Virgin Galactic IPO and Investing in Space Tourism

Commercial space travel is closer than ever before, but will it be profitable to shuttle folks around in space pods? Virgin Galactic plans to find out, soon. In this week's episode of Industry Focus: Consumer Goods, host Nick Sciple chats with Motley Fool analyst Luis Sanchez about the upcoming Virgin Galactic IPO, and what investors need to know before diving into this risky but undoubtedly exciting new idea. What's a SPAC IPO, and what does it mean for Virgin Galactic investors? How many people out there would actually shell out hundreds of thousands of dollars for space tours? What advantages does Virgin Galactic have as a first mover? How does it stack up against SpaceX and Blue Origin? Tune in to learn more!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on Aug. 6, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Tuesday, Aug. 6, and we're breaking down the Virgin Galactic IPO. I'm your host, Nick Sciple, and today I'm joined by telephone by Motley Fool contributor Luis Sanchez. How's it going, Luis?

Luis Sanchez: Hey! Happy to be here!

Sciple: It's great to have you! You've been with the Fool since earlier in 2019. This is your first appearance on the podcast. For folks who might not have read any of your writing, and obviously, nobody's heard you on the podcast, why don't you introduce our listeners, what's your background and how you came to the Fool?

Sanchez: I've been contributing to The Motley Fool since about February of this year. I have a very traditional finance background in that I went to school for finance, got my undergraduate degree in finance and accounting. I spent time working in investment banking at two of the largest banks. I've also worked at hedge funds. When I'm not writing for The Motley Fool, I also work as a financial advisor, primarily working with individuals. As far as investing, I'm most interested in corporate actions and long-term growth plays, which is basically what got me into researching the space industry.

Sciple: Yeah. That's what we're going to talk about today. First off, you've talked about investing in corporate actions and those sorts of things. One type of corporate action touches this IPO we're going to talk about today, which is an IPO via a special purpose acquisition company, commonly shortened to a SPAC. For folks who aren't familiar with the SPAC IPO process, can you give us a high-level overview of how it differs from a regular IPO, and what investors should know about this process?

Sanchez: SPACs are interesting. They're sort of like an IPO, but not really. They're actually what's known as a reverse merger, in that there's an already public blank check company and it merges with a private company, which effectively takes it public. In a more traditional IPO process, there's a more rigorous regulatory and audit process where the company that wants to go public puts together a prospectus, they submit it to the Securities and Exchange Commission, and the SEC will approve it or give them comments. Then investment bankers come in, they take a close look at the company that wants to go public before they basically pitch the company to their investor base and determine what price the IPO should be priced at. 

On the other hand, a SPAC IPO can circumvent this process. The regulatory oversight is much, much lighter. There's no, I guess, what you would refer to as a "go big or go home" moment, where there's this big public IPO offering date. Given the lighter regulatory process, some people view the SPAC process as a little bit of a red flag. There's definitely some evidence to show that quite a few SPACs haven't performed all that well. But the flip side of that is, SPACs tend to go public at a discounted valuation to more traditional IPOs. The other interesting thing is, you don't have to wait for the IPO to close. You can actually invest in a SPAC before any deal is announced at all, including the SPAC that we're going to be talking about today.

Sciple: Exactly. So, a SPAC will be, like you said, a blank check company with the intent at some point to acquire a company. And when that happens, you'll see the SPAC IPO, like what we're discussing today with Virgin Galactic. As you mentioned, SPACs have been popular in the past. Following the financial crisis, they really slowed down significantly. But last year, we really saw a big uptick in SPACs in 2018, we had the most SPACs go public in any year since 2007, raising more than $10 billion in capital. These are companies that folks might be familiar with -- Hostess went public via SPAC, Chuck E. Cheese's, but the one we're talking about today is Virgin Galactic. 

On July 9, Virgin Galactic announced plans to go public via deal with Social Capital Hedosophia Holdings Corp, which is a SPAC company created by Social Capital CEO, Seamus Palihapitiya. As part of the deal, Social Capital will invest $800 million for a 49% stake in Virgin Galactic with an implied valuation of $1.5 billion. 

Obviously, as we mentioned, Virgin Galactic is a space company. But for folks who may not be as familiar with this company, can you give us a high-level overview of, what's the history of this business, and what services do they provide to their customers?

Sanchez: Virgin Galactic was actually founded by Richard Branson. It was founded back in 2004. Over the past 15 years or so, it's invested over $1 billion into making human spaceflight safe. They're definitely oriented at trying to commercialize human space transport, but they also have a long-term aim at disrupting long haul travel in general, being point-to-point travel between two different locations. The opportunity that they're focusing on right now is actually space tourism. They have a plan to start sending paid tourists into space in 2020. That's kind of an odd concept. It's definitely something new. But the idea is that insanely rich people might be willing to pay about $250,000 for a ticket, which grants them about a four-day space tourism experience, which includes a couple of days of training, a full dress rehearsal, and then it culminates in a flight, which sends them into space for about 90 minutes.

Sciple: So they're marketing a full space tourism experience to ultra wealthy folks. When you look at the investor presentation of this company, they compared the market for this to something like ultra luxury private jets, or yachts, those sorts of things that can cost in the realm of hundreds of thousands per reservation. Myself, I just got back from Orlando last week. I don't even like roller coasters, so going into space on a rocket ship is a little bit out there for me. How big does the company think this market can be? What could it grow to over time, assuming everything works out?

Sanchez: It's definitely a novel idea. You almost have to take yourself out of your own personal experience to understand the typical consumer. They put out this investor presentation which described the investment thesis, which basically says that insanely rich people, people who might have wealth upwards of $10 million, $100 million, they're willing to pay, and they often do pay, hundreds of thousands of dollars just to have a single vacation. And that's about what it costs to charter a yacht or rent a private island, or fly private around the world. There's also some evidence that maybe there's something about the human spirit that is interested in having these unique physical accomplishments. Right now, we're seeing record people climbing Mount Everest. There's a lot of people also interested in things like ultra marathons. 

There is this existential question of, is this something that people are interested in? It's certainly what I was wondering. But the company has disclosed that they've already taken about 600 reservations and collected over $80 million in deposits against these reservations. Apparently, the company hasn't even been actively selling this package. They paused selling efforts about five years ago, and they claim to have thousands of leads for additional future customers. So, there apparently is demand for this. 

How large could this market be? Well, there's something like two million people in the world with a net worth growth greater than $10 million. The company claims that they just need to fly about 1,000 people per year to have a viable business. 1,000 people is less than 0.1% of the two million people who could potentially afford it. It's definitely within the realm of the possible. And then, of course, over the longer term, the company might be able to lower the costs through better technology or some kinds of efficiencies. To the extent that they're able to lower the ticket prices, they are interested in bringing this space tourism experience to an even wider audience.

Sciple: Certainly, as the price comes down, that addressable market grows. Even at that current, people with a net worth greater than $10 million, if they hit that 1,000 spaceflights per year to become viable, that's a massive growth in space flights just for humanity. If you look at Virgin Galactic's investor presentation, they call out only 571 people have ever been to space. If you're talking about 1,000 every year, obviously that's a significant growth. Richard Branson thinks that they can decrease prices over time. 

Obviously, this is a brand new market. Virgin gets some inherent advantages as a first mover. When you take a look at the assets that the company is invested in, and how it stands, what do you think are their key advantages moving forward relative to new entrants who might come into this market?

Sanchez: Great question! I think the biggest advantage that the company has is the fact that they got started 15 years ago putting together rocket ships, seemingly without any interest in immediately commercializing the offer. They were just really interested in seeing if this could work. Lo and behold, 15, 20 years later, there might actually be a business here. So, they have this potentially multi-decade head start against any potential competition. And as a result, they have a lot of intellectual property that's probably worth a lot. They're vertically integrated. They're actually designing and manufacturing their own rocket ships. They could eventually build spaceships for other companies. 

Something interesting is that they've actually received the first FAA approval for commercial space travel. Obviously, that's critical for sending humans on commercial vehicles. They got that space approval from the FAA essentially through extensive testing, both with humans and without humans, to prove that this whole thing is safe. 

The last interesting thing that I would point out is, they have this beautiful spaceport that they've built in [New Mexico], actually in partnership with the state of [New Mexico]. This space port essentially has everything they need in terms of luxury accommodations and airfield space, as well as training facilities. It has everything they need to basically get this business going.

Sciple: New Mexico is the location, just for clarity, of Spaceport America. The other thing I found interesting about that is that New Mexico, the state, funded all the upfront development costs of the spaceport in exchange for $5 million in annual rent from the company. You're seeing this company build out this incredible amount of assets, as well as the first to commercially develop a spaceport in the world, and the company still has zero debt. They've signed some deals that they think can continue to expand abroad. They signed a deal with Italy back in 2018, a deal with the UAE in March 2019. There's some opportunities. They have these existing assets in the U.S.A., as well as the opportunity to expand abroad when it comes to their spaceport facility.

When you talk about safety and their development strategy, vs. some of the other rocket companies folks might be familiar with -- SpaceX, or Blue Origin, Jeff Bezos' company -- Virgin uses a horizontal takeoff and landing approach. You take off a normal plane, towed by a mothership, and then the rocket will go from there. They also land horizontally. There's an argument to be made that there's a little bit of familiarity with folks to that process of air travel. That maybe will add a comfortability folks don't enjoy otherwise.

So, when you take all these advantages, Luis, both the physical assets in New Mexico and abroad, as well as the IP they have for developing over 15 years, there are some clear advantages and a clear lead for this company. When you look at the financials of the company, though, do you see a clear path to profitability to leverage those advantages, and then create shareholder value over the long term?

Sanchez: Real quick, you actually touched on an interesting point in regard to governments being willing to offer grants and subsidies to companies in the space industry. That's actually something that you see across the board in the defense contracting industry as well. As it relates to the company's potential financial outlook, governments actually are involved in subsidizing R&D, and it's actually quite materially helpful in reducing capital expenditures, and can make a business like Virgin Galactic a lot more capital-light than people would assume. 

In regards to the specific financial outlook, this is actually one of the things that I was most surprised by -- Virgin Galactic articulates a very clear path to profitability within the next three or four years. It all starts with the fact that each plane carrying about five passengers can deliver a unit economic profit margin of about 65%. If you think about that, each person is paying about $250,000 to get on the flight. Each flight can carry about five people. So, you're looking at $1.3 million in revenue. There's a couple of hundred thousand dollars in there of fuel costs, lodging costs, insurance, etc. At least on the per-flight level, the company is projecting over $800,000 in net profit per flight. 

Now, of course, there's going to be corporate overhead. The company still has to pay for its staff, its marketing budget, R&D to the extent that it has to pay for that. So, it's going to need to have some scale as a company to hit profitability. The company estimates that by 2023, I believe, they can be EBITDA profitable if they're able to hit something like 270 flights carrying 1,500 people or so. 

So, it comes down to the question of, if the company hits its financial targets, then the stock could actually look pretty cheap. According to the company's target, by 2023, at the current valuation implied by the IPO deal, this might be trading for 5.5 times 2023 EBITDA, which really is pretty cheap for a company that isn't going to be facing a lot of competitive pressure, probably not going to be all that cyclical. 

But, obviously, we're talking about if that happens. You're underwriting a lot of risk. It doesn't take a rocket scientist to figure out that space travel is pretty complicated.

Sciple: Right. It's really an addressable market question, to me. How many people are going to be willing to fly on this aircraft? And then, as well, there's a question -- right now, you're looking at folks who are early adopters. No one has ever engaged in any recreational space travel. These are the folks who traditionally would be the most comfortable with risk, most comfortable with being the first to do something. You could easily see that addressable market start to skew up in a really significant way as things are proven to be safe, and it becomes more generally accepted. However, on the other side, if one of these things blows up and if someone is injured, you could quickly see the addressable market diminish very quickly. It's something to be seen. But as you say, if the company's projections pan out, there is a path to very, very rapid growth, and it's something that could easily justify the valuation that they're coming at today. We'll just have to see how things progress.

When we talk about these commercial space companies, the big three for sure right now are Virgin Galactic, SpaceX and Blue Origin. There's also United Launch Alliance, that's a partnership between two major U.S. defense contractors. But the three big ones right now are SpaceX, Blue Origin, and Virgin Galactic. When you compare what Virgin Galactic is doing with this focus on recreational space travel via space planes, how does that compare and contrast to what we're seeing from those other two big space companies, SpaceX and Blue Origin?

Sanchez: The landscape of the future space industry is pretty interesting. For some reason, a lot of these companies tend to be started by outspoken billionaires, and aren't traditionally backed companies. Although, as you mentioned, there are a couple of companies like the United Launch Alliance that might be a little bit more traditional. But it's funny. You have to think, why are so many billionaires starting space companies? It's probably because starting a space company is something like the ultimate vanity project. As mentioned, I don't think that when Jeff Bezos started Blue Origin, or when Richard Branson started Virgin Galactic, they were primarily interested in making a ton of money. I think they just wanted to see if they could build a spaceship. [laughs] 

Sciple: [laughs] Space is cool, and they're grown up little kids. They want to go to space. But, there really has been proven out to be a market.

Sanchez: Yeah, absolutely. When you're talking about the 800 pound gorilla in the room, you're talking about SpaceX, which is the venture backed by Elon Musk. I say that it's the 800 pound gorilla because it has a large valuation by leaps and bounds. It was reported that it just did a private funding round implying a valuation over $30 billion. The company has secured a bunch of lucrative government and commercial contracts, mostly to launch satellites. But they've really done a good job with their PR. You may be familiar with some of the videos of them launching and landing their reusable rockets on platforms in the sea. Elon Musk has a longer-term ambition of sending humans to Mars, but for now, he seems to be really focused on the commercial opportunity to use heavy lift rockets to send satellites into orbit. There's definitely a lot of demand for that. 

Next, I think Blue Origin is also pretty interesting. Blue Origin is the company backed by the Amazon founder and CEO, Jeff Bezos. Blue Origin has taken this middle path somewhere between Virgin Galactic and SpaceX in that it's simultaneously working on space tourism and commercial launches for satellite. Although, maybe because it's trying to accomplish a little bit more, I'd argue that it's a little bit behind its rivals, in the sense that Virgin Galactic, as we mentioned, is getting ready to commercialize space tourism by 2020, whereas Blue Origin, they have something in development, but it hasn't been tested with humans yet. It certainly doesn't have FAA commercial space license, and it hasn't even started selling reservations or tickets. So, that's TBD. On the other hand, Blue Origin also has a different class of rockets that it's developed for sending satellites into space. That business hasn't started collecting revenue yet, either, although it has signed some pretty lucrative deals for the future. I would say that Blue Origin isn't in any particular hurry. It's definitely well backed. Jeff Bezos has been selling about $1 billion of Amazon stock every year to fund the venture. It's hard to argue that Blue Origin hasn't made incredible progress given the technology that it's developed so far.

Sciple: If you look at Virgin Galactic as compared to Blue Origin and SpaceX, Virgin Galactic is much more of a pure play on the recreational space travel industry vs. the other two. SpaceX has talked about sending a Japanese billionaire around the moon, but that is a long-term project. 2023 is their target there. Blue Origin has talked about putting folks into space. That'll be a little bit different space flight than Virgin Galactic has. It's a vertical takeoff vehicle, more similar to the Apollo style rockets vs. the Virgin Galactic, which is a horizontal takeoff and landing space plane vehicle. The Blue Origin recreational spaceflight is projected to be around 11 minutes, versus the Virgin Galactic is projected to be around 90 minutes. 

But Virgin Galactic, compared to the other two, doesn't have nearly the same exposure when it comes to commercial launches of satellites. Part of that is just the nature of that horizontal takeoff and landing, being towed by a mothership up to 45,000 feet, it limits the amount of weight that you can carry. If you're going to invest in Virgin Galactic -- these other two aren't publicly investable now, but relative to these other two, Virgin Galactic is much more of a pure play on recreational space travel. You really have to believe that that market is going to grow in a meaningful way in the coming years. Whereas the others, you could fall back on the satellite launches. We've talked about these low Earth orbit internet projects that are becoming more and more popular. There's a little bit broader addressable market for the other two relative to Virgin Galactic. 

Now, when you look at this SPAC, the deal is expected to be finalized later this year. The Social Capital SPAC is currently trading on the market as IPOA. Whether you want to buy the SPAC today, or whether you're looking at investing in Virgin Galactic moving forward once the deal is closed, as an investor, what will you be paying attention to when you think about Virgin Galactic as an investment? What are the important metrics you'll be watching decide whether this is something that should have some real capital invested in it?

Sanchez: I'm certainly intrigued by the company and the industry. There definitely appears to be something here. I'm not sure if it's necessarily tourism, if that's going to be the big market. And I'm certainly not quite there yet on investing in it. But there's definitely some things to like about it. In general, one of the things I think is interesting is, everyone that I've spoken to about this idea is extremely skeptical of just the premise. It seems like people don't even want to take it seriously. I haven't met anyone who's actually dug in and researched the facts. But, if the company does what it says it'll do, I think the stock could do well. There is definitely some circumstantial evidence that is a real business. They've received government licenses, they do have a backlog, they've had some good PR.

But certainly, there's a lot of things that need to go right for this to work as an investment. Some of the things that I'll be watching are, right now, the company has been a little vague about when its first commercial flights are going to take place. They've alluded to a start sometime in the first half of 2020. It'd be great to see something a little bit more definitive on the calendar, or maybe even wait and see, wait until after a couple of these flights carrying paying customers have gone and come back just as a proof point. [laughs] There's definitely a risk here that, because it's such a new idea, it's such a complicated industry, it took 15 years just to put together the technology, that there could be delays. Things could get pushed back due to technical issues or other kinds of issues that are hard to foresee. And this investment becomes less appealing if the timeline is shifted back a few years. 

Another thing that I think is really important to pay attention to is the backlog to the extent that the company continues to report it. I think the backlog is going to be the best indicator of long-term demand for this kind of thing. It was really helpful for us to see that the company has disclosed that there's already 600 reservations and $80 million in deposits. Will more people be interested in space tourism? Who knows? But the backlog is probably going to be your best indicator. 

The last thing that I'd probably pay attention to is the average ticket prices. The reason I say that is because the company indicated that some of its initial reservations actually came in at a discount. Perhaps because of selling to early adopters, or who knows exactly why. But the bottom line is that the economics of this business are going to be tough to justify if Virgin Galactic can't maintain its pricing. If demand is just a little bit softer than they're advertising right now, it wouldn't be crazy to see them discounting the price, which also would make the investment a lot less appealing.

Sciple: I think the recurring theme from all of those there is, how big is demand going to be, and when can they start delivering the product? When you look at the backlog, if you start to see that backlog start to slide down, that could be evidence of, there's a small group of people who are super interested in this, but it's just that, it's a small group of people. Likewise, if you see average ticket prices start to fall, the folks in that higher-end market, there's fewer of those who are willing to pay that price. We'll just have to see how big the market is going to be and how big that demand is going to be. If the numbers that management has put out there prove to be true, demand is robust enough to support this business and to justify a valuation that continues up over time. As you mentioned, I too would like to see a couple of these flights take place and land safely before I'd want to really consider investing in the company. Like I said earlier, if there's some sort of accident, you could really see how that shrinks the addressable market. But if you have several safe space flights take place, you could really see folks get excited about engaging in space tourism, and even more demand swoop in. So, I think those early days are going to be very important. 

Any last thoughts, Luis, before we send it home?

Sanchez: On that final note, I think that one thing that this crop of space companies, and not just Virgin Galactic, have in common is that they seem to be very masterful when it comes to PR. To the extent that they are successful in sending a few missions to space, I could definitely see them drumming up excitement in terms of PR. That could also have an impact on the stock price and how people perceive the company.

Sciple: Yeah, it'll be something to follow, for sure. Something very exciting, a market that has not existed, like we said before. There have only been 571 people who have ever gone to space, and this company is projecting to do over 1,000 each year. Really exciting opportunity. We'll continue to follow it. 

Luis, hope to have you on again soon! Thanks so much!

Sanchez: Great! Thank you, Nick!

Sciple: As always, people in the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Luis Sanchez, I'm Nick Sciple. Thanks for listening and Fool on!