Rocket Lab: Stellar Innovation, Stock On Hold

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Introduction

The core argument of this piece is that the main engine propelling Rocket Lab's (NASDAQ:RKLB) valuation and potential profit expansion is its Space Systems business segment. However, despite its expansion, the stock is somewhat overpriced. Therefore, I suggest postponing any immediate purchases. Rocket launches draw significant public and analyst attention, the quieter, less visible manufacturing side of the business is the primary driver of value and future growth. The company's ability to increase revenue while decreasing costs in its Space Systems segment demonstrates a capability to execute effectively in a growing production environment. The company's manufacturing segment also benefits significantly from any major constellation business wins, as these can heavily increase backlogs, enable further economies of scale, and higher gross margins. On the other hand, the rocket launch segment, while showing considerable top-line growth, faces challenges due to its inability to reuse rockets, leading to gross profit difficulties.

The Quiet Machinery

While revenue may have increased slightly in the Space Systems Segment YoY, the costs of revenues have dropped and gross profit has increased significantly (58%) showing their ability to execute and reduce costs in an expanding production environment. While a favorable mix of products can cause gross profit fluctuations, their guidance for Q2 from this segment proves continued Q1 23 gross margins were in fact not a fluke.

This manufacturing business is also a massive beneficiary of any sort of constellation business win. As can be seen from this TechCrunch article, one single program win can double the backlog and enable further economies of scale off of these manufacturing lines. This large win was just for a single component of a satellite, this sector of the business is vertically integrated and if they end up producing a satellite constellation (either owned by them or made for someone else) it would be a massive win for an operational successful side of the business. As detailed by Peter Beck (founder and CEO) in the latest earnings call:

Peter Beck

Yeah. So, on the Space Systems side we are getting a lot of increased kind of high-value opportunities for not only on the component side, but also on the full spacecraft side of things. This is -- the way that we've constructed the Space Systems business is that we're not going after kind of small 1z, 2z opportunities.

We're going after large chunky programs then when they do close, will be meaningful movers to overall backlog. So I would say that, we continue to see momentum and kind of progress towards, but those deals have taken a little bit longer to close, I would say, than smaller deals, which kind of makes sense.

This side of the business has expanded organically and through various acquisitions. Below is a list of acquisitions and their various structures.

A total of $121 million of cash plus shares was used to acquire the core manufacturing business which is now bringing in ~$160M - $200M in revenue next year. These acquisitions were also made during a period of increased valuations and yet the management team was able to successfully purchase these business at a fair valuation and operate them to great and scalable success.

As seen through the recent acquisition of Virgin Orbit's manufacturing plant management is constantly looking for opportunities and I believe that the collapse of many small launch providers and the spotlight of investor focus shifting to AI/ Big-Tech provides unique opportunity for Rocket Lab to expand horizontally and vertically in this space. I believe the establishment as a full-service satellite factory will enable them to eventually innovate or acquire into the high margin consumer and government focused services. I believe a key target may be PL or RDW.

Launch Systems

While there is significant Top Line growth for Launch Systems (+~200% YoY) the inability to reuse rockets also means that the cost of revenues scales with each launch (+177% YoY). Meaning that the gross profit here is challenging in the short term and makes RKLB fall into a similar unit economics of traditional rocket launch providers (everyone except SpaceX).

These challenges have led to multiple rocket providers to either go bankrupt or have to be forced to pivot dramatically in order to stay alive in a more capital restrictive environment.

This is also true for RKLB's launch business. The following is again from the latest earnings call:

Peter Beck

[...] but I would say, again, we're on track to 15 this year, 20 next year on exiting at a rate of 24, and then we'll see where it goes from there.

At an assumed revenue of $7.5 million per launch and 5 launches per quarter (not including Q4) this puts launch systems est. yearly revenue ~$157 million and assuming 10-15% GM this puts about $15 million - $20 million in term of gross profit next year from launch. Assuming a terminal launch rate of ~30 launches a year for the self-described "niche" electron and an assumed margin improvement to 20-25% (similar to SpaceX margins) this business unit would provide ~$210 million revenue and $42 - $52.5 million GP. The upside to the Electron Rocket is limited by the ability of missions like Transporter-8 to ride share along a single rocket. This single Falcon 9 launch has an estimated price tag of $52 million. In comparison this launch had an estimated payload of 5,000kg and would have taken 16 Electron launches and cost $120 million for Rocket Lab to deliver the same payload to the same assumed orbit.

This is why we see a pivot into the HASTE and Neutron development. There just isn't a large enough market for small launch.

Valuation

Business Segments

At a currently profitable and growing business segment I value Space Systems at ~FWD EV/Sales of 5X due to the ability of this business to grow profitably and the high potential of huge high margin contracts. At an estimated $160-$200 million next year that values Space Systems at $800 - $1,000 million.

The value of launch systems segment can be split between Electron and their future development projects. I believe the electron business is worth ~FWD EV/Sales of 3x because of its seemingly capped ceiling in terms of launch cadence, and lack of large upside potential. At an estimated 21 launches next year and an estimated capped demand for the satellite business around 30 launches puts the value of this part of the business at $600-800 million.

The HASTE and Neutron Opportunities are much tougher to model at this time because a lack of clear market dynamics for HASTE and hypersonic test beds. Neutron is the future of the launch side of the business but until it flies commercial flights or has booked customer, I am hesitant to value it in to the value of the business as a function of revenue. So I value it at roughly the cost of development * 1.6 factor = $250 million * 1.6 = 400 million. The reason I chose this valuation metric is because I believe that if the program was to be sold off piece-meal it would sell off for roughly this price.

Balance Sheet

Typically when a company is burning cash quarter over quarter, I discount the net cash of the business by roughly their 3-year burn rate. For example if a company has $300M dollars of cash and no debt but they are burning $100M annualized then the balance sheet is worth $0 for my calculations.

RKLB currently sits has a balance of $446 million in cash and short-term investments as well as a net cash of $249 million. Their annualized burn is roughly $140 million a year. This would value their cash reserves at $-171 million for my model. But due to the structure of their debt being interest only as well as the proven ability of the company to manage cash well I am only going to discount the cash and short-term investments by the 3x burn factor instead of the net cash which puts the value of the balance sheet at ~-$26 million. Essentially a net wash. Based on Q2 target of 480 million shares, this puts my fair value assessment of Rocket Lab at ~$1.8-$2.2 billion or $3.75-$4.60 per share. When Rocket Lab reaches this prices level, I will list it as a Strong Buy. At current prices at ~$5.50 a share ,I am taking advantage of the recent run up and I am selling covered calls in the $6-$8 range

Risks

As the title foreshadows, I believe in this company's ability to innovate but I also simultaneously believe that at current valuation levels that it is fairly priced to slightly overpriced and I will look to dollar cost average lower through selling cash covered puts and covered calls.

Having a hold position offers risks both to the upside and downside. I believe risks to the potential upside include large contract wins on the space systems side, Neutron development moving ahead of schedule and the HASTE market being larger than a few launches a year.

Risks to the downside will be the macroeconomic conditions negatively affecting RKLB's customers as well as the potential of rocket failure. There are also risks of medium launch companies developing, launching and booking customers before Neutron is able to successfully launch.

Conclusion

Rocket Lab's value and potential growth are primarily driven by its manufacturing segment, specifically its Space Systems segment. The company's ability to increase revenue while reducing costs, especially in a growing market segment, and its propensity to benefit from significant constellation business wins, illustrate the strength of this part of the business. These factors contribute to a promising future outlook for Rocket Lab, despite challenges in the rocket launch segment due to the inability to reuse rockets and grow margins significantly.

The company has shown a strategic approach to expanding its manufacturing capabilities through key acquisitions and a keen eye for potential opportunities. This suggests that Rocket Lab is well-positioned to continue its growth trajectory by capitalizing on existing trends and its strong balance sheet.

It's important to recognize that there are risks involved. This includes the company's ability to secure large contracts, the pace of Neutron development, and the size of the HASTE market. Additionally, macroeconomic conditions and potential rocket failures could adversely impact Rocket Lab's business. Despite these risks, Rocket Lab's robust manufacturing segment provides a strong foundation for the company's future growth.

Moreover, the valuation of the company appears to be fair to overpriced at present, with some room for adjustment based on future performance and market conditions. However, investors should continue to monitor Rocket Lab's performance as well as broader market trends and conditions, to make informed investment decisions.