- Non-exclusive technology license means if they succeed, they will face competition.
- Significant capital spending will also be required, and the market is small.
- Huge volatility and risk of a short squeeze make it a risky short.
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Virgin Galactic (NYSE:SPCE) describes itself as "a vertically integrated aerospace company pioneering human spaceflight for private individuals and researchers." The firm licenses the "Virgin" brand name from Richard Branson's Virgin Group, and they went public through a merger with a special purpose acquisition company [SPAC] run by Chamath Palihapitiya. The firm has been planning to test their craft from a spaceport in New Mexico, but there have been multiple delays.
Drivers behind SPCE Meteoric Stock Price Rise
The company has become very much a "darling" of the market recently, with space companies in general being bid up. They are also a constituent of the ARK Autonomous Technology & Robotics ETF (ARKQ). That is important because assets to all the ARK funds have been growing, which increases demand for the stock, and because there are many investors who are following Ark's moves. Speculation in the name increased recently as ARK announced they are launching a Space themed ETF. Virgin Galactic is likely to be a holding in the ETF, considering they already own it in another of their funds and many of the large next generation space companies are still private (Space-X, Blue Origin). That provides a potentially significant amount of buying to the stock, and excitement around the fund propelled the stock to new highs.
SPCE Stock Forecast
While there have been a number of significant positives for the firm, their momentum has been rocked by some bad news recently as well. Notably, ARK has been selling shares from their existing ETFs, which is a negative. Both in the short term (as the supply of shares increases) but also potentially in the long term. If that implies Cathie Woods and her team is less bullish on the company, that may suggest that Virgin Galactic won't be as big a constituent in their new space ETF as the market is expecting.
They have also delayed an important test flight. The firm is still a long way from generating any actual revenue, and eventually the market is going to want to see revenue (and maybe even earnings!) to support a $10 billion dollar market capitalization. Delays in their test flight program push their ability to actually operate passenger space flights further into the future. That means it will take longer to both generate revenue, and increases the chance that well funded competitors will be able to take their market. If Space-X or Blue Origin decided to enter their market I think it is likely that they would get pushed out. Delays also push back a potential marketing opportunity for the stock. Their third test flight is scheduled to have Richard Branson aboard, which will get them a great deal of press, and probably attract buyers to the stock. But with continuing delays the ability of market participants to patiently wait for these catalysts could be in doubt.
Can innovation and technology alone justify SPCE stocks' valuation?
In the long term, I think the primary issue with SPCE is that is based on a foundation of marketing. The continued delays (and they been a year or two away from passenger flights for years now) suggest that their technology may not be as mature as they have marketed. Virgin is fundamentally a marketing organization, but operationally I don't think they're as strong. Both of the Virgin branded airlines filed for bankruptcy in 2020. Granting that was an extremely hard year for airlines, but many of their competitors were able to persevere through the pandemic.
In the same way, I think Virgin is likely to be successful at marketing space tourism. Their recent hire of Joe Rhode from Disney Imagineering as "Experience Architect" is an example of that, and Richard Branson has always been a consummate salesman. However, no matter how good their sales pitch is unless they are able to develop and get the technology they need approved they won't be a long-term success, because they won't be able to collect the money from their sales.
I think the following quote from their most recent 10-K is relevant here:
We are party to a Spacecraft Technology License Agreement, as amended, with Mojave Aerospace Ventures, LLC (“MAV”) pursuant to which we possess a non-exclusive, worldwide license under certain patents and patent applications, including improvements that have been reduced to practice within a specified period. Unless terminated earlier, the term of this license agreement will expire on the later of a fixed date and the expiration date of the last to expire of the patent rights granted under the agreement. The license agreement and the associated licenses granted thereunder may be terminated if we commit a material breach of our obligations under the agreement that is uncured for more than 30 days, or if we become insolvent.
Under the terms of the license agreement, we are obligated to pay MAV license fees and royalties through the later of a fixed date and the expiration date of the last to expire of the patent rights granted under the agreement of (A) a low-single-digit percentage of our commercial spaceflight operating revenue, subject to an annual cap that is adjusted annually for changes in the consumer price index, (B) a low-single-digit percentage of our gross operating revenue on the operation of spacecraft, and (C) a mid-single-digit percentage of our gross sales revenue of spacecraft sold to third parties.
Even if they are able to begin carrying passengers they will need to pay a relatively significant royalty to the owner's of the underlying technology. What's worse, is that those licenses are not exclusive, so if they succeed competitors will be able to enter the market with the same underlying technology. That reduces their ability to have any competitive moat significantly. If their application fails shareholders lose in the long term, but if it succeeds competitors can launch, and the sexy space industry is likely to attract lots of capital. We've already seen from the airline business that the Virgin branding isn't a guarantee of success (or even survival) so while that will probably help I doubt it would fend off competitive threats.
Is SPCE's stock worth the price?
From a fundamental valuation point of view there is basically no way to justify the current stock price. Their current business plan of taking people on short sub-orbital flights as tourists has a relatively small total addressable market. The number of people willing to spend a quarter of a million dollars on that is going to be limited to people with significant net worth. Even if they eventually pivot to transportation (eg sub-orbital flights from LA to Australia) they would almost certainly face significant competition from others, and the cost would be limiting for all but the very wealthy and large corporations.
I believe the current stock price appreciation has been largely based on momentum and fear of missing out as opposed to a rational assessment of the company's long term value. That doesn't necessarily make it a bad purchase, but it does make it speculative.
Should you buy or sell SPCE stock?
Since I just stated I think the stock is overvalued, the logical question to ask is should it be sold. I have a good record shorting stocks, but I don't do it often. And Virgin Galactic Holdings doesn't meet my criteria for a short - I think the risk of the shares staying high or even rising further based on newsflow is simply too high for a short sale to be an attractive risk-reward. I wouldn't be willing to own the stock as a long either, because I don't believe in the long term fundamentals of the company. I suspect there will be some good opportunities in the future for options trades, especially around events. For example, if the stock moves up on the scheduling of another test flight, there could be opportunities with short term options.
I do think it is likely this bubble will eventually deflate, but the puts are very expensive here and I don't want to take the risk of getting squeezed out of a borrow, so for now I have no position. For those on the long side, I think the very high implied volatility makes selling covered calls a potentially attractive way to take money off the table.
Virgin Galactic has gotten bid up on momentum and hype. The company's business model is unlikely to ever produce the type of profits that would be needed to justify the current valuation, and even if profits were to rise there would be significant capital spending required. But the current market conditions (with short squeezes and high options implied volatility) make taking a short position very risky.
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Safety In Value is a microcap specialist providing research on underfollowed small cap value stocks and analysis for actionable special situations. He looks for companies with a margin of safety to their value, and avoids downside risk. He believes strongly in the first rule of investing - ""Do not lose money.""He runs the investing group Microcap Review. Coverage includes: multiple monthly arbitrage and special situation ideas, “Net-Net” ideas covering companies where the cash and current assets exceed all the liabilities and the market cap, and coverage on general value stocks in the microcap space. He believes any small company trading for less than its worth is fair game.Learn more.
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