Space: the final financial frontier

The space industry is entering uncharted territory and, right now, the issue of survival is uppermost in the minds of many firms, writes Richard Willsher

In recent times, those involved in the manufacture and launch of commercial satellites have seen their business ebb away to almost nothing. Research by Fairfax Virginia based specialist aerospace and defence sector analysts, Teal Group, shows that in 1998, the best year on record, over 100 commercial satellites were launched. Last year this is reckoned to have fallen to less than 20, which was about the same level as 2001.

The outlook appears to be as bleak for the period from 2003 to 2012, according to Teal's Marco Caceres, who estimates that only 324 commercial satellites will be launched in that time. 'Something,' he says, 'has to give... We see inconsistent and insignificant growth in the market for commercial satellites.' What he says is needed is 'more available capital and willing investors, new and profitable consumer applications, and (or) significantly lower launch prices'.

The reason why the commercial satellite sub-sector is in such a parlous state is that future growth projections for many firms were built upon expected large-scale demand for future satellite applications. In particular, telecoms firms were planning to meet burgeoning consumer demand for satellite telephony services. In the event, the projections were overblown and the result has been excess build and launch capacity in the industry. The choices open to sector firms is to change, merge or go out of business.

Structural change

In both the United States and Europe, the two dominant producer areas, a series of structural and strategic changes are happening which will result in a newly configured aerospace industry as a whole. The first phase of these changes is more or less complete, with the number of original equipment manufacturers dramatically reduced over a period of 11 years of continual merger and acquisition activity. Research by JSA Research of Newport, Rhode Island, tells the story.

Source: Aerospace Mergers & Acquisitions/JSA Research Inc

This research (see tables) demonstrates the steps major players have taken in response to falling government defence budgets in the wake of the break up of the former Soviet Union and, at the same time, to enhance their critical mass to shoulder the massive research and development costs common across the whole of the aerospace/defence sector. This trend also points to a further consolidation phase, currently happening among second and third tier suppliers to the original equipment manufacturers (OEMs), which is likely to continue for some time.

Source: Aerospace Mergers & Acquisitions/JSA Research Inc

But, concurrently, some businesses that were strongly committed to commercial satellite work have started to focus more on military applications. This is particularly true of US corporations, for example Orbital Sciences and Ball Aerospace, while Boeing has signed agreements with European firms, BAE, EADS and Alenia to co-operate on missile operations.

Whereas once American firms benefited from the 'safety net' of US Government military spending, the scale of expenditure now in process is moving the industry to a whole other dimension.

Military spend

In the wake of 11 September, the war on terrorism and its avowed intention to embark on aggressive action towards those 'rogue' states with nuclear armaments and weapons of mass destruction, the Bush administration is in the process of developing its national missile defence shield at a reported cost of $238bn. The signing into law of the 2002 Homeland Security Act in November was another significant step for businesses in the aerospace sector.

Although there has been little mention in the press of the benefits to the European aerospace sector from a war in the Middle East, similar though smaller benefits could flow through, depending on the degree of support given to the Bush administration. As far as the UK is concerned, collateral benefits would seem likely to accrue should the Blair Government agree to basing interceptor missiles in the UK.

Little wonder then that US aerospace stocks have performed particularly well over the last year. Paul Nisbet, aerospace and defence analyst at JSA Research, calculates that, although the S&P 500 index fell by 24% during 2002, an index of nine aerospace stocks - including, among others, Boeing, Northrop Grumman, Lockheed Martin and General Dynamics - was up 6% on the year, outperforming the market by a net 30%. He notes that the market is quick to anticipate the effect of increased defence spending on company earnings, even if the wheels of government may grind very slowly and cash may be slow to come through. Nisbet says that his 2003 outlook for US aerospace and defence stocks is optimistic.

While that part of the space industry which is driven by US military spend is likely to gain from the current turbulence in international affairs, those businesses which are based outside the US, and which are commercially orientated, are unlikely to fare so well. For example, despite its size and spread of operations, which includes ownership of Airbus, EADS - European Aeronautic Defence & Space Company - was obliged to announce in mid-December that it would not achieve its target double-digit pre-interest and tax earnings margin until 'later than 2004'.

In another European disappointment Galileo, the proposed European rival to the US military-developed Global Positioning System (GPS), has yet to take shape due to failure to agree terms between members of the European Union and the European Space Agency (ESA). Billed as a superior global navigation system by PricewaterhouseCoopers, which is advising on the project, Galileo has already been a long time in the making and the chances of it generating significant revenues from a range of civil applications some time soon look remote.

For the time being, the best hope for the space sector to make ends meet seems, therefore, to be through public sector support, particularly through military spend. But then again, it was ever thus. Whether funded through NASA or ESA, or another government or trans-government entity, the space sector has always been characterised a high level of public sector support. For it is only they who can afford to sponsor scientific development in areas of uncertain commercial return and to 'boldly go where no one has gone before'.

Richard Willsher is a financial and business writer with a background in investment banking. He is former editor of The Investor magazine.