I For One Welcome Our New, Scaly Overlords…

Well, it looks like Rand and Clark and Jeff are too busy blogging about the New Space conference to start synthesizing things yet, so I’ll just make some comments on the big news from yesterday. In case you don’t read Space Transport News every morning like most of the rest of us, it was announced yesterday that Northrop Grumman is buying out Scaled Composites. Unbeknownst to much of the alt.space world, Northrop has actually owned 40% of Scaled for some time now, possibly several years, so this move isn’t quite as surprising to me as to some others.

Now, while some of the comments I’ve seen about the acquisition seem to “get it” (particularly comments from Nathan and Ferris over on Hobbyspace, and surprisingly enough, Mark Whittington as well), there still seems to be a lot of people who are worried that this will become a case of a “big dinosaur company gobbling up a plucky alt.space mammal.” On the contrary, I would argue that not only is this acquisition likely to be a net win for Scaled, but in fact it may be one of the most important events this year for the future of commercial space development. Here’s some thoughts on why:

Northrop’s Skunkworks
First off, lets talk about why this particular deal is likely going to be win-win for both Northrop Grumman and Scaled Composites. Unlike Lockheed Martin, who has Skunk Works, and Boeing that has Phantom Works, Northrop Grumman really doesn’t have an lean-and-mean R&D shop of the same caliber. Scaled comes with a reputation in that area that compares well with Northrop Grumman’s competitors’ secret projects shops, has the capability of doing important work very quietly, and has a longstanding relationship with Northrop.

With the size of Scaled’s existing revenue streams, I wouldn’t be surprised if the buyout was worth over $100M. Northrop isn’t about to screw with a system that works so well that it’s worth that kind of money, especially with how much Northrop would benefit from continuing to run Scaled the way it has been run.

The reality of Scaled is that Burt Rutan is eventually going to retire. Using Esther Dyson’s meme of startups being either “toys” or “children”, it is apparent that Burt is smart enough to realize that if he runs Scaled like his own personal toy, it won’t outlast him. He’s taking the probably painful step of letting his child grow up. By taking steps now, there’s a good chance that Scaled will continue on long past his retirement as one of the world’s premier aviation prototype shops.

I’m sure having a huge infusion of capital won’t hurt Burt’s aviation or space projects very much either.

Now, there are some real risks involved in such an acquisition process. Things don’t always go smoothly, and there are bound to be some clashes of corporate culture even if Northrop tries to take a very liberal approach with Scaled. Things may yet get botched, but if they do, it will be because the execution was botched, not that the deal was a bad idea from the start.

Selling out to “The Man”
One of the comments I’ve seen many make is that Northrop is just buying Scaled to squash the competition. This meme of big, bad dinosaurs trying to maliciously destroy their mammalian competition needs to die. But this meme is even sillier in this particular case. I mean, what business exactly is Northrop supposed to be protecting by squashing Scaled? In fact, if we’re talking about manned suborbital flight, none of the dinosaurs really have much to lose, because none of them are involved in that market.

More to the point, I’m not sure I’d even be worried about things if Boeing or Lockheed were the ones doing the acquisition. There may have been a time in the past where it was in the economic self-interest of some of the “dinosaurs” to squish their “mammal” competitors, but if there ever actually was such a time in the past, it doesn’t appear to be the case any more. I mean, it should be an eye opener when the head of Exploration Systems for a dinosaur company is singing the praises of a launch vehicle being developed by one of their competitors. More to the point, and I think this is going to be a theme to be developed over the course of many blog posts in the future, I think that most of the big aerospace companies are starting to see New Space companies not as threats to be beaten, but as opportunities for collaboration. I truly believe that we’ll see many examples over the next decade of alt.space and big.space companies working together to achieve things that would’ve been impossible to achieve alone. Heck, even some small parts of NASA are showing some positive trends in that regard.

Once again, the caveat has to be said that sometimes mammals can be squished accidentally even when the dinosaurs are trying to play nice with them. When you have firms of drastically different size working together like that, things have to be thought through carefully, because there are many ways the collaboration can be screwed up. But even with that caveat, I think that more often then not it is worth the risks to both sides to try and collaborate where common ground can be found.

But more on that at a future date.

Liquidity Events and “The Netscape Moment”
The last point I want to make about this deal, and the one that I think will be by far its most important impact, is what it means for investment in this industry. Investors typically don’t risk large amounts of money investing in startups with the intention to just hold the resulting stock indefinitely. As one investor put it, if they wanted dividends, they’d buy utilities, not invest in startups. What investors want is a realistic exit strategy–basically an exit strategy is some way that down the road they can get their money back out with a severalfold increase. Since most of these startups are privately held companies, in order for investors to be able to “exit”, there has to be some sort of “liquidity event.” Due to both SEC restrictions, and the typical form of resulting stock agreements for privately held companies, it is very hard to actually sell stock held in a privately held company. In order to easily convert that stock back into liquid assets, the easiest way is if the company’s stock becomes public. Which leads to the two main types of liquidity events that I’ve heard discussed for alt.space type companies: acquisitions by publicly held companies, and IPOs. Acquisitions being by far the most likely type of liquidity event for most alt.space companies.

Basically, as I understand it, when a private company gets bought out by a publicly traded company, the publicly traded company will usually buy the startup out using stock instead of cash. If an investor owns 10% of the privately held company after money, he’d get 10% of the stock in the public company doing the acquisition. That investor can then turn around and sell those stock to get his money back out to reinvest in other projects. [Note: if Steven or any other of the more investment savvy people are reading this and would like to provide clarification, I’d love to have your comments].

What this transaction shows investors is that there really is a realistic exit strategy for successful alt.space firms. When investors start realizing that they can put money into a promising alt.space startup, and that if all goes reasonably well the company has a good chance of getting bought up by a big, publicly traded aerospace company a few years down the road, you’ll start seeing more investors willing to make the plunge. When people start seeing that it really is possible for them to turn a small fortune into a bigger one in this industry (instead of the other way around as the joke usually goes), you’ll start seeing a lot more of them becoming interested. As it is, without valid examples of good exit strategies in and industry, its hard to attract much investment even if you have a rock solid business case and a top-notch team.

Now, I think this particular deal isn’t like our industry’s “Netscape Moment”, I think we’re definitely getting closer. I also doubt that this acquisition is going to lead in the immediate near term to wholesale buyouts of alt.space companies by big.space companies. However, I wouldn’t be surprised to find out several years down the road that this event led to several big.space companies starting to make small strategic investments in the more promising alt.space companies, opening the door for future acquisitions.

So, if a couple of months or years down the road you hear about XCOR or Masten or Armadillo or even SpaceX “selling out to The Man”, it might be worth reserving judgment for a while. You never know what might come of it.

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Jonathan Goff

Jonathan Goff

President/CEO at Altius Space Machines
Jonathan Goff is a space technologist, inventor, and serial space entrepreneur who created the Selenian Boondocks blog. Jon was a co-founder of Masten Space Systems, and is the founder and CEO of Altius Space Machines, a space robotics startup in Broomfield, CO. His family includes his wife, Tiffany, and five boys: Jarom (deceased), Jonathan, James, Peter, and Andrew. Jon has a BS in Manufacturing Engineering (1999) and an MS in Mechanical Engineering (2007) from Brigham Young University, and served an LDS proselytizing mission in Olongapo, Philippines from 2000-2002.
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17 Responses to I For One Welcome Our New, Scaly Overlords…

  1. Brian Swiderski says:

    Ken,
    You make a lot of good points, but I wonder about something: What was the last commercially significant product to come out of either Skunk Works or Phantom Works? Have any of their developments in the past three decades led to radical departures in the status quo? Unfortunately, despite all the talent and money invested in them, upper management still decides what projects those resources are applied to, which is why the Pan-Am spaceplanes never materialized. The wizard shops in Big Aerospace were set to work building stealth bombers, not the future.

    My fear for Scaled is not that they’ll be liquidated, or interfered with on an operational level, but Northrop is clearly more interested in the capabilities of the business than in specific projects. While I agree there’s no immediate threat to Rutan’s space vision, there is also no guarantee (to my knowledge) that a few years from now HQ won’t decide the resources devoted it would be better applied to more profit-critical projects. Now, I doubt they’d abandon an established revenue stream from SS2, but I do think it’s unlikely they would be allowed to continue pursuing radical new commercial spacecraft beyond it.

    Even though Northrop’s intentions may be pure as snow, and their interest in Newspace genuine, they can’t escape the fact that they’re a publicly held company that must take the route of highest possible profit over shortest possible time. That means bloated cost-plus contracts, and anything else has to be somehow squeezed in between DoD projects. We haven’t seen the last of Scaled Composites per se, but the first generation of Virgin Galactic is the last time they will lead a revolution in space.

  2. Brian Swiderski says:

    Woops, sorry Jon – I thought the post was from Ken. Could have sworn I saw “murphydyne” at the bottom.

  3. Iain McClatchie says:

    Jon,

    Basic math slipup.

    Northrup Grumman (NOC) is trading at $77.70/share right now, and has a market cap of $26.8B. Suppose NOC acquired Scaled in an all-stock offer. It would issue 772 thousand new shares and exchange those with the 60% of Scaled stock that NOC doesn’t currently own.

    Those who previously owned 60% of Scaled will now own 0.37% of the combined entity.

  4. Jon Goff says:

    Iain,
    I wasn’t trying to suggest that someone who owned 10% of Scaled would therefore own 10% of Northrop. I was saying that they would own 10% of the Northrop stock that was given to Scaled as part of the purchase. Ie if Northrop gave Scaled $100M worth of Nortrhop stock for the sale, that a person who owned 10% of Scaled would therefore own $10M worth of Northrop stock, which he could then sell or trade publicly.

    ~Jon

  5. john hare says:

    >>>>>Woops, sorry Jon – I thought the post was from Ken. Could have sworn I saw “murphydyne” at the bottom. < <<<<< Brian, If it makes you feel any better, the writing didn’t have the usual flavor of Jon’s writing. I thought it was Ken’s also until I saw some of the trademarks and doublechecked the sig line.

  6. Ferris Valyn says:

    Brian S,

    If this was before the first flight of SS1, I think your concern about killing the space research might have a point. However, you yourself have pointed out that they won’t screw with an existing revenue stream (more likely they’ll want to expand it). That being the case, SS2 can be seen as an existing revenue stream (or at least one that they’ve invested to much into and simply walk away) for Virgin Galactic.

    So I think anyone who looks at it rationally realizes that, short of something major, Virgin Galactic will be flying SS2 by the end of the decaded. That being the case, the real question is whether VG can deliever in terms of the space tourism market, rather than whether SC can deliever SS2.

    So, if VG can show there is a market for sub-orbital tourism (and I expect they will), NG would have no reason to walk away from continued work on SS2 – indeed, they’d be more likely to invest more into it.

    That being the case, then the real demand for an orbital craft is more likely to come from Virgin Galactic (or some other carrier) NEEDING an orbital version, to sell tickets on, rather than Scaled Composites tinkering around. That would point to the carrier actually going out and soliciting a request for an orbital version (whether it comes from Scaled, or someone else, doesn’t matter so much). And thats why I think your seeing just as much come from Virgin Galactic about SS3 and SS4 as you are from Scaled Composites.

    The point is that the real challenge now isn’t proving the technology is there – its proving the market is there. And I suspect that Virgin will prove it.

    I am still not convinced that this is perfect, but I also don’t think the sky is falling. Truth is, I think its kinda too early to tell.

    BTW, while I’ve got your attention, I have to say, I am looking forward to your next “There is a Way” post. And I should also mention I am hoping you’ll join the yahoo group I started for bringing space to DK. click here for the link

  7. Ferris Valyn says:

    Jon,

    I must object – everyone knows that all modern day dinosaurs have feathers – I would argue we’ve seen the first true evidence of feathers evolving on the big guys (well, maybe the second).

    That being the case, our ne overloads aren’t scaly, but feathered
    😀

  8. Brian Swiderski says:

    Ferris,

    I agree that SS2 is a done deal, barring total catastrophe. However, it’s important to realize that the Spaceship Company is a joint venture between Scaled and Virgin–i.e., the latter is a partner rather than a customer, meaning that development expenditures will not likely be borne entirely by VG.

    So imagine that VG and TSC are both quite profitable, the space tourism business is exploding, and SS2s have become an industry standard. Who decides where the profit from Scaled’s share of TSC is directed? Will that be whoever is running Scaled, or will it ultimately be Northrop Grumman headquarters? If the latter, then there might be a problem–given good enough performance, shareholders will expect higher dividends. Also, customers will want more resources devoted to advancing the SS2 line, on which their businesses depend. If there’s no simple straight-line from SS2 to an orbital vehicle, there’s not going to be a business case from the viewpoint of the shareholders, the NG directors, and possibly whoever ends up replacing Rutan if/when he retires.

    Think about commercial aircraft for a moment. They’ve been manufactured for nearly a century, have been a massively profitable industry for most of that time, and yet despite drowning in money and customers they’ve been remarkably static: Commercial aircraft fly at the same altitudes, and virtually the same speeds as they did 40 years ago. And that isn’t because the businesses lack talent or vision, but simply because the risk of taking revolutionary leaps is too high. The more profitable Scaled becomes, the less likely Northrop will be to allow them to pursue quantum leaps without complete external funding.

    BTW, I went ahead and joined the Yahoo group yesterday. Sorry I wasn’t able to see your recent SRWN until just now, as I’ve been caught up with various things and only posting here and there on the fly. I’ll be starting my next TIAW soon, and probably I’ll post my intended topics in the group.

  9. Anonymous says:

    Well, they are “Scaled” Composites, after all, so maybe they found the right scaley mate. Seriously, though, I think it’s interesting that NG is getting involved this way (even if it’s more for air rather than space reasons) – and also sponsoring the Lunar Lander Challege and Zero-G teacher flights. The perception for future investors is important -lots of computer startups are funded in the hope of being bought out by a Microsoft type of company. Now it’s up to NG to provide the right environment – give Scaled appropriate resources without imposing the NG culture on them too much, or the golden goose (or at least the Scaled employees) may fly away.

    Ray

  10. Anonymous says:

    Unfortunately, SS2 will be the last of the private space projects to come out of Scaled. Once all of the little guys are eaten the status quo will be upheld until another little startup comes out with new technologies and business plans that would have been considered too risky for the public share holders to endure. RIP Scaled. It’s no longer a big player, and will stagnate at the SS2.

  11. Sam says:

    Mammals don’t die by being eaten by dinosaurs, they die by intermarrying with them–most of their genes are recessive. As long as Burt’s around, Scaled will be innovative. Maybe even for decades after he leaves. But corporate culture permeates and ultimately causes output to regress to the mean of corporate results.

  12. murphydyne says:

    See guys, that’s why I always note “by guest blogger Ken” right at the start of my posts. So as not to confuse anyone about who’s doing the posting.

    I personally think that NG purchased SC LLC to get technology and skillsets. My WAG is that NG wants to use the suborbital tech to emplace drones surreptitiously, allowing deployment from the US with minimal detection before arrival. Or in reality-land they likely want to apply SC LLC’s niche to their drones.

    The Bloomberg at work was pretty quiet about the whole thing today, but the BBN story didn’t come out until after 3pm CST. We’ll see what tomorrow holds.

    I’m actually happier that SC LLC got bought up by a traditional corp rather than by a private equity firm. Their whole function seems to be to extract value from the corporations for themselves rather than grow the firms organically.

    Here’s how it works:
    The financial details were not released, so it’s not clear the extent to which NG borrowed money to do the transaction. Assuming they used all stock,
    NG can either issue new shares of stock (pisses of existing shareholders), or use shares that they have repurchased in the open market, or treasury stock. NG will offer SC LLC a certain number of shares whose market capitalization (# shares x market price) is ‘equal’ in value to the 60% equity share of SC LLC that NG does not already own (actually it will be a contrived price based on a variety of market parameters). The existing owners divvy up that block of NG stock proportionately, and are then free to sell or hold shares however they see fit. Since this is in publicly traded shares, the “liquidity event” arises when shares are sold and Mr. Rutan gets a big check deposited in his bank account. NG may have also paid in some combination of cash and stock, or SC LLC might have acquired some NG intellectual property. Since it is a contract, there can be all sorts of goodies embedded in there.

    The question of the JV with VG is an interesting one. The folks at SCLLC may have been permitted to keep their equity in VGJV. I honestly can’t see a military contractor like NG wanting to get mixed up in a potential ITAR morass with that one. If NG did have to acquire it I think it’s likely to be spun off in some way.

    The “Netscape moment” will be when a private equity firm buys out a NewSpacer for some serious dough. The obvious target there would be SpaceX.

    I’m kind of in agreement that NG/SC is likely to stagnate at the SS2 level. If the concept proves out I can see the Kingfisher guy in India picking up one or two for his lifestyle corporation. Some of the big package shippers might pick up a couple for high-margin same-day package deliveries. This will effectively make it the DC-3 of the suborbital industry, and a fair seller until supplanted by a superior model.

    I am kind of ambivalent about the overall impact in attracting investment capital to the nascent industry. I think investors would like to see a few more successes before really getting interested. X Prize Cup should help, and EVERYONE needs to be exhibiting there, raptors to rodents. Even though Boeing wouldn’t have a direct return to shareholders from such an exhibit, it is nevertheless a very wise investment in future corporate opportunities to do so. The sooner they can get SS2 test flying, the better.

  13. Ashley says:

    I can believe that Elon might sell SpaceX after it achieves his goals, since he sold Zip2 and PayPal.

  14. Anonymous says:

    New Space is doomed for failure. Cots is about to collapse and they can’t raise money themself.

  15. Anonymous says:

    New Space is only doomed to failure if COTS is our only hope.

  16. Anonymous says:

    Apologies if I am mistaken or if I am duplicating, but …

    I was under the impression that only the subsidiary “The Spaceship Company” was being “sold out” to Northrop Grumman, NOT Scaled Composites in its entirety. I have only read the standard news stories and not the trades, so, perhaps I am wrong.

    In any case, at the time of this comment, I have just learned of the accident in Mojave and all of this is rather moot for now as I pray for those lost, those injured and their families.

    Not to be tacky or cliche, but nothing else seems more appropriate for all of us …

    Ad astra per aspera.

    Godspeed Todd, Glen and Eric.

    Healing prayers and wishes to everyone in the Scaled family.

    http://www.scaled.com/

    PS I am currently unable to publish this comment under my google blogger account(?)

    My name is Bill Harrison

    I can be reached at blharrison1@yahoo.com

    Great blog, Ken.

  17. Michael Antoniewicz II says:

    *One* of the COTS companies is about to fail at it’s required fundrasing mainly because everyone who does venture capital is looking at the past record of K/R’s management team when they were at Kisler and “progress” the designers and builders did when they were at Rocketplane.

    Right now, just looking at the publicly avalable info without digging to hard, you’d have a better shot with a $5 investment in a State Lotto rather then in K/R.

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