mission. (As always, space launch is following the missile market. Multiple smallsat deployment is a bit like multiple-independent-reentry-vehicle ballistic missile warheads in reverse).

So we can see that the deflationary method that Elon Musk learned in tech has been brought to one of the most expensive unit cost markets in the world, space launch. It’s no surprise that SpaceX has been eating up market share. Not only is it low cost, but the service is high reliability as well. There have been a couple of well-publicized launch or test failures, but that goes with the territory. Space launch isn’t as reliable as commercial aviation, and commercial aviation isn’t 100% failure-free either.

Musk’s true genius is in our view unsung. He is probably the greatest government-sector salesman that ever lived. It would take us a week to count the dollars he has raised from the federal US government and other non-US governments in various flavors, be it revenue, tax credits, direct investment, land zoning permissions, or manifold other kinds of hard and soft money. And he has used the money to deflate the most incumbent of incumbent industries in the US. Banks. Auto. Energy. Space launch. The government knows this. They pay him less to do the same thing that they pay other companies. SpaceX is getting $2.6bn for its NASA Commercial Crew contract, Boeing (BA), $4.2bn. (See NASA Selects Boeing and SpaceX for Commercial Crew Contracts - SpaceNews.com). We suppose there are differences in the deliverables. But again, the point is directionally correct.

SpaceX doesn’t – yet – have a temporary monopoly in space launch. There are all sorts of national security reasons why the federal government won’t want it to have one. But if tech-sector deflation keeps hammering on the door of Boeing and Lockheed Martin – and if the pace of innovation can’t keep pace at the two incumbents (see our note here >> In Space, Lockheed Needs Another "Martin Moment"), SpaceX is going to continue to win share. It already has Europe worried (as you will know, Ariane is a major Euro-government project which competes with SpaceX). European government money will be committed to developing reusable launch vehicles in the coming three years - you can read more here - Europe says SpaceX "dominating" launch, vows to develop Falcon 9-like rocket (This sounds an awful lot like 2000-era European “we must catch up with Silicon Valley” spending projects. They haven’t caught up yet. It’s nearly 20 years in).

We will continue to cover SpaceX and we’re very much looking forward to its IPO.

Cestrian Capital Research, Inc – 8 August 2019.

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Disclosure: I am/we are long MSFT, IRDM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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