Investors became enamored with space economy stocks during the COVID-19 market bubble, specifically from special purpose acquisition company (SPAC) mergers. With money seemingly flooding from all over the world to these speculative asset classes, pre-revenue companies were trading at market caps north of $10 billion for a short period.
One of the leading bubble stocks was Virgin Galactic (SPCE -5.47%), a space flight company that is trying to build a tourism business by charging hundreds of thousands of dollars to take trips into low orbit.
Virgin Galactic has fallen 90% from its highs during the COVID-19 SPAC frenzy but is still one of the most popular stocks on Robinhood. Here's why you should stray from the Robinhood crowd and avoid buying the dip on this stock.
Q4 results: More of the same
In late February, Virgin Galactic updated its investors with full-year and Q4 financial results for 2022. The report showed more of the same: little revenue generation and ballooning losses.
In 2022, Virgin Galactic generated $2.3 million in revenue. Its expenses were over $500 million, up from $323 million in 2021 and $276 million in 2022. Cumulatively, over the last three years, it has generated a net loss of approximately $1.5 billion with negligible revenue, meaning these are almost entirely fixed costs. Spoiler alert: Sustainable and safe space travel is incredibly costly to achieve.
At the end of the year, Virgin Galactic had around $1 billion in cash on its balance sheet. That leaves it around two years -- maybe less -- before it runs out of cash.
Expensive dilution or debt is coming (or both)
A huge cash burn means that Virgin Galactic will need to continually raise money from the capital markets. This is easy when capital is seemingly infinite, with low interest rates and a soaring stock price, but becomes much harder with high inflation and a bear market.
As of this writing, Virgin Galactic has a market cap of $1.5 billion. That means if it raises $500 million in funds through a stock offering (which will only cover one year of expenses), it will increase its shares outstanding by 33%, or reduce the value of any existing share immediately by one quarter.
But what about debt? That will likely be even more tricky. The company already has $425 million in convertible notes it is paying 2.5% in interest. If it aimed to raise money through a debt offering today, that interest rate would assuredly be much higher, given where the Federal Reserve has pegged the federal funds rate. A billion dollars in new debt (which, again, would only give the company liquidity for two years at its current burn rate) at a 10% interest rate equals $100 million in annual interest expenses, or around 25x Virgin Galactic's current annual revenue. I'm not predicting that is the expected interest rate on new debt. It's just a hypothetical example here. The interest rate might change slightly depending on whether the debt is a convertible note or standard bond issuance, but that won't change much in the big picture.
Virgin Galactic will need to start making money from operations, or its shares are not going to be worth much -- if anything at all -- within a few years. You can't expect a company to burn cash and raise more money and simultaneously expect its stock price to rise higher. But the problem is, its business model doesn't even make sense if it scales up to hundreds of flights a year.
The long-term economics don't make sense
Virgin Galactic's stated goal is to reach 400 space flights a year. With an average ticket price of $450,000 and up to six people on every launch, that would work out to $1 billion in annual revenue if it could reach this annual trip rate.
You might think this is good, since Virgin's operating expenses were only $500 million last year. But that doesn't include variable expenses that will scale along with every flight the company makes. Fuel/maintenance costs are enormous for space travel, along with flight, landing, and control room crews. It is hard to run the math on exactly what gross margins Virgin could sustain at 400 flights a year, but I think it is unlikely that the company would be generating any bottom-line profits under that scenario.
But remember, even if Virgin Galactic is still not profitable at 400 flights a year, the company is many years away from making this a reality. That means hundreds of millions in cash burning away from its balance sheet each year for the foreseeable future -- which is not a recipe for strong long-term stock returns.
