Take the deep dive on the go with the free video:
Edited by Brian Birnbaum.
Organisational excellence applied to space.
During the Q2 2024 earnings call an analyst asked CEO and founder Peter Beck why the cost of the Neutron rocket program was considerably lower than other programs in the industry. Beck’s answer points to the deep dive’s takeaway, which is that, like Duolingo, RocketLab has considerable process power. They’ve built a track record that shows they can get their customers to space faster, more reliably, and in a more cost-effective manner. Beck’s answer is perhaps everything you need to know about RocketLab’s organisational capabilities and what makes this company special at present:
So it comes down to just the experience of the team and also a development approach.
We like to fail fast but not at the system level. We'll fail quickly at the component level, but by the time things get built up into complete systems, we kind of expect them to work.
And it's just the way that we've always been. It's the Rocket Lab magic, if you will. And right throughout the history of the company, we've always managed to develop these systems at a speed and a cost that pretty much others can't.
The thesis can be reduced to just a few KPIs (key performance indicators) that elegantly depict RocketLab’s process power. RocketLab’s business is about launching into space rockets strapped with payloads, typically satellites. RocketLab designs, manufactures, launches and operates spacecrafts for customers. It also takes care of the overall mission design, which allegedly is the most complex element of the operation. Should the company produce results across all functions, RocketLab will likely satisfy the equation that Beck laid out in Q2 2024, leading to significant growth:
I've been very public in the fact that I think the large space companies of the future are the ones that are going to have the ability to build whatever spacecraft they need to build, the ability to launch them on demand and deploy constellations at cost.
Gross margins are up from (2.22)% in FY2019 to 25.04% in the TTM (twelve trailing months). This portrays pricing power and costs optimization. Further, launch turnaround times (the time between launches) decreased from 31 days in Q1 2022 to just eight days in Q1 2024. The most important thing for customers in this business is timing and, as turnaround times decrease, so does value. Proximity (how close they are able to deliver a spacecraft from the target) has gone from 500m in Q1 2022 to less than eight meters in Q2 2024. Higher proximity unlocks more complex missions, potentially opening up uncontested markets. And lastly, ASP (average selling price) has gone from around $5M per launch a few years ago to $8.2M in Q1 2024.
The above points to a rocket company enhancing its ability to build any form of spacecraft, launch them on demand, and deploy payloads (usually satellites) in a cost effective manner. The ultimate reflection of their ability to solve a growing volume of acute customer pains in a way that’s hard to replicate is a rising ASP. While other metrics denote technological prowess and an ability to optimise costs, ASP denotes that their payloads are in short supply in the marketplace. This is also further evidenced by their rising backlog (the total dollar amount of contracts they have signed and are yet to fulfil), which you can see in the graph below.
It seems that there are only two companies in the world that can launch space product in a cost-effective manner: SpaceX and RocketLab. The difference between the two companies is that SpaceX focuses on heavy payloads, between 22,800kg and 63,800kg, with Falcon 9 and Falcon Heavy respectively, while RocketLab closer to 300kg with Electron.
Structurally, 50% of RocketLab’s revenue comes from the government–“almost every” U.S. government defense and civil agency. The other half comes from commercial customers. As happened with Palantir early on, this company therefore has the U.S. government’s imprimatur. Simultaneously, as of Q2 2024 over 70% of the customers are recurring, lending stability to the top line.
Per the graph below, RocketLab does not currently produce cash from operations, consuming $81M in Q2 2024. The company has a net cash position of $102.4M, with $496.8M in total cash and short term investments and $394.4M in debt. While progress in KPIs and the American government’s imprimatur is encouraging, the concern remains whether this company will start to print cash, if at all.
The path forward is to solve more acute problems for customers in space in an increasingly cost effective manner while commanding a higher premium over time.
Management has reiterated numerous times since IPO that launching two Electron rockets per month gets them to breakeven. Electron is the rocket with a 300kg payload and Neutron is the mid-payload rocket they are working on at present, expected to carry up to 13,000kg. As of Q2 2024, RocketLab had completed nine launches, equating to 4.5 launches per quarter and 1.5 per month. RocketLab is 0.5 launches per month from reaching breakeven. At start of the Q2 2024 call, Beck mentioned that launch cadence was up 100% in H2 2024 with respect to H1 2023.
RocketLab seems to be on a good trajectory as it refers to the launch business. Over the last four earnings calls, management has consistently reiterated that launches are currently limited by “customer readiness.”
Most modern orbital rockets are designed as two-stage vehicles. The first stage is the part of the rocket involved in getting the rocket out into space. Once this is achieved, the first and the second stage separate, with the first stage falling back into Earth and the second stage moving on to execute the remainder of the mission, as depicted in the image below. In figure A you can see the rocket flying upwards with the two stages attached and in figure B, you can see the two stages decoupling, with the first stage falling back down and the second stage flying off into space. The first stage requires two thirds of the Electron rocket’s total cost (generally this is true for any rocket).
In Q1 2024, RocketLab fully recovered Electron’s first stage for the first time, putting it back into the production fold. This is the first instance of RocketLab successfully reusing a first stage and along this path, the company may see notable unit economic enhancements. In Q1 2024, however, Beck mentioned that he sees reusability as a “distraction” from production. He sees the most leverage potential in simply producing and launching more rockets in the short- to mid-term.
Before moving on to RocketLab’s space systems segment, I want to put particular emphasis on the upcoming Neutron rocket. It’s forcing the company to increase OpEx, and although the investment may well pay off, it is muting the progress RocketLab is making on the Electron side as it refers to the income statement. RocketLab started Neutron development in March 2021. You can see in the graph below how this coincides with OpEx trending higher and net income lower. In the same graph, the right hand axis shows how this perfectly coincides with the increase in CapEx. In Q2 2023 management stated that they do not expect OpEx or CapEx to trend down until the inaugural launch of Neutron. And in Q1 2024, the launch was pushed back by 6 months, for apparently no particular reason other than the complexity of the task.
However, in Q2 2024 RocketLab completed a hot fire test of the Archimedes engine, which will power the Neutron rocket. Hot fire tests represent one of the final and most critical steps in rocket engine development, providing confidence in the engine's readiness for actual launch conditions. Coming up next, the company will be focusing on building the remaining parts of the rocket. Importantly, RocketLab does not simply build a prototype. They reverse engineer the design in order to facilitate at scale production a priori. In the Q2 2024 call, Beck said that investors should thus look out for infrastructure build (that enables them to build the other parts of the rocket), as the company continues to execute against its target of performing the first Neutron launch in 2025. Until then, the above graph will continue to trend in the same direction with no expectations of positive cash from operations.
Delay of Neutron’s launch adds to the uncertainty brought about by negative cash flow and meager net cash position. Yet I wouldn’t like to see them rushing into a Neutron launch. What’s important here is that they fully productise the rocket in order to achieve even better KPIs over time, essentially delivering higher payloads, more reliability, lower turnaround times, and so forth. In Q2 2023 Beck mentioned that Neutron will have the same economics as Electro, but with an “extra 0.” In this sense, I believe management perfectly understands the importance of pursuing the fully productised route. When talking about the Archimedes engine in Q1 2024, Beck was explicit about how the company thinks about taking time to then scale up Neutron (and the Archimedes engine) more easily:
We've got about four sets of engines on the go right now. Perhaps the biggest point I want to make here too is that we haven't taken any huge concessions just to make fire for the sake of it.
We've been very intentional and methodical with Archimedes making sure to refine its design so that now we're at a point that we've got an engine that can be readily [productised] long term.
To what extent RocketLab succeeds with Neutron remains an uncertainty. But in Q1 2023 I found something that reveals the company’s organisational excellence. In Q1 2023 RocketLab was able to reassign production personnel to R&D initiatives on the Neutron and Photon operations. The fact that RocketLab can steer top talent away from production while scaling up Electron manufacturing shows how powerful their workforce is. Since then, none of the KPIs mentioned at the start of this deep dive have suffered as a consequence, leading me to think that the company is particularly capable from an engineering standpoint and in my view makes it likelier than not that Electron will be a success.
Here’s what Beck said about the topic, in the Q1 2023 call:
So again, I was trying to convey earlier that we've been fortunate that we've been able to repurpose our production resources to support the neutron and Photon R&D initiatives.
So it's really a case where we've gotten to be much more efficient, building electrons that we have these resources. So rather than higher incremental R&D heads to support those programs, we can now just basically move or reclass those resources from production to support R&D.
So that kind of just speaks to the fungibility and flexibility of the types of resources that we have, where, again, our production folks are equally capable performing very complex R&D tasks, and those super helpful for us to be able to have a really fungible workforce that we can move around as need be.
Electron is the fastest rocket to hit 50 launches in history. Meanwhile, inflation was running rampant. Quite the headwind for many companies, inflation can crush a small rocket company with much fewer resources than its billionaire-led competitors, like SpaceX and Blue Origin. You can see in the graph below how Electron’s launch cadence has fared relative to Spacex’s Falcon 9 and other less industrious rockets of the past. In the next graph you can see how RocketLab’s total return on capital has trended up despite inflation, denoting a rising efficiency of overall operations. This has been made possible by RocketLab’s vertical integration strategy, whereby M&A and organic development minimises external dependencies over time.
According to CFO Adam Spice, efficiencies from vertical integration also drive RocketLab´s pricing power. Here’s what he said about this in the Q1 2024 call:
But I also think that when you look at our Photon pricing, if you look at the contracts that we're competing on, the contracts that we're winning, we're not winning on the lowest price, it's quite the opposite.
Like, we can oftentimes price at a premium to our competition, again, because of the fact that we're bringing that level of vertical integration, which translates into schedule certainty and performance certainty, right?
RocketLab is more than a launch company.
Photon is Rocket Lab's versatile satellite bus (dropping satellites off at particular locations in space) and spacecraft platform designed to offer end-to-end space mission services. Photon was launched in 2020 and represents a significant expansion of the company's capabilities, transforming it from a launch provider to a full-service space mission provider capable of supporting a wide range of missions, from Earth orbit to deep space exploration. As you can see in the graph below, over 70% of RocketLab’s revenue came from its Space Systems business segment in FY 2023. In Q1 2024, this metric remained unchanged and, therefore, launching rockets is a foundational yet shrinking aspect of RocketLab’s business. From studying RocketLab´s Space Systems segments I’ve learned that the company is capable of major civilisational advancements and efficient M&A.
Before getting into these two takeaways, it’s worth considering the TAM (total addressable markets) of both of RocketLab’s business segments. As Beck explains in the Q1 2024 call, launch is a $10B TAM, spacecraft or services spacecraft is about $20B, and then services from orbit is about a $320 billion TAM. Ultimately, by providing launch and spacecrafts RocketLab is evolving into a platform capable of capitalising on the $320B opportunity that essentially consists of operating spacecrafts that send data back to Earth. I also believe that over the long term plenty of new areas will emerge within the space industry that will expand these TAMs–e.g. asteroid mining and so forth. To me these numbers were not apparent at first, and I was especially surprised by the TAM for services.
RocketLab is well suited to capture a good part of that TAM per the missions they have performed over the past few years, which have pushed our civilization’s ability to explore space. The most insightful of these missions was CAPSTONE, which was successfully executed in Q2 2022. This was humankind’s first return to the moon since NASA’s Artemis mission in 1970. Initially, CAPSTONE was launched into lower orbit on an Electron rocket. From there the in-house-designed and -built Lunar Photon spacecraft (an iteration of the original Photon launched in 2020, made 100% by RocketLab employees) set CAPSTONE on a ballistic lunar trajectory. Since, CAPSTONE has been flying on and testing the Near Rectilinear Halo Orbit, on which NASA plans to deploy a space station in the future. In the illustration below, you can visualise what this orbit looks like.
What’s fascinating is that this mission unlocks other deep space missions using small rockets, bringing the cost down from billions to millions of dollars and the time required to plan and execute from a decade to just a few years. RocketLab had to design an efficient trajectory which allowed them to get to the moon without using much fuel, as NASA did in 1970. Additionally, this mission carried the heaviest payload to date, coming in at a total of 320kg. More than a spectacular innovation from a civilisational point of view, this mission also succeeded in pushing pre-existing capabilities, despite the enormous complexity of the challenge.
The Varda mission in Q1 2024 also caught my attention. RocketLab sent one of Varda’s manufacturing capsules, which produces pharmaceutical crystals. Varda is a microgravity-enabled life sciences company that processes materials in orbit and returns them to Earth. These crystals confer new properties when synthesised in a low-gravity environment. The world’s first space manufacturing mission, it was also the first time RocketLab successfully executed a capsule reentry, “absolutely nailing” the target, in Peter Beck’s words. This makes RocketLab one of only two companies in the entire world with spacecraft reentry capabilities. While I lack comprehensive knowledge of the space industry, RocketLab appears to be an extraordinary company.
I could outline many such recent missions. But the main takeaway is RocketLab’s capacity for great innovation in Space Systems. I’m relatively confident at present in their ability to continue innovating and capturing a growing share of the $320B TAM over time. As mentioned, the second main takeaway is RocketLab’s M&A. The segment has developed over the years primarily by acquiring companies and integrating them into the chain of command. Its successful evolution denotes management’s ability to analyse, manage, and integrate cultures.
While business experts qualify 90% of worldwide annual M&A operations as failures, RocketLab has managed to successfully integrate three businesses since IPO. In 2021 RocketLab acquired ASI and Planetary systems, which focus on flight/mission simulation software and spacecraft separation systems, respectively. Toward the end of 2021, RocketLab acquired SolAero, a leading manufacturer of space solar power panels and precision aerospace structures. The SolAero acquisition came with the world’s largest space solar panel manufacturing site, located in Albuquerque. Reading through the various quarterly earnings call transcripts over the past few years, I’ve seen numerous examples of RocketLab contracts involving the deployment of technologies across all three acquisitions. A significant proportion of these missions push humanity’s space exploration frontiers.
By Q2 2022 ASI had successfully deployed MAX flight simulation software for 12 Electron launches. In Q1 2022, RocketLab signed a $143m deal to supply the Globalstar constellation with 17 spacecraft buses. The spacecrafts were contracted to feature components and subsystems produced by its acquisitions, including solar panels, software, and reaction wheels–the latter of which coming from Sinclair Interplanetary, which RocketLab acquired in March 2020. Although the purchase price for Sinclair was not disclosed, RocketLab verifiably spent just over $200M on the other three acquisitions. The Globalstar deal alone has produced nearly as much cash to date. As of Q2 2024, RocketLab allegedly remained “on track” to execute against the Globalstar contract.
Another great example is the VICTUS HAZE mission, scheduled for 2025. RocketLab signed the $32M contract with the U.S. Space Force in Q1 2024. The mission is set to showcase the results of RocketLab’s aforementioned vertical integration strategy. This is the first mission that RocketLab will fully operate, end-to-end. How well this mission goes will give great insight into RocketLab´s M&A strategy and performance. Separately, the fact that NASA has entrusted RocketLab with the mission is itself a notable achievement. Here’s what Beck had to say about the mission in Q1 2024:
This one is really a full end-to-end mission solution that will really show off the success of a vertical integration strategy. We'll be designing, building, launching, and operating the spacecrafts to demonstrate technically responsive space for the Department of Defense.
The spacecraft will come with all of their own components, including propulsion systems, solar cells, erection wheels, star trekkers, flight ground software, spacecraft on and on and on it goes.
Then we will fly it on Electron, and once it's in space, we'll be operating it to demonstrate [Technical Difficulty] with another spacecraft in orbit, which is a highly sought-after capability for the DoD.
And I should mention that our task is to launch the spacecraft within 24 hours' notice from the Space Force. It's the first-time we've sold a complete end-to-end mission solution and to a prestigious customer as well. It's a super exciting mission that showcases our ability to meet the DoD's growing need for rapid and responsive orbital capability.
Peter Beck has reiterated in the various quarterly conference calls that customers most value timing. According to Beck, “delays are incredibly costly to customers” in this business, leading to him citing “rapid and responsive” capabilities. Prior to the Q1 2024 call Beck discussed his intent to move into this space. The aforementioned deals signal good progress on this front.
At present, RocketLab operates three launch complexes, which, according to Beck, situates the company optimally to deliver responsive services. In the Q2 2022 call, CFO Adam Spice mentioned that responsive missions come with a 15-20% premium, offering RocketLab an opportunity to flip operations into the black. Beck’s words in the Q2 2022 earnings call provide more operational context:
When we talk about responsive space, we're talking about the ability to rapidly replace or replenish new assets on orbit. This is a critical and growing need for government and commercial operators alike, because the unavoidable truth is that satellite do fail. Whether they age out, experience technical failure or are disabled through deliberate actions, all satellites are vulnerable.
To a responsible launch on Electron, we can replace these assets in a matter of hours or days, not months or years, but we also know that launch is just one piece of that puzzle, which is why we can also have Rocket Lab designed and build satellites on the ground 24/7 awaiting the call to be integrated with the customers payload and launched rapidly.
In Q2 2023 RocketLab purchased Virgin Galactic’s Long Beach manufacturing facility in California. Beck pegs this facility at $100M–RocketLab paid $16.1M. In the Q2 2023 call Beck stated he believes this facility will act as a “scaling enabler” for propulsion manufacturing. While I haven’t found anything to suggest progress on this front, I believe this investment may rear its head as the company seeks to scale the production of the Archimedes engine, which will power the Neutron rocket. Much like the VICTUS HAZE mission, Archimedes will yield valuable insights into the company’s ability to execute M&A and perform, indicating the status of internal culture moving forward.
Wrapping it up.
RocketLab exhibits clear signs of organisational excellence. While it doesn’t produce cash, and the balance sheet isn’t overly abundant in cash, progress on aforementioned KPIs indicate that fixing this situation likely is only a matter of time: RocketLab seems to have the process power required to succeed. While, financially, the development of the Neutron rocket is weighing down progress on the Electron, I believe the investment could pay off handsomely over the next decade. Indeed, moving into the middle segment of the launch market only makes RocketLab’s operations harder to imitate, with a vast runway ahead. Space is in fact the next frontier.
Further, RocketLab’s achievements within Space Systems suggest the company will be capable of capitalizing on its launch capabilities, capturing a meaningful share of the aforementioned $320B services TAM. RocketLab is building a platform that will likely expand beyond this TAM and serve as a trampoline for others to do all manner of productive galactic endeavors.
I often note the universe’s abundance. Out in the deep black of space, many of the Earth’s scarcest resources can be found in unfathomable volumes. If RocketLab continues executing its algorithm, the odds of becoming a major facilitating player in this space–so to speak–are meaningful. In the meantime, I will continue to study the company quarterly. Valued at just over 10 times sales, the market is not unaware of the RocketLab’s notable organizational properties. However, at a market cap of just $5B, the upside is vast if the company manages to get its affairs in order in the coming years.
Until next time!
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Great write up Antonio, I enjoyed it a lot. I'm trying to do more research again in disruptive innovative companies similar to previous investments made (and still hold) in Tesla, Bitcoin.
Different ways are needed to spot these potential opportunities early (although I've shifted more to waiting for strong evidence that a CF BE will be hit without a company needing to do big raises, after some small loses in earlier stage companies as well).
Process and operational power is one potential tool in the arsenal to spot this. I like vision, long-term allocation of resources, efficent use of resources, speed of execution and innovation, ability to attract top talent.
Personally I've seen a shift in myself after the pull-back in 2022 to focus a bit later in a companies stage (ie in this case, perhaps once they reach BE or very close to) but I'll do a deeper dive into them for sure :)