In David Einhorn's most recent letter to shareholders of his hedge fund, Greenlight Capital, he specifically called out Space Exploration Technologies (SPCX -1.96%), which went public last quarter.
The initial public offering (IPO) was historic for its size, and Einhorn notes that SpaceX is still making history, citing key analyst reports that have a massive impact on financial markets. But that history isn't necessarily a good thing for SpaceX investors, and it could have broader implications for the market in general.
SpaceX has the capacity to shatter records
Einhorn didn't pull any punches when it came to his thoughts on SpaceX's valuation. He believes the $1.75 trillion that the IPO underwriters assigned to SpaceX is far too much. He failed to grasp the extraordinarily high level of confidence investors have in the company's long-term prospects, despite the significant hurdles it must overcome to realize its potential.
Image source: The Motley Fool.
But what he sees as even more questionable is how the credit-rating agencies view SpaceX and its potential debt. Einhorn wrote:
According to Moody's, SPCX has the capacity to become one of the largest non-financial investment-grade borrowers, even though it isn't expected to be cash flow positive for years. We can't find any other examples of investment-grade ratings being awarded to a company with a multiyear forecast of negative free cash flow and no history of generating free cash flow.
SpaceX's ability to raise capital by selling bonds at relatively low yields is key to its success. Even some of the most bullish analysts on Wall Street don't expect the company to produce positive free cash flow anytime soon. Morgan Stanley analyst Adam Jonas has a $300 price target on the stock, indicating it could more than double from its current price. Even so, he doesn't see the business generating positive free cash flow until 2035, burning an average of $84 billion per year before then.
NASDAQ: SPCX
Key Data Points
That means there's a tremendous amount of risk investing in SpaceX. The cost of capital is a necessary concern that may not be fully accounted for in investors' outlooks. A reduction in SpaceX's credit rating, or even the continued march higher in interest rates, could have a severe negative impact on its finances. Alternatively, using equity to fund capital expenditures would further dilute existing shareholders.
Just add it to the list of risks for SpaceX stock
Einhorn argues that the credit risk of SpaceX is just one of many risks that investors are not properly accounting for. He listed a bevy of potential business endeavors for SpaceX to pursue over the long run but added, "We doubt that the discounted value of those possibilities, using an appropriate risk-adjusted discount rate, would lead to a number that approaches SPCX's market capitalization."
NYU professor Aswath Damodaran puts SpaceX's current valuation well above the 90th percentile of his model, which is already arguably very optimistic about the growth and profitability of SpaceX's various segments.
Over the long run, SpaceX's stock price will closely reflect its ability to deliver positive cash returns and earnings. The investment time horizon may be much longer for SpaceX than for a typical company, but that only increases uncertainty about the company's actual value. In such cases, investors should demand a wider margin of safety relative to their best estimate of intrinsic value. And based on the way the stock is trading, it doesn't appear to have much, if any, margin of safety.
That sort of behavior is worrisome to Einhorn. He finished his discussion of SpaceX with a warning: "Our sense is that this IPO is something we might look back on as a marker that a major speculative top is near."
While there may be significant speculation in some corners of the market, the underlying fundamentals of the current stock market still look fairly strong. It's not time to panic on the whole market, in my opinion, but investors may want to carefully consider what's reasonable for SpaceX.
