Space SPACs and the Private Markets

Welcome to the very first issue of my monthly newsletter! You're receiving this exclusive email because you've referred at least one reader to Payload. I promise I'll come up with a better name, but for now this will have to do. The primary goal of this newsletter will be to highlight the financing side of the aerospace world, helping both investors and founders navigate the capital markets.

I'll spend time covering fundraising trends, offering market color, and doing the occasional business model deep-dive.

If you have any questions, comments, or topic requests, please email me directly at [email protected]. Thanks for reading!

The Haves and Have-Nots of the Space Economy

The bifurcation of performance between the traditional A&D sector and space SPACs could not be more obvious. Despite the broader market’s abysmal performance this year, traditional aerospace & defense companies are in the green. Certain companies like Lockheed Martin, Raytheon, Northrop Grumman, and BAE Systems are outperforming significantly, trading between 10 and 30%+ YTD. The sector has strengthened on increased demand in response to Russia’s longer-than-expected war in Ukraine and the growing risks posed by China’s own military and space ambitions.

Consider also:

• Global military expenditure now exceeds $2T per year for the first time, and is set to keep rising as European nations modernize their systems.

• The US defense budget is seeing dramatic increases. The 61st Annual National Defense Authorization Act (NDAA) agreement supports $778B in funding, a 5% increase for fiscal year 2022.

• Only eight nations out of 28 currently meet NATO guidelines for defense spending, at 2% of GDP. Expect more nations to readjust spending to get closer to NATO recommendations (especially since the vast majority of <2% spenders are located in Europe).

Meanwhile, commercial space companies that SPAC'd have been decimated. The entire group is down over 30% (market cap weighted), but on average down 38% YTD. Since going public, the group is down 54% on average.

On the surface, it’s a head scratcher, considering some of the industry tailwinds. According to Euroconsult, 2021 was a record year for government space investment: $92B+ (the share going to defense was +20%). And President Biden has requested a $26B budget for NASA in the fiscal year 2023, the highest request ever for the agency.

Geopolitical conflict has touched many important verticals in commercial space:

• Launch: Russia refused to launch satellites for satellite broadband provider OneWeb. With the Soyuz no longer an option + growing demand for mega constellations awaiting deployment (OneWeb gen-2, Kuiper, etc.), the launch market will likely remain tight for the next several years as the industry works through long manifests of missions.

• EO: Satellite imagery is illuminating the true atrocities of the war, drawing attention to the ways space assets can dramatically increase transparency. Imagery demand will certainly increase as a result of the conflict, but the longer-term trend of the U.S. government ramping up its satellite data procurement (see the long-awaited NRO contract, i.e. the largest-ever commercial imagery contract) is the real tailwind. You can also expect increased demand from governments with smaller defense budgets that can't afford their own EO constellations.

• Supply chain: Russia announced that it will be discontinuing rocket engine sales to the US. Since the 1990s, the country has delivered 122 RD-180 engines to the US. Boeing, Lockheed Martin, and Northrop Grumman all rely on Russian-made engines, and will now want to look towards domestic solutions.

• Cybersecurity: Satellite operator Viasat and SpaceX’s Starlink have strengthened cyber defenses and their security postures in response to internet service outages and jamming in Ukraine.

• Infrastructure: The International Space Station (ISS) has already become a political casualty of the conflict, with Russia reducing collaboration with partners.

We could continue...

...but you get the point. What's going on and why is the underperformance so stark?

• "SPAC" baggage: The word SPAC, plain and simple, has a negative connotation that not even great businesses can avoid. The De-SPAC ETF, an index that tracks the broader universe of companies that have completed their SPAC mergers, is down 48% YTD. Space SPACs are effectively tracking that performance.

• Space is new: Pure-play space companies are a new area of investing for the public markets. Most of the investment banks barely have research coverage for the industry, so it's hard to see how the broader markets would understand how to trade them. Case in point: certain space SPACs have traded higher upon news of a signed launch contract with SpaceX (which generally reflects an expense, not revenue).

• R&D isn't meant for public markets: The public markets are no place to build your first product—especially when your financial projections were based on technical milestones that were ambitious to begin with. Fee-driven investment bankers led companies astray as they built comp tables and valuation models that were inherently flawed.

What it all means for investors

Despite the souring market, there will be significant opportunities for investors within both public and private markets. Many of the space SPACs are part of markets that have real demand and robust customer backlogs. However, you must assume that these companies will have a very difficult time accessing the public markets again. For the companies that don't have a consistent working product yet, pay attention to cash balances and burn rate. You'll have to estimate if they can get to a viable product before capital dries up.

For the companies that do have a working product, remember this: SpaceX is currently fundraising at a $127B valuation. Should Rocket Lab (RKLB), a vertically integrated launch service provider with a demonstrated track record of execution, really be trading at 1.8% of SpaceX's valuation? And yes, I'm aware of Starlink, Starship, hypersonic point-to-point travel, interplanetary colonization, and all the other projects SpaceX will tackle, but the reality is that most of those business models are currently unproven. This makes it fairly clear that there is a disconnect that can be exploited.

TL;DR — Companies with flight proven spacecraft, clear scalability, and operations in markets where there is real present demand—not future 2025E customers—are worthy of a second look. There are certainly diamonds in the rough.

What it all means for founders

If you're considering a SPAC, consider why the traditional IPO process is not open to you. The likely answer is that you're not ready for prime time. Redemption rates still remain incredibly high, and without a robust PIPE market, getting deals done requires an immense amount of creativity (i.e. convertible note rounds at discounts or built in IRR hurdles to help bridge the SPAC), or a member of your team that's a master fundraiser.

If you must go the SPAC route:

1. Consider structuring sponsor payouts that are dependent upon financial milestones that align with the broader shareholder base.

2. Propose a valuation and build projections that are reflective of company and market realities. Remember that bankers are paid based off of deal size, so of course they're incentivized to build a dream scenario. Public markets will always bring those back down to Earth (pun intended), and reporting misses on your quarterly calls will get old...fast.

3. Work with a sponsor team with operational experience in the industry. If your proposed sponsor is the CEO of a consumer brand, keep looking.

If you're still in startup mode, one of the biggest friction points to address now is investor liquidity. The last two years were an amazing environment for space startups raising private capital. Investors saw a path to liquidity through the use of SPACs. Many rounds were completed with the hope that a SPAC exit would be likely within 1-2 years. This is no longer the case. You'll now have to present a use of proceeds plan that does not require you to come back to the market every six months.

• If you're building a capital-intensive product (as most space startups are), raise as much as you can to get to your next biggest technical milestone or, better yet, a customer.

• If your product is dual-use, highlight and emphasize that. Even though there may be a massive commercial market in the future, the government is open for business today.

The upshot: There is still an enormous amount of dry powder in private equity. Deep tech investing will certainly slow, but it's not going away. You may have to add structure to deals (liquidation preferences, anti-dilution provisions, etc.) or be much more flexible around valuation, but we at Payload can see that deals are getting done. We're familiar and close with founders who are raising capital, and although it's a more difficult environment, tenacious teams are still executing term sheets.

Largest Space VC Deals of Q2 (so far)

Despite the market headwinds, space has never had more clear industry tailwinds both commercially and geopolitically. We're still very optimistic about the long-term future of this industry. PS: if there is anything that we can do to help, please don't hesitate to reach out. We can provide insights into which investors are active and broader fundraising trenf

For more founder advice, take a look at Sequoia's recent 52-page guide to navigating the downturn.