Space: investing in the final frontier

As featured in the October issue of Master Investor.

When Neil Armstrong became the first person to walk on the moon, it was (as we all know) “one small step for a man, but one giant leap for mankind.” However, it was also a giant leap that for a long time wasn’t followed by many other big steps. In retrospect, the 1969 moon landing was more of a PR stunt borne out of the rivalry of two superpowers, throwing oodles of money at government vanity projects.

Commercial applications based on space exploration were few and far between, and space remained the domain of a small number of publicly funded organisations, like NASA in the US. Cynics described the space industry as the modern-day equivalent of a Viking burial for one’s money: you put your money in a rocket, you set it on fire and you send it into space, never to see it again. Wernher von Braun’s generation had managed to push the boundaries and fulfill mankind’s dream of venturing into space, but it came at a tremendous cost and with relatively limited use.

All that started to change in the early 2000s, when the first pioneers of a new generation of space entrepreneurs started to set up their firms. First and foremost among them is Elon Musk, the serial entrepreneur and multi-billionaire. Musk sunk a good part of the funds he received from selling PayPal, the online payments provider, into his “Space X” venture.

Friends considered him mad at the time, but Musk saw a market that was ripe for disruption. Using rocket technology he purchased in Russia, he subsequently managed to build a privately funded organisation for bringing down the costs of rocket launches from $1bn to somewhere nearer $10m – decreasing costs by a factor of 100! Besides cutting costs, he also helped to simply sped up the process. Launching a rocket used to take years of preparations, and can nowadays be done within a matter of months.

All of this is now receiving more and more public attention, not the least driven by competitions such as the “Google Lunar XPrize”, which is asking for a company to successfully land a robot on the moon’s surface, travel at least 500 metres, and then transmit images back to earth. Following a bit of a false start in the 1990s, the public’s fascination with space exploration is growing again.

It’s now obvious that Musk has almost single-handedly started a new wave of enthusiasm for exploring space and developing commercially viable products and services related to space. If rocket launch costs could be cut down to a fraction of what they used to be, which other parts of the space industry could be disrupted and pushed towards making the kind of giant leap that Armstrong did back in the late 1960s?

The space industry has actually by now entered our lives on a daily basis, if only in a way that few people ever think about. Global Positioning Systems (GPS) are built into virtually any mobile device and enable us to use real-time mapping services as a free part of mobile phone services instead of paying hundreds of Pounds for the kind of satellite navigation systems that were popular in the late 1990s and early 2000s. Satellites have shrunk from being the size of a van to the size of a shoebox, and with the decrease in size comes a decrease in cost. Satellite imagery has become so cheap that you can now visit any place on earth using Google, if only with somewhat limited image quality. But all that is going to experience a step change soon.

During the next ten years, an unprecedented number of new satellites will be launched into orbit and create the capacity for entirely new data services. For example, GPS will be used for precision farming, enabling huge farms to run on the back of automated machines and robots, and that way increase harvests and decrease the cost of agricultural products.

There has been explosive growth in the number of companies that are working on the exploration of space. In 2011, there were only 125 companies trying to find ways to make money in space. Fast forward just four years, and there are more than 1,000 new entrants. Among them are ventures funded by backers with deep pockets, such as the satellite imaging firm Skybox, which in 2014 was taken over by Google and which is another example of the kind of growth the industry could experience.

Skybox is working to launch a network of small satellites, which by 2016 will enable it to take pictures of the entire earth twice a day and at a level of detailed resolution that was until recently unthinkable (and also prohibited because of the potential military use). By 2018, the company expects to image map the entire earth at a resolution sufficient to capture, for example, real-time video of cars driving down the highway. Satellite imaging could then be used for everyday tasks such as directing traffic in the parking lots of Disney World. Companies operating such networks and controlling the data are expected to be extremely profitable.

How can investors get in on the growing boom of space commercialisation?

The good news is, there is a growing number of areas where companies are investing with a view to developing businesses related to space. A recent report also mentioned space tourism, robotic servicing of space infrastructure, and even mineral mining in space as potential growth industries. The mining of minerals could be used to produce and maintain infrastructure in space. This in itself is a mind-boggling thought, but one that a number of companies are already working on, with strong backing from venture capital financiers. Among them is Deep Space Industries, a venture that aims to mine mineral rich asteroids near earth to produce feedstock for 3D printing in space. Their technology is still 10-12 years from being commercially viable, but could one day become a game changer for the entire space industry.

Ventures such as Deep Space Industries could turn out to be as profitable for investors as the first funding rounds of Google or Amazon. Whoever gets in early and gets it right could grow their investment by a factor of 50, 100 or even 1,000. However, there is also one considerable challenge for private investors. Most of the exciting start-ups are not yet public, and funding deals are more often than not agreed between existing networks of investors in Silicon Valley and elsewhere. It’s not easy to get in on the act.

Master Investor did a survey of the industry, to see how private investors can benefit from the window of opportunity that has opened in this industry. It’s already clear that going forward, investing into space commercialisation will include companies that in the past wouldn’t necessarily have been considered space-related. Proprietary data services and data analytics is one area that is bound to benefit hugely from the new satellite networks that are being prepared for launch, and by extension these will also count as being part of the industry. The opportunities for investors will become much more numerous in the coming years. Until then, the companies covered throughout this feature will give you an initial insight into what opportunities you can already access right now.

QinetiQ (QQ.) – James Bond in Space

QinetiQ is perhaps best known for providing Ian Fleming, himself a former British intelligence operative, with the inspiration for “Q” in his James Bond novels. However, since its Initial Public Offering back in 2006, QinetiQ’s stock market performance has been somewhat lacklustre. Initial concerns were focused on the Ministry of Defence’s 53% retained stake in the company following floatation, which led investors to question what kind of say they would have in the management of the company. However, in 2008, the Government sold its entire stake except for a ‘golden’ share, which would enable it to block a takeover bid if it so wished. While this allayed corporate governance concerns, the financial crash of 2008 precipitated a tightening of military budgets and the stock halved, but it has since recovered lost ground and is trading around its initial IPO price.

QinetiQ’s Space Products business provides satellites, payload instruments, sub-systems and ground station services.  Early in 2015 it was awarded a contract worth 16 million Euros over three years to develop the computer and avionics for the European Space Agency’s (ESA’s) Proba 3 satellites that will fly in formation and use an eclipsing mechanism to study the Sun. The business is also playing a vital role in ESA’s IXV mission launched in February 2015, as its technology will be responsible for guiding the “space taxi”, a smaller version of the US space shuttle, safely back to Earth.

While Space Products is currently a relatively minor contributor to group earnings, there is every likelihood that its importance will grow in future as the company pursues its ‘Organic-Plus’ strategy. This is aimed at building on the firm’s track record of delivering ‘more for less’ to win market share in its core markets whilst nurturing ‘Explore’ opportunities to deliver growth particularly beyond defence. Other ‘Explore’ ventures currently include areas like Cyber Security and Unmanned Aerial Systems and Robotics, all of which clearly position the firm to take advantage of emerging trends.

To top it all off, QinetiQ boasts a strong financial position with net cash of £195.5 million (as at 31^st March 2015), some of which was recently put to use in a £150 million share buyback which, along with the 17% increase in the full year dividend, underlines management’s confidence going forward. The underlying cash conversion ratio was strong at 103%, as was the book to bill ratio of 1.1x (orders won divided by revenues recognised). Despite all this, QinetiQ shares do not appear aggressively valued on a prospective P/E of around 15x (at time of writing) and offering a prospective dividend yield of 2.5%. They are an attractive buy for investors looking to gain some exposure to the space sector but via the comfort of a more diversified UK business.

Take off with Orbital ATK (NYSE:OA.)

As a direct investment in the future of space travel, you’d be hard pressed to find purer exposure than that offered by Orbital ATK. Formed from the merger of Orbital Sciences and Alliant Techsystems in February, the firm combines satellite and rocket expertise, giving it a key advantage over competitors.

Also of particular note is the fact that Orbital ATK is the only company that is currently involved in two major launch vehicle/spacecraft projects. The Antares/Cygnus combination developed by Orbital Sciences delivers cargo to the International Space Station for NASA; but Alliant is also a major player in developing the Space Launch System, which is essentially NASA’s long-awaited replacement for the famous Space Shuttle. This exposure to two major projects gives Orbital ATK a hedge against any potential setbacks or failures, as happen from time to time in the industry.

As for the valuation, the forward P/E is just under 17x (at time of writing), which is by no means a stratospheric valuation for a stock with strong growth prospects. There’s also a modest 1.33% prospective dividend yield. Orbital ATK is a more focused investment for those looking for a more direct play on the future of the space industry.

Satellite stocks map out a path to growth

Those companies that manufacture, operate and manage satellites currently make up the bulk of the space-related industries and together account for around $250 billion in revenue. The satellite industry is therefore pretty hard to ignore if you’re seeking some space industry exposure in your portfolio. Thanks to strong demand from firms and governments, the sector has seen double-digit sales growth for the last decade. That trend looks set to continue as wireless data volumes continue to grow exponentially and as the potential applications of satellite technology increase.

Perhaps the obvious choice for UK investors looking to tap this market is FTSE 100 constituent Inmarsat (LSE:ISAT). The firm specialises in providing phone access to areas of the planet where there is no mobile phone or broadband coverage, or where those services are restricted by the government. Its customers include businesses, aid agencies and governments – particularly armed services.

Inmarsat shares have been performing well of late on the back of the successful launch of a rocket carrying the third and final satellite of its $1.6 billion Global Xpress superfast broadband programme. Global Xpress will deliver broadband speeds around 100 times faster than its fourth-generation service, and management believe it should help them secure an additional $500 million of annual revenues by 2020.

While satellite operators such as Inmarsat offer some attractive characteristics such as high barriers to entry and visibility of cash flows, in Inmarsat’s case we believe these attractions are already, more or less, baked into the price. The shares trade on a prospective FY16 P/E of around 28x (at time of writing), which offers little downside protection against a slower than anticipated rollout of Global Xpress or any other setbacks. The stock offers a reasonable prospective dividend yield of 3.5% for FY16, but this is scarcely covered by earnings estimates.

Luckily for UK investors, there are other options in the satellite arena. Avanti Communications (LSE:AVN) is rolling out its own fleet of HYLAS Ka-band which enables it to service the fixed data market at a lower cost than legacy operators. However, the firm carries a high level of debt on its balance sheet and we note that it has disappointed the market several times in the past.

For readers with a higher tolerance for risk, one interesting little company that might be worth investigating is Satellite Solutions Worldwide Group (LSE:SAT). This £14 million minnow offers satellite broadband services to rural locations across Europe where it is not viable to upgrade the fixed-line infrastructure for broadband connections. There are estimated to be almost 20 million such households in Europe that cannot access even slow broadband speeds. While the firm does not operate its own satellites, it has agreements in place with three European satellite companies that enable it to offer maximum coverage.

House broker Arden Partners anticipates a loss of £0.9 million for the current year to 31^st December 2015, but a profit of £0.8 million in 2016. The firm recently completed its third acquisition since floatation, that of number two French satellite broadband player Sat2Way, which increased subscriber numbers by 65% to c.20,000. Organic growth has also been strong, with recent interims showing a record 528 new customer additions in July. Arden Partners believes there is material upside for the shares on the basis of the market consolidation opportunity combined with an experienced management team and access to capital. Assuming the broker’s revenue expectations for FY17 (£33.2 million) are met, the EV/Sales falls to just 0.4x on Arden’s forecasts. “If this multiple were to move to 1.2x,” notes the broker, “it would imply that the shares could triple on a one to two-year view.”

US defence giants reach for the stars

Many of the major US defence outfits, including Boeing (NYSE:BA), Lockheed Martin (NYSE:LMT) and Northrop Grumman (NYSE:NOC), have exposure to the space sector, not least through their relationships with NASA.

Of the three, Boeing and Lockheed are perhaps the most obviously associated with space, through their role in the Space Shuttle programme in particular. Boeing is in competition with SpaceX and Sierra Nevada Corporation to build the next generation of NASA space shuttles, which could land the firm with additional revenues of $4 billion per annum. It is also heavily involved in producing rockets and managing launches.

Meanwhile, Lockheed has a stated target to capture 10% of the global space industry by 2030. Crucial to its plans is its role in the development of a new manned craft, the Orion Multi-Purpose Crew Vehicle. However, investors should note that the first mission to carry astronauts is not expected to take place until 2023 at the earliest, although NASA officials have said that their staff are working towards an “aggressive internal goal” of 2021.

Northrop offers a slightly different approach. It has recently been involved in NASA’s solar probe mission and the James Webb Space Telescope, which will be 100 times more powerful than the Hubble Space Telescope. A key attraction, we believe, is its Scaled Composites division, which produces experimental aircraft. Scaled Composites is famous for being the first private company (prior to its acquisition by Northrop) to complete two flights that breached the Karman line which marks the beginning of space. Notably, Virgin Galactic plans to use a spacecraft designed by Scaled Composites to provide regular flights across the line.

All three of these titans come with the added benefit that they are also major defence contractors in their own right, which helps to balance out the somewhat riskier space activities. Of the three, we prefer Northrop, which also comes with the added benefit of being a takeover target.