There is a tendency among space buffs to focus on next-generation technologies and cutting-edge science. An important factor that drives engagement with space is grounded in more everyday concerns about making money. The space sector can ultimately be thought of as simply another area of business. And there are changes afoot in the business of space. The role of venture capital is growing. To learn about the role of venture capital, we spoke to Justin Cadman. He is a partner at Quilty Analytics, an advisory firm servicing firms in the space sector.
For private investors focused on the space sector, how have their investment patterns changed in recent years?
The space sector is undergoing rapid change and growth across the ecosystem.
Aside from satellite communications, most of the commercial venture space segment (Venture Space) is still embryonic. It is evolving rapidly, as any young and promising industry would be at such an early stage in its lifecycle.
In order to fully understand the evolution of recent investment patterns, some backdrop is useful. There are numerous factors which have contributed to the growth of Venture Space over the last decade, despite the space sector’s historically poor alignment with the venture capital investment model. Venture capital investment decision-making is heavily influenced by the typical fund’s ten-year life. During that time, a fund is architected to generate 20% or more in terms of portfolio internal rates of return (IRRs) to limited partners. This is done by underwriting individual investments to 30%, 40%, or more in terms of IRRs (depending on the target stage and risk). Venture Space companies are often capital-intensive, hardware-centric, technically challenging, and serving immature end-markets – all while taking years to gestate.
Given all this, what transpired over the last decade to push the Venture Space market from “zero to sixty,” inspiring a vibrant ecosystem of players? A key part of the answer, now obvious in hindsight, is the lower cost of access to space, driven by novel launch solutions. The early and well publicized commercial success of SpaceX created a surge of venture investor interest. In many cases, these were the same investors that historically viewed space as a slow-growing, capital intensive, government-dominated sector – in other words, the anti-venture capital target industry.
SpaceX’s success was transformational to the industry for four reasons. First, it proved that a capital-intensive hardware business like launch services could potentially meet a venture fund’s hurdle rate. Second, it created a sense of “don’t get left behind” or “fear of missing out” (“FOMO”). Third, it enabled other new business models that are dependent on lower-cost access to space. Fourth, it triggered culture shock within the well-established, but often-complacent, ecosystem of incumbent space contractors.
With lower cost to access space, new approaches to space took hold. These new approaches are pushing the industry dramatically forward. Small satellite systems, distributed constellation architectures, the use of iterative development approaches leveraging low-cost commercial components – such innovations have helped to dramatically reduce the cost of space markets. (What they do not do, however, is assure top-line revenue success.)
Add on top of all of this the fortuitous timing of a generational financial markets rally during the recovery from the Great Recession of 2008/2009. While of course not specific to the space sector, the expanding risk appetite and the hunt for outsized returns that accompanied the economic expansion pulled new investors into frontier technology sectors like space.
With this backdrop in mind, where does this lead us to the original question about recent trends? Over the last decade, lower-cost access to space and innovation in space systems development have empowered a wave of investment activity in everything from satellite communications (satcom) to Earth-observation (EO) and space infrastructure (Enablement).
Activity has occurred in several waves of end-market focus. The first major wave, roughly from 2013 to 2016, was largely about cubesat-driven markets and smallsat-based Earth-observation. This aperture expanded quite a bit from roughly 2016 to 2019, to include satcom (IoT and LEO Broadband). Meanwhile, still more challenging subsectors (even in the context of space tech) gained traction in 2018 and 2019. There were, for example, a wave of new launch startups and direct-to-device communications platforms with significant investor backing.
Over the next few years, we anticipate market growth to pick up where it left off prior to the Covid-19-induced pandemic. There will be growth driving innovation in new satcom hardware as well as a continued convergence of satcom with the broader telecom industry. Further, we see continued adoption of downstream Earth-observation platforms and data analytics taking hold, leveraging cloud, AI, and computer-vision technologies. On the Enablement front, smallsat systems in the range of 100 to 300 kilograms will serve an expanding array of end markets, while the landscape of smallsat launch players will likely consolidate. Further on the horizon, new commercial players may find opportunities to exploit interest in human spaceflight, cislunar/lunar activities, and beyond. This will particularly be the case as government agencies increasingly partner with commercial entities (e.g. NASA working with SpaceX on its Commercial Crew Program).
Following a decade of thriving Venture Space activity, the industry is vibrant but at a key inflection point. Investors need to see more success stories via critical mass end-market breakthroughs or exits via mergers and acquisitions.
While a small universe of core investors was the primary driver of Venture Space investment in the 2013-to-2016 period, the universe of investors expanded greatly in the 2016-to-2018 period as the sector became higher profile. We anticipate that the early investors will be taking a breather over the next few years as they evaluate the success of their existing space portfolio companies. And some of the new entrant investors who came in during 2018 and 2019 will move on to other sectors given the changing financial market risk environment in the wake of Covid-19. Meanwhile, new investors will enter the fold in years to come as the industry attracts media attention and as business models mature.
Most of the investment activity into the sector to date has been via venture and corporate venture capital in the early-stage company category. There has been less activity by private equity firms and corporate or strategic investors, at least within the early-stage community. This is because, generally speaking, these investors are primarily focused on revenues and profits, with little interest in pre-revenue companies with attractive but unproven potential. Likewise, most space startups are not well-suited to public equity markets at least in the near term.
Thus, while the last decade could perhaps be characterized as an early-stage Venture Space renaissance, the next decade will be defined by the maturation of most subsectors while a few other subsectors simply stall out.
As private investment takes on a more prominent role in the space sector, how is this affecting the sector’s overall direction?
The biggest contributing factor to the sustainment of Venture Space investment growth is the expansion of civil and defense government space programs like Artemis and the Space Force. These are only examples from the United States, of course. Globally, though, governments are pursuing their own space interests. Their programs support the Venture Space ecosystem.
Historically, Venture Space companies have been reluctant to focus on government end markets, but that attitude has been gradually shifting, jolting forward noticeably in the wake of Covid-19. Commercial space end-markets are likewise growing but are still mostly nascent; they represent upside and option value with modest near-term revenues, though with very high long-term potential.
In the end, it’s important to remember that space is not a business model but just an environment from which a business model is enabled. The Venture Space industry must rapidly head toward revenue generation. This will mean different things in different space end markets.
How did you come to focus on the intersection of private investment and the space sector, and what opportunities exist for individuals with similar combinations of interests?
Our firm is unique in that our team’s financial industry heritage and space sector expertise dates back to the early 2000s. As a group, we’ve observed space investment trends across multiple industry and economic cycles. We’ve been covering the industry since well before the current tidal wave of activity. We feel that this grounding helps us understand not only the Venture Space sector’s origins but also where it might be heading.
The sector is certainly attracting a wide range of new stakeholders, which is great for all involved. However, if you’re a newcomer to the industry during the last few years, your perception may lack historical perspective about the foundation on which the industry has been built. Investors will always find a new fad, but even as some of the recent Venture Space investors move on to other new shiny objects, the space industry has already reached a key inflection point. There will be changes, of course, and as a whole we expect the space ecosystem to develop and prevail on a stronger, more sustainable footing in the 2020s.
Opportunities in the sector still abound but finding the Venture Space whitespace will be harder in the decade ahead. There will be failures, survivors, and unicorns. Next-generation space firms will provide inspirational stories for humanity as SpaceX is doing now.