Investment Perspectives: Smallsats Focus on Business Execution

February 14, 2019 • By Sven Eenmaa, Director of Investment and Economic Analysis for the ISS National Lab

Last week’s SmallSat Symposium, a growing industry gathering of small satellite industry participants with close to 950 attendees, provided updates on trends and focus areas across the industry’s value chain. It also provided the International Space Station (ISSInternational Space Station) National Lab with an opportunity for discussions with a cross section of participants ranging from startups to leading aerospace and defense companies, government and research entities, as well as investors.

Although NewSpace as an industry is still relatively new for the broader public, many companies in the sector have been building out their technology, product, and business operations for some time. For example, SpaceX was founded in 2002, RocketLab in 2006, Planet in 2010, and OneWeb in 2012. Investments in the NewSpace sector have accelerated in this decade as well, with venture capital/seed/grant funding totaling nearly $7 billion for 2012 to 2017, with 2018 estimated to be around another $3 billion. The industry has seen the emergence of more than 110 launch startups and business plans, although with an increasingly visible group of leaders. There have been large communication constellation announcements from the SpaceX, OneWeb, Telesat, and others, and researchers such as NSR, are tracking more than 15 planned smallsat constellations looking to enter and gain share on machine to machine (M2M) and internet of things (IoT) communications markets. Presenters at the SmallSat Symposium cited statistics of more than 900 commercial space companies with plans to launch around 20,000 satellites.

Undoubtedly, great work has been done in the industry so far toward technology and product development and demonstration, as well as initial constellation launches, and there are many technology areas to be excited about. However, it is also clear that many of these businesses are capital intensive with significant additional funding required in years to come to reach targeted business scale and economics levels. As the rubber has yet to meet the road for many of the end-customer facing new entrants (smallsat communications services, Earth observation/analytics providers, etc.) in terms of material traction with actual cash-generating commercial or consumer applications, many of the underlying future demand assumptions are yet to be validated. This uncertainty has implications also upstream in the smallsat value chain, including for manufacturing and componentry, small launch platform, and satellite connectivity business plans. All the growth expectations are encouraging, but the extensive market entry also implies intensifying competition for both customers and resources, which one would expect to lead to a healthy rationalization over time. Hence it is not surprising that the SmallSat Symposium struck the tone of an increased focus on the actual business fundamentals of many of the targeted opportunities.

The informal audience polls at the symposium indicated that best business opportunities for smallsats, as seen by industry participants, lie in the domains of communications and IoT, followed by Earth observation and then areas such as sensing and satellite AIS (automatic identification system) and space situational awareness. Given the sheer size of the global communications markets, the value propositions to expand affordable communications coverage to markets currently not served at all or significantly underserved look indeed promising. Needless to say, this will require cost-efficient execution in both space-based and ground-based segments, including antenna and terminal technologies as well as spectrum and customer acquisition, to become and remain competitive with terrestrial competitors (an issue in the prior cycles). Compatibility and competitiveness with imminent 5G deployments was a significant topic at the symposium as well, as was the rapid price compression satellite capacity has seen in the recent years.

The big-picture view of the Earth observation market looks promising as well, particularly as it relates to the value-added services, where Euroconsult sees the global market opportunity expanding as high as $9 billion by 2027 (assuming certain technology and service developments) from $3.2 billion in 2017. The $1.4-billion market for the underlying commercial Earth observation data is expected to expand at a slower pace (5% CAGR through 2027), partially due to the anticipated pricing compression from upcoming constellations.

It was encouraging to hear increasing discussions by several Earth observation data and analytics companies about puts and takes around the actual feet-on-the-street business development execution, efforts to expand the addressable markets via customer education, competing for talent to strengthen data analytics teams, improving analysis and end-product delivery cycle times, as well as addressing value propositions at acceptable price points. It is important to note that with Planet and Spire Global accounting for 359 and 97, respectively, of 663 commercial smallsats launched between 2012 and 2018 (per Bryce Space and Technology data), most of the other planned constellations are still in early stages of deployment, with resulting impact to available data/analytics offerings and pricing yet to be seen.

In a couple of instances at the symposium, there were statements of downstream analytics providers being limited by the data that is currently available, and there is likely to be further debate on the extent of vertical integration required to compete on these markets. In terms of key future technology developments in smallsat Earth observation payloads, the informal polls at the symposium pointed to highest expectations toward SAR (synthetic aperture radar), boding well for Capella Space, ICEYE, Ursa Space Systems presenting at the event, followed by higher spectral diversity/hyperspectral, higher visible resolution, and high-resolution infrared band technologies. The key for many of these technologies beyond initial demonstration successes is to aggressively to drive down the cost curve to allow them to become cost competitive with already abundant and lower-priced optical imagery.

With defense applications currently accounting for more than 60% of the commercial Earth observation data market and expected to account for an increasing share of value-added services markets (per Euroconsult), there was strong interest in presentations focused on the role smallsats can play in the defense industry. Questions asked include whether smallsat startups are ready to meet the rigor and resiliency required from these markets, whether they have inhouse expertise to compete for this business and manage long sell cycles, and whether go-to-market through a prime contractor would be required. Companies such as HawkEye 360 highlighted required “all in” focus as demonstrated by DigitalGlobe on this market and likely challenges faced if one would just “minor” in addressing the defense market needs.

In terms of access to capital, the expressed consensus views at the symposium pointed to expectations of funding levels comparable to what the industry saw in the recent years, while individual investor views ranged broadly from expectations of continued strong momentum to recommendations to bolster balance sheets urgently. There were questions raised on whether some of the targeted sub-sector revenue opportunities will actually lend themselves for return profiles required by venture capital. Some investors also pointed to the dearth of measurable metrics to assess progress toward initially expected growth trajectories, as well as to the interdependence of many of the NewSpace business models in terms of key value drivers that are yet to be validated. The symposium provided valuable commentary on how startup funding in the industry could potentially evolve. One of the scenarios discussed was a “dumbbell effect,” under which early-stage venture funding will continue, and mature sector leaders who separate themselves from the pack will receive funding while those in the middle will face tougher times. Given the large number of market entrants in recent years, the funding discussion inevitably branched toward scenario views on the nascent industry’s ability to handle market participant failures over the next one to three years, particularly if emanating from well-funded and well-publicized names, and whether the risk of such failures is already sufficiently baked in by current investors. In summary, following increased investment activity over the last five to six years, successful exits by some of the industry leaders would clearly go a long way toward validating NewSpace return potential for the investment community.