Space investing, it's not rocket science. Investors are known to demand returns proportional to the risks they assume, but you might be surprised by what convinces them to put their money in NewSpace ventures. For the past two decades we’ve seen early-stage capital flood to Internet and mobile startups, but increasingly, investors are looking for more systemic innovations. While they love financial profit (who doesn’t?) many are in it for more than just the monetary returns.
Today we often see angel and venture capital flooding to mass market software startups, where companies with minimal startup costs get loads of funding to achieve scale. However, investing in the 2nd and 3rd Verticals is often different from your typical Silicon Valley deal. Capital intensive companies, with long technology development lead times require significant investment in R&D and incubation, well before they are ready to be considered by early-stage capital providers. This is nothing new and generally agnostic towards the industry in question. The most obvious example is the Internet, initially funded by the US Department of Defense in 1960. Microchips also owe their emergence to US military and space programs, and GPS was originally created and deployed by the US military’s NAVSTAR satellite program. The list goes on.
Through government funding, the technology for human spaceflight was demonstrated in 1961, but it by no means had the scale or efficiency for widespread adoption. The Internet, microchips, or GPS would not be part of our daily lives if not for pioneer investors that were willing to take substantial risk to bridge the equity gap between government funding and early-stage investment. Aside from those like Vinod Khosla who admittedly invests in “science projects,” early-stage investors generally want to invest in growth, not technology development. But today we are seeing private investors with ambitions that only governments once dared to have. So why, in line with this month’s theme, do they choose to invest in launch vehicles and human spaceflight, given that they have other investment opportunities? The answer is blended returns.
As a general rule, governments are “impact first” investors, i.e. more concerned with the economic effect (jobs) or “impact” of their spending than any associated financial returns. By contrast, and again as a general rule, early-stage “finance first” investors demand a return on capital invested commensurate with the risk they assume, but do so by investing in transformational businesses. In the 2nd and 3rd Verticals there are a growing number of pioneer investors willing to bridge the equity gap and assume risk which is outside the threshold of a typical early-stage investor, because the returns they seek are multi-dimensional. In an interview with NSG, Lee Valentine, an XCOR investor, explained, “Of all the investors we have in XCOR, I would have to say that the clear majority really are interested in developing a mature space transportation system. They think that has a big benefit for humanity as a whole. But they all want to make money too. Nobody invested money into XCOR who isn’t expecting a return.” Of course, a market this large has huge financial upside and indeed XCOR, SpaceX, Virgin Galactic, and others are all developing businesses to capitalize on that potential. But many finance first investors are involved for reasons beyond financial potential alone.
Over the past two months we’ve seen each of these companies reach significant milestones from XCOR’s first piston pump fuel delivery system, to SET’s successful 820ft test flight of Grasshopper, to VG’s first rocket-powered flight of SpaceShipTwo. As companies prove technology, generate revenue, and progress toward early-stage development, finance first investors are beginning to take notice. But young markets, such as those of launch providers and human spaceflight, remain fundamentally uncertain. The risks of starting a NewSpace company in the 2nd and 3rd Verticals are compounded as they rely on customers who also operate in nascent markets. Amid such uncertainty, early-stage investors want to understand a company’s critical dependencies and plans to mitigate those risks. Experienced investors, like Aabar Investments, know that companies with long-term plans need near-term revenue.
In 2009 they bought one-third of VG’s holding company for $280Mln, while subsequently committing another $110Mln to finance the development of small satellite launching capability. While Aabar is ultimately looking to capitalize on the anticipated demand for human spaceflight, satellite launches might provide much needed revenue during unforeseen periods of delay in development. Other NewSpace companies are following suit: e.g. XCOR has developed its own satellite launch system aboard its Lynx Mark III spacecraft to supplement space tourism revenue; zero2infinity has announced its plans to launch small sats from its high altitude balloons; and Swiss Space Systems is taking it one step further by developing their initial launch vehicle as a dedicated small sat deployment system.
What types of companies do investors look for when they want to change the world? Reusable vertical takeoff, vertical landing (VTVL) rockets have the potential to reduce launch costs by a factor of 100, thereby increasing access to space dramatically. SET has already lowered launch costs by a significant number with its Falcon-9 rocket, and Elon Musk has estimated that reusable VTVLs could further reduce that cost to ~$100/lb as compared to $10,000+/lb. today. When it costs the same to send something to low Earth orbit as it does to send a package from Seattle to London, you’ll know you’ve done something to change the world forever. SET’s Grasshopper, Masten’s Xaero, and Blue Origin’s New Shepard are all working to deliver that access.
A significant number of early-stage investors who are looking to make money but also to change the world are beginning to set their sights on the NewSpace industry. Already we’ve seen investment in 2nd and 3rd Vertical companies by traditionally finance first investors Founders Fund, Draper Fisher Jurvetson, Aabar, and members of Space Angels Network. And NSG sources indicate that a number of well-known Silicon Valley VCs beyond the publicly known funds are quietly starting to accumulate stock in SET. While recognizing that early-stage investments in the 2nd and 3rd Verticals is high-risk, investors are also aware that if they back a successful company, the returns could be out of this world. People tend to be skeptical of new technologies before there is an obvious market for them, and 2nd and 3rd Vertical products and services are no exception. But just as pioneer funding of Amazon and Google paved the way for widespread adoption of the Internet 35 years after it was developed, so too will the trail-blazing investors of NewSpace drive exponential growth of the industry.
This article appeared in the June 2013 edition of NewSpace Global's Thruster market analysis report.
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