SpaceX to the Moon and a Railroad Bidding War

In this episode of Industry Focus: Energy, Motley Fool contributor Lou Whiteman returns to the podcast to talk with host Nick Sciple about SpaceX's winning the NASA contract to return humans to the moon, the Mars helicopter Ingenuity, and Canadian National Railway (CNI 0.24%) challenging Canadian Pacific's (CP 0.66%) bid to acquire Kansas City Southern (KSU).

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This video was recorded on April 22, 2021.

Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. We've got lots of news to run down in energy and industrials this week, and I'm excited to have Lou Whiteman back on the show with me to break it all down. Lou, how's it going?

Lou Whiteman: I'm doing well, how are you doing?

Sciple: I'm doing fantastic. We've got a couple of topics to break down today. We'll update listeners on the Kansas City Southern acquisition we discussed about a month ago. It is already a super-complicated acquisition. We weren't sure if the government was going to approve it. Now we've got a bidding war on top of that with Canadian National Railway jumping into the mix, we'll break that down and see what could come next when it comes to this transaction. But first, I want to start with SpaceX scored a huge win at the end of last week when NASA selected the company as the sole winner in the bidding to provide the landing equipment needed to bring humans back to the moon. Lou, what does this news mean for SpaceX and for the space industry more broadly?

Whiteman: Yeah, this was a huge deal. This is part of NASA's big Artemis project, which as you say, is going to bring us back to the moon. This is $2.9 billion with a bid contract for the human landing system. This is the part that is going to bring astronauts from orbit to the moon surface and back. This has been in development for a long time, there was a who's who's list of people signed up for this. NASA narrowed it down to three bidders, we had expected two winners, but it ended up being a winner take all and SpaceX has beaten out Dynetics, which was a Leidos Holdings subsidiary, and Jeff Bezos's Blue Origin, for a really big important contract on this whole moon landing project.

Sciple: Right. One of the things we saw coming out of this news, Lou, is that how SpaceX won this deal, was they just bid significantly less than some of these other folks operating in the industry. What is allowing SpaceX to do this, is it their special rockets or what's behind this?

Whiteman: It's really interesting because since this is a government deal and you can protest it, NASA really had to justify their decision. They wrote a long 24-page document basically explaining why and what comes out is, yeah, that SpaceX was "significantly lower" than Blue Origin and Blue Origin was significantly less than Leidos, so yes, SpaceX really won on cause. But what they're doing is they're taking on a lot of the risk themselves. SpaceX volunteered to self-fund and assume financial risk for about half of the development and testing, which is a massive number, that's how you get this down to only $3 billion. It's interesting because this is a unique advantage SpaceX has. They're involved in so many things, they're working to get to Mars for Elon Musk eventually. A lot of this work will complement the work they were going to do already. With that public-private partnership, that commercial element, they are able to justify taking on this risk that a pure defense contractor that's only going to be doing this for NASA, maybe can't justify taking on that risk.

Sciple: Right. SpaceX can tell themselves a story about, "This work we're doing on this Artemis project can give us some benefits on the big super rocket that'll take us to Mars," or what have you, and so therefore, these dollars can get spent twice in a way.

Whiteman: Right. It's important to say too, SpaceX is a start-up. They're doing a good job breaking in, but they are still trying to break in. As a newcomer, you're always going to need a price to get involved. SpaceX, as far as we know, isn't a profitable company. They're not really focused on profits right now. They're focused on adding scale, adding business, hitting these huge development goals. It's much different. It's almost a fair or unfair advantage but they came into this bidding a lot different than, say, a publicly traded company that wants to do a deal and earn their X% margin. It did really set up well for them to triumph here.

Sciple: All right. You talk about technology from one part of the business, maybe there's some synergies here. A lot of people are going to ask or wonder, is this using SpaceX's renewable or reusable rockets as part of this, this Artemis deal, or is this separate technology? What do we know about where this fits in?

Whiteman: Well, by nature here you have reusable rockets, just like you did with Apollo, because you need to go both down and up. The reusables that we think of with SpaceX that they've been developing are the ones that are going to break through the Earth's atmosphere and those are the big guns. It's going to be a modification on the Starship where it's not going to have all the heat shields and all the things you need to get back to Earth. This craft is going to sit in orbit, get refueled in orbit, go down to the moon and back. It's going to be using it's thrusters over and over again, but it's not like what we've seen with the big rockets trying to break through the Earth's atmosphere.

Sciple: We talk about how this is an opportunity for SpaceX clearly, when you're the only company and you get the contract to take people to the moon. That's a big deal for your business. But you also talked earlier, Lou, about the idea that these bids can be challenged and that NASA likes to have redundancy when they bid out these products. What led to the point of SpaceX being the sole source provider and what are some potential issues for NASA that may come from that?

Whiteman: Sure. This is a new world for NASA. NASA used to do everything in-house and the new NASA is putting a lot more responsibility on the contractors. But in return, they want redundancy, they want different people involved. For example, SpaceX, there are other signature projects, the Crew Dragon getting astronauts from Earth to the space station, and Boeing won that, and so far Boeing has not been able to deliver. It's good that NASA had two. In this case basically, if you read the statement, NASA honestly didn't even have enough money for one award based on the cost and funding is going to be an issue for this project. We can talk about it, but NASA is in an odd position where originally the goal was to get to the moon by 2024. That was the previous administration. You could probably guess that the previous president who would have been term limited by 2024, wanted to see during his tenure. That was what was really driving the timeline. Obviously, he's not there anymore. We have maybe a longer timeline, and that's good because NASA said it needed $3.3 billion for this project to get there in that timeline. So far they've only gotten $700 million or so, total in the last two years. There's a risk to NASA with one bidder. There's honestly a risk to SpaceX that a lot of this could be for nothing because we really don't know.

I think we'll get to the moon eventually, but when, how, the details on this, there's just a lot of uncertainty about this and how big of a priority it is for Congress. If nothing else, SpaceX and NASA are going to get a lot of good R&D out of this. If SpaceX can establish itself, it really might have some of its competitors thinking, "How are we going to do this in the future with the low cost?" There's a lot of moving parts, there is stuff to be gained, but for all the headlines on this deal, I'm not sure this gets us much closer to the moon by 2024 anyway.

Sciple: Maybe one of the potential risks for both NASA and SpaceX in this case is that the Congress doesn't play along. There's just not enough money to make ends meet and pay the bills needed to get this project off the ground to use a pun.

Whiteman: Yeah, and obviously, since this project was written up, we've had a lot of big expenses with COVID. The new administration has a lot of priorities and it's in their first year. We have infrastructure, we have a lot of things going on, so I don't think we're going to hit that 2024 deadline. I think regardless of it though, it's a good win for SpaceX and it should advance their mega-projects along, but it's far from certain for any side what's going to actually come out of this right now, I'd say.

Sciple: But before we move on from SpaceX, zooming out from Artemis, talking more broadly about space as a business and SpaceX as a company, what are your biggest questions about SpaceX's future? Is it government funding or something else?

Whiteman: I think SpaceX has really proven itself that it will get a share of the business, both from the Pentagon side and NASA side. Without doubt, SpaceX has done a lot of amazing things, especially for a start-up in a very difficult business to get established in. I think the biggest question would probably be concerning NASA and funding. There's going to be X amount of business from the Pentagon, but that's lower margin, less ambitious stuff. It's more reliable, but SpaceX has some $150 million rocket launch deals. Those are much more reliable but they pale in comparison to a $2.9 billion NASA deal. It's a good, steady business, but these home runs and how certain they are, how well they'll get funded, and how much you can rely on them to build your business, that would be the bigger question out of NASA, I think.

Sciple: Moving on this space topic, a little bit less investing focus, but more about the state of technology and the role that space plays in moving that technology forward. Just over the past few days, we've seen the first flight of the Mars helicopter Ingenuity. Lou, what can you tell us about this project and what it says about space technology and the state of drone technology today?

Whiteman: This is NASA at its best. This is NASA the scientist. This is an $80 million project, maybe $85 million if you count those packing up and going on, all done in-house. There is no contractor involved here. This is done by an internal team at the Jet Propulsion Laboratory working with off the shelf parts, basically just science for the sake of science to prove that this was possible. This is a heck of a challenge. Mars's atmosphere is about 1% of the density of Earth, which if you understand anything about helicopters, makes helicopters very hard. The gravity is only 38% strong, but they're using a Qualcomm Snapdragon processor that we got rid of in our phones five, six, seven years ago because it wasn't good enough. It's the most powerful silicon on the entire Mars mission though, because they were able to buy it off the shelf. It's $80 million, it's a drop in the bucket if it was a contractor thing, but this is a reference for bigger projects that we'll see contractor involvement.

You're going to see contractors working with the JPL coming out of this for what's next, not only in space. You can see space just surveying bigger helicopters, autonomous, because of the delay, the thing has to fly on its own. You have an eight-minute delay, you cannot do this remote, so this has to be fully autonomous. The developments in miniaturization, in autonomous, in just how you do things on a foreign world, you will see that trickle-down, maybe not as quite the same as the way Tang came out of the Space Program, but this is a reminder of the bleeding edge R&D and the stuff that we take for granted that does come out of just science for the sake of science.

Sciple: Lou, you've talked about several times so far on the podcast of this shift from NASA doing its own development in-house to more of a reliance on contractors. You also mentioned Tang and you talked about Velcro or lots of other different types of technology developed in space, developed through the Space Program. Is space still an area we can think of as developing the absolute cutting edge of this technology? Does NASA still play that role or is that something that has also moved over to contractors?

Whiteman: They do to some extent, but if nothing else, NASA is a powerful grant writing body. Even if one day the next helicopter doesn't come out of NASA, I think it will come out of Stanford University or some research lab with NASA funding. I think for the sake of the mission of NASA, they have to constantly push that envelope forward. Yeah, I think science for the sake of science or science just to see if they can, which is what this helicopter was trying to do. Let's see if this is possible. That's still an important part of NASA's role and whether or not it's inside the JPL or a $80 million deal with some contractor. That's more reasonable to expect than these $3 billion deals, to be honest, I think.

Sciple: Moving on from space, we've talked about this absolute cutting edge of technology, both with the new moon mission as well as what's going on with the Ingenuity Mars helicopter. I want to transition back from cutting edge technology to probably the opposite of cutting edge technology, railroads, 200-year-old technology that's really been under development since, maybe, the early 1800s. Last month we discussed Canadian Pacific's $30 billion proposal to acquire Kansas City Southern, which would have been the first railroad acquisition in over a decade. This week we've seen Canadian National launch a competing bid at $33 billion. Lou, what can you tell us about what's going on here?

Whiteman: This is getting very interesting because we have had, as you said, the status quo of railroads for a long time. Now that someone's going to break that up, everybody's looking to get involved. Canadian National has always played the big brother foiling Canadian Pacific's plan, so it actually works. The narrative is perfect here. We're not building more railroads. We need more shipping efficiencies. Kansas City Southern has a unique set of assets running down the spine of North America to Mexico. Buying them here is a play on insourcing. It's a play on post-COVID, the renaissance in manufacturing in North America, in particular Mexico. That is the part of these sets of assets that you cannot replace. Now that it's on the market, everybody's trying to figure out, "If someone's going to get that, I wish it would be me," and so here we are.

Sciple: When you look at Kansas City Southern coming up for sale this year, you've got an asset that you're never going to see, probably come up for sale again in an industry where you're not going to see a new railroad probably ever be constructed. In that context, it's the perfect scenario for a bidding war. If you're an executive at a railroad company and you want to have on your resume that, "I did a big acquisition," this may be the only time in your entire career that you get this opportunity. If there's some structural advantage for you to gain for your business by attaching a complementary asset, this may be the only complimentary asset that ever comes available as well.

Whiteman: Yeah, and what is the price to put on it? Last fall, Blackstone, which obviously wanted a good deal, but they are very sophisticated investors. Their best and final record on Kansas City Southern when they were going to take it private was about $20 billion. Now we're at $30 billion, now we're at $33 billion. When Berkshire Hathaway bought Burlington Northern, now granted this was a while ago, they were sold for about three times sales. We're pushing 12 times sales now with this deal. These are valuable assets. As we said, with the trends, you'd think that connecting Mexico, Canada, to the United States, it's only going to grow more important, but at some point it is that lost opportunity. This is your one opportunity to get these assets. I don't know if it can go higher, but certainly, we're past the point where you can just sit down with a spreadsheet and say, "Yes, this makes sense." There's more to it than the numbers at this point, which gets interesting.

Sciple: If you're Kansas City Southern, what are you to do in this situation as the executives at that company?

Whiteman: They've been pretty silent forever. Right now the bidders are fighting each other. Canadian Pacific came out yesterday on their earnings call. Really talked down the Canadian National offer, said it was much too reliant on debt, which makes you wonder, does that paint them in a corner where they can't raise theirs and take on more debt, but also their warning that the Canadian National deal can't get by regulators. Canadian National is out today saying baloney, so it's back and forth with them. Kansas City Southern just lying back and saying, "You guys just figure out what [laughs] size of check you want to write and we'll take it," I think, right now, but yeah, it's a weird time. We used to have three, maybe four at Berkshire. We have large U.S. railroads that I think would face a lot more of a challenge, but who knows. We can even see another bidder get involved for all I know.

Sciple: Kansas City Southern, hush up and let them pump the price up as much as they want. The other player in this and you mentioned maybe another railroad gets involved. We'll see what happens there, but regardless, there's a 4th player involved. We've got the two Canadian railroads, trying to acquire Kansas City Southern, and then we have the government, the regulator involved in this, and it's not clear that the regulators will let anybody acquire Kansas City Southern.

Whiteman: Right. The reason we haven't seen any major railroad deals is because last time they tried this in the '90s, they screwed everything up and made things miserable. The Surface Transportation Board, the relevant regulator, basically said "no more." Now Kansas City Southern was the smallest of the big railroads. They always were sort of exempt from this, and I think a deal can get done with them, but both of the Canadian companies want to come up with some trust that is going to get you the payout sooner because right now we're talking at least a year for regulatory approval, even when it was just one bidder. The Department of Justice has come out and said that's a mockery of the regulation. You can't have that happen, so there is so much out there. It's really hard to read.

I will say, I do think Canadian National has the tougher case to make. It is much bigger than either of these other companies combined in terms of revenue, Canadian Pacific and Kansas City Southern would still be smaller than Canadian National in terms of revenue. Canadian National back in the late '90s, bought a company called Illinois Central. It gave them track down the Mississippi to the Gulf Coast. That is redundant to what Kansas City Southern brings in the United States. You cannot make the same argument Canadian Pacific that it creates a new competitor with one line track, so I do think it is a thornier, but I certainly don't think it is undoable to the point where they shouldn't have even bothered. I think it's just a crazy situation right now where the regulator has a lot of difficult decisions to make that will impact the fate of the industry and all of these companies.

Sciple: We talked about previously, Lou, that best-case scenario, even without another bidder getting involved, this is probably a two-year process to close this transaction. Now, that Canadian National has jumped into the bidding, is that push this out even longer. Are we looking three, four years before this could realistically close, given all the machinations behind the scenes.

Whiteman: I doubt it goes that far, but I do think it could make things go [...]. For one thing, we don't really know if the clock has started yet because we don't know what the application is going to end up being. I do think that summer of 2022 is suddenly looking optimistic instead of a long way off. One other thing I'd note, I don't think this is Canadian National's primary motivation. I do think they want the access to Mexico, but it serves them, and probably the U.S. railroads are just fine to muddy the waters enough that no deal gets done, and the status quo remains where Canadian Pacific and KSU are smaller railroads that have to partner with these big guys. There's really no downside for Canadian National other than they're going to have to figure out how to integrate it and pay down the debt if they actually win it, but the status quo benefits them, which adds to the intrigue of what they'll do and how they'll play it out, I think.

Sciple: There's a whole poker game going on, and who is bluffing, who's got a great hand, and it's still to be determined. At the end of the day, the regulators are going to call a lot of the shots in what goes on here. When we get some official opinions, that'll be some impactful information.

Whiteman: It's going to be fun. This is the early stages of this. We've already gone a long way, but yeah, it's going to manage to see where that goes.

Sciple: We'll continue following the story, Lou. I thought maybe a fun closing question for you. Mac Greer likes to do the desert island questions. So desert island, you've got to own one of these for the next five years. You've got SpaceX. We're going to assume SpaceX is a public company, its most recent private round is $74 billion, so I'll give you SpaceX at $74 billion, or you can buy shares in any of these railroads: Canadian Pacific, Kansas City Southern, or Canadian National. You've got to hold it for the next five years. Which would you pick and why?

Whiteman: This is such an interesting question, isn't it? Let's start with SpaceX. I am very impressed with SpaceX and they are definitely my favorite Elon Musk related company. They have done a lot. There's a lot to like about where they're going, but $75 billion, for that $75 billion, you can buy all of Northrop Grumman plus all of Leidos holdings and get two powerful space businesses plus a whole lot more. I know we're not supposed to fixate on valuation, but that is a heck of a valuation for a small revenue wise, niche business that is probably not profitable. That takes me to the railroads and absent going into this, I could have made a case to buy any of those three. My cheating answer is probably I will buy the Canadian one that doesn't win the auction because they're not going to have the integration, but just since that's cheating, I'll take Kansas City Southern on the fact that I do think trends are going in their direction as far as Fortress North America and the advantages of Mexico. If a deal gets done, it's cash and stock, so you get a payout plus you get to ride the rails with whoever wins it for the long term. There's just a lot to like about railroads right now, and it might take a while for this to work out, but Kansas City Southern's sitting pretty right now.

Sciple: I think I'd agree with you, Lou, Kansas City Southern, maybe a bidding war bubbling, and this idea with the USMCA, they're the perfect railroad for that, and I think they've been pitching themselves. If you wanted to go with the Rule Breaker approach, I wouldn't blame you with going with SpaceX. It is the top dog and first-mover and it checks off every box, including the extreme overvaluation according to financial media. If you want to take a big swing on growth, SpaceX checks off just about all the David Gardner Rule Breaker boxes. We'll certainly be paying attention to that company if it's ever something we have an opportunity to look at for public investors, and when that time comes, Lou, you will be on the show with me to talk about it. If you're willing to come on.

Whiteman: Pleasure, and I'll probably be pretty positive because it is a cool company. [laughs]

Sciple: Well, until then, as always, people on 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 Tim Sparks for mixing the show. For Lou Whiteman, I'm Nick Sciple. Thanks for listening and Fool on.