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Rocket Lab Goes on the Defensive and Diversifies

Just about any bit of positive or negative news is enough to send a stock soaring or sinking in today’s meme-ified metaverse of investing. The trend has made the real news events, like year-end earnings reports, seem more anti-climactic than ever. Such was the case a few days ago when Rocket Lab (RKLB) released its 2023 results. It was pretty much a non-event after investors had punished the company a month earlier after it had revised its Q4-2023 guidance downward and announced $355 million in convertible notes. 

Click for Rocket Lab company website

The double news whammy sent Rocket Lab stock down nearly 20% at the time because a) investors do not like to learn that company revenues are going to fall short of expectations regardless of the reason and b) they definitely do not like the prospect of share dilution (more on that later). That meant, short of any other big revelations, the stock barely budged when Rocket Lab’s charismatic CEO Peter Beck did the company’s big year-end wrap-up at the end of February. Still, there was plenty to unpack from the numbers and the news from one of the most popular stocks that we cover.

Launch No Longer Losing Money

Let’s get the more mundane stuff out of the way. Rocket Lab grew 2023 revenues about 16% from the year before to nearly $245 million. More importantly, from our perspective, the company more than doubled gross margin from 9% in 2022 to 21% in 2023. That’s been a real sticking point for us in terms of investing in Rocket Lab stock. It appears the company is figuring out the right revenue mix so that it can at least start generating some positive cash flow in the near future – even if profitability seems like it’s still in a galaxy far, far away. 

Rocket Lab revenue
Credit: Rocket Lab

One key development in that regard is that the company effectively broke even on launch services in 2023. It costs about $7 million per launch against $7.1 million in revenue. Compare that to the previous year when Rocket Lab lost about $800,000 per launch. Management credits a higher launch cadence with the decrease in costs. Those numbers should continue to improve as Rocket Lab shoots for an annual launch cadence in the mid- to high 30s with its workhorse Electron rocket in the nearish-term. Beck says the company has built the infrastructure, like launch pads and factories, around a production capability that could support 52 launches per year. That represents more than $350 million in annual revenue based on 2023 average launch revenue.

SpaceX 2023 estimated revenues.
SpaceX launch revenue is already 10X that of Rocket Lab’s projected future capacity based on 2023 launch revenues. Credit: Payload Space

That sounds pretty good until you consider that SpaceX already earned an estimated $3.5 billion – 10-fold of Rocket Lab’s best-case future revenue – in launch revenue last year, according to some number crunchers at Payload Space. Just four Transporter missions, which are the rideshare missions that carry dozens of payloads on a Falcon 9 rocket, made an estimated $180 million – more than double Rocket Lab’s current launch revenue. The ability for SpaceX to get stuff into space cheaper and faster than most small launch providers probably means that Darth Vader Elon Musk will continue to rule the galaxy for the foreseeable future. 

Rocket Lab Relies More on Defense Contracts

Of course, Rocket Lab is not just any other small-launch provider. It completed 10 missions last year and is already on pace to exceed that number in 2024 after two successful missions so far. The company plans to have its medium-launch rocket, Neutron, on a launch pad by the end of this year as well (more on that later). In 2023, Rocket Lab successfully launched a new commercial vehicle, the Hypersonic Accelerator Suborbital Test Electron (HASTE), which uses a modified Electron rocket to carry larger payloads for suborbital missions – mainly for U.S. military and spy agencies. The company signed 25 new launch contracts last year, including 18 Electron missions and seven HASTE missions. The need for a company not named SpaceX to offer launch services should help keep Rocket Lab competitive.

Timeline for Neutron rocket.
Timeline for Neutron rocket. Credit: Rocket Lab

Rocket Lab is also no longer just a launch company. Its Space Systems division accounted for more than 70% of revenues in 2023 and is expected to be a major driver of growth on the back of two big contract wins. In February 2022, Canadian space company MDA (MDA.TO) awarded Rocket Lab a $143 million subcontract to build 17 spacecraft as part of a satellite communications network for a company called Globalstar (GST). More recently, Rocket Lab scored a $515 million prime contract with the Space Defense Agency (SDA) to build 18 satellites. 

It’s the biggest contract in the company’s history. Between the HASTE program and SDA contract, Rocket Lab is joining the ranks of aerospace defense companies like Lockheed Martin and Aerojet Rocketdyne. On one hand, that’s obviously good for business. On the other, Rocket Lab becomes more reliant on government customers to make ends meet, and that represents its own set of risks, as we often warn investors. 

Rocket Lab Eyes Further Diversification

Still, the company is making good on its goal to diversify and move beyond being a pure play on rockets. Last month, it unveiled its portfolio of spacecraft, which includes its original Photon vehicle and others designed for deep-space missions to planets like Mars and Venus. The shift started in 2020-21 with a series of acquisitions that has turned it into a satellite and space components manufacturer. The latter business, according to management, is helping boost gross margin. Rocket Lab CFO Adam Spice specifically called out the MDA subcontract and a component called a reaction wheel, a sort of flywheel that enables precise control of a satellites positioning and orientation using stored rotational energy.

This year will be a very good year for growth in our reaction wheel business, particularly tied to that one mega constellation deal that we announced a couple of years ago.

Rocket Lab CFO Adam Spice

Remember that $355 million in convertible notes issued by Rocket Lab? The company is using some of the money to retire about $40 million debt and fund completion of the Neutron rocket. However, management is also keen to acquire additional companies to complement its current capabilities and support its goal to rule the galaxy expand its space services.

I would say we have a reasonable focus on payloads…  as a prime now on the SDA mission, the only thing that we’re not really doing [is] the actual payloads and sensors, so I think that’s obviously an area of interest. And I’ll remind you that the end goal here is not just to be a bus provider or even a prime. It’s to ultimately have our own constellation in orbit providing services, because that’s where we ultimately think this all goes. … It’s not about buying revenue. It’s about making sure we have the capability in-house and with the end goal of doing our own thing in the future.

Galactic Star Lord and Rocket Lab CEO Peter Beck

While management did not name names of possible acquisitions, CFO Spice did say that the current valuations attached to some public space companies make them more affordable than startups. That certainly jives with what we’ve seen happen among space stocks, many of which were launched through mergers with special purpose acquisition companies (SPACs). Most of those companies have seen their valuations plummet or have outright gone bankrupt. Meanwhile, investment in space startups remained strong at $4.6 billion in 2023 despite a tough fund-raising environment last year due to rising interest rates. Space infrastructure was particularly hot, according to Crunchbase.

Still a Bumpy Road Ahead

Rocket Lab is looking more investable, as it scales operations and diversifies revenues, which has helped improve gross margins and win new business. However, that $355 million in convertible notes raises some obvious concerns around shareholder dilution, which one estimate places at between 12% and 14% based on the fully converting 69 million outstanding shares. On the plus side: There was enough interest from investors to exercise a $55 million option, so basically it was an oversubscribed funding round that shows institutional faith in the company. The additional cash helps position Rocket Lab to pull the trigger on any M&A deals quickly if the right opportunity arises.

Graph showing Rocket Lab's Net shares issuable upon conversion
Rocket Lab management said it opted to finance operations through convertible notes because it offered the most flexibility to “run the business the way that we think it needs to be run” and had the “lowest cost to capital” versus other kinds of straight debt options. Credit: Rocket Lab

Probably the biggest risk for Rocket Lab right now is the Neutron rocket. The company is investing a lot of resources in its success in order to compete with SpaceX and other competitors in the launch market. While Neutron may be on the launch pad by the end of the year, as we noted earlier, that does not mean it will be ready to fly missions by Dec. 15, the deadline to apply for the multi-billion-dollar National Space Security Launch (NSSL) program with the U.S. Space Force. A Congressional memo leaked last month suggests that Rocket Lab has overstated the readiness of the rocket to compete for the NSSL contracts using Neutron. Even if Rocket Lab misses the deadline, it can apply for other NSSL business in the following years, so it seems like the company is probably just being aggressive in its PR rather than outright dishonest. 

Conclusion

Last year, we compared Rocket Lab stock against MDA stock to see which space stock we liked more. We gave the edge to MDA for its diversified revenues and more reasonable valuation. At the time, Rocket Lab shares were trading at a simple valuation ratio (SVR) of 15 compared to 1 for MDA. Today, Rocket Lab’s SVR is closer to 9, while MDA has inched up to 2. If Rocket Lab hits its Q1-2024 mid-range guidance of $95 million, that drops the SVR down to 6, which is right in line with the average in the Nanalyze Disruptive Tech Portfolio. An SVR in that range, combined with the company’s improved margins thanks to its increasingly diversified business, means it might finally be time to consider holding Rocket Lab stock.