Investment Perspectives: SmallSat Symposium Cheers the SDA Awards, Hopes for Better Capital Markets

February 20, 2024 • By Sven Eenmaa, Director of Investment and Economic Analysis for the ISS National Lab

It was great to return to SmallSat Symposium this year. This event remains a source of valuable conversations and industry updates, reminding us all that the small satellite (smallsat) sector is no longer that small. According to data from Orbiting Now, more than 8,300 satellites currently reside in low Earth orbit(Abbreviation: LEO) The orbit around the Earth that extends up to an altitude of 2,000 km (1,200 miles) from Earth’s surface. The International Space Station’s orbit is in LEO, at an altitude of approximately 250 miles. (LEO), and BryceTech stated that more than 8,450 small satellites have been launched since 2014. This is a substantial difference compared with the more than 550 satellites in geostationary orbit (GEO), for example. This year’s event highlighted strong tailwinds from defense spending, continued push to gain commercial traction, as well as expected and needed innovation across the value chain. The challenging funding conditions appear to be bottoming, setting the stage for the next leg of industry growth.

Industry Growth and Drivers

While the smallsat industry continues to show healthy deployment metrics, most of the constellations remain in relatively early stages of deployment. Per Quilty Space, there are more than 400 constellations in various stages of construction. While Starlink’s and One Web’s progress has been impressive, most of the announced LEO telecommunications mega constellations are in early beginnings of deployment. When it comes to Earth observation and remote sensing, the industry commentary remains centered on the imminent revenue inflection, benefiting from expanding use of AI/machine learning (ML) to identify commercial use cases and deliver analytical capabilities. This inflection has been elusive for some time now, and the sector has remained around 80% dependent on government demand.

Overall, while we continue to see aggressive progress with some constellations, others need to demonstrate their business and competitive viability under current, more demanding funding conditions. The SmallSat Symposium commentary from McKinsey & Company pointed to only 25% of various constellation plans presented in the last five years as progressing toward the announced targets, and to less than 5% achieving their target plans.

Undoubtedly, the Space Development Agency (SDA) has provided a strong stimulus to the smallsat industry. SDA’s orders for Proliferated Warfighter Space Architecture (PWSA) now total a whopping $9.9 billion toward 438 satellites through tranche 2 of the architecture, with deployments through FY26. Tranche 2 will be followed by tranches 3 and 4 later in the decade, followed by replacement orders, thereby remaining a significant source of revenue for the smallsat industry. Beyond the more immediate order book and scale impact, there are also expectations that the absorption of non-recurring engineering costs will lead to more favorable economies of scale and unit economics when addressing commercial demand of the future. This demand is also highlighting various growth and investment opportunities in relevant manufacturing and supply chain segments.

While the smallsat industry continues to mature, various technology innovation opportunities remain, and there appears to be selective investor interest toward them, dependent on underlying business fundamentals. Our discussions at the symposium on technologies that still have room for innovation and improvement pointed to satellite power systems, solar cells, propulsion, microelectronics, communications, antennae technologies, and edge processing, to name a few.

Furthermore, with industry launch capacity expected to expand significantly as Starship and New Glenn become available, smallsats, which have been designed for the constraints of the current Transporter and small launch missions, do not necessarily need to be that “small” anymore.  We are already seeing some drift to larger sizes with PWSA requirements as well as with Starlink’s V2 Mini and some of the emerging startups.  With the further decline in transport constraints, more performance could be achieved with the same (or lower) cost rate, whether via large size of the satellites, different materials used, or constellation sizes. One key caveat here is the need for launch pricing per kg (not just costs) to come down, and that would require emergence of platforms beyond Starship to force the competitive dynamic. Industry expectations are that the Starship’s initial capacity will be primarily used toward Artemis and the Starlink constellation. After all, Starlink terminals are now available for purchase from Best Buy, and the company needs to deliver on QoS beyond early adoption and as the demands on the constellation increase.

On the global launch markets, SpaceX’s current share is nothing short of impressive. With maiden launch expectations for vehicles such as Blue Origin’s New Glenn and Rocket Lab’s Neutron on the calendar for 2024, it remains to be seen how or when there will be an impact to the market dynamics. With continued defense-sector interest toward multiple provider support, we are also continuing to see investment in a few earlier-stage vehicles, as well as strategic discussions around the ULA sale.

Nevertheless, when one thinks about the industrialization of LEO, including in-space manufacturing, investor requirements appear to be for the business models to pencil out at the current Falcon 9 pricing. There is unwillingness to bake in a passthrough of the Starship cost savings at this stage, given the lack of comparable operational competition today.

Investment Environment and Consolidation Thoughts

For 2023, the U.S. venture capital deal volume declined close to 30% year-over-year and came in at less than half of the activity level of 2021. For the space economy, where capital access declines have not been as steep as in some other industries, the environment continues to bottom. While we saw an uptick in investment dollars in 4Q23 toward several later-stage infrastructure rounds, the sustainability of this improved activity remains uncertain. With the opportunities to raise bridge rounds shrinking, the investor commentary at the symposium pointed to expectations of some level of reckoning in 2024, particularly for those who lag competitively.

Per our checks, there is no meaningful change to the broader investor sentiment versus recent quarters. The costs of risk capital have increased, growth and profitability expectations are now more critically questioned, and investment criteria have been tightened. Funding for multi-billion-dollar space infrastructure builds remains challenging. Observing public space SPAC performance over the recent years, where companies largely failed to meet their respective financial targets, such investor caution appears fully justified. Furthermore, the valuation multiples are likely to trend closer to those of legacy aerospace, defense, and industrial peers, particularly if the previously promised growth and profitability trajectory is not achieved.

In terms of M&A, as valuations and market expectations have now been recalibrated, and as current reality is becoming increasingly accepted, the environment should allow for increased meeting of the minds as 2024 progresses.

There are several areas of expected activity for 2024/25, some driven by necessity, some by strategic preference. Following the sharp competitive impact of LEO constellations on satcom broadband pricing, and some consolidation already in 2023, structural changes in the industry remain topical. SDA’s PWSA remains a market-changing demand driver, raising questions on various market participants’ interest in improving their respective value chain positioning, vertical integration, or acquisition of exposure to various parts of constellation buildout. Regarding acquisition appetite by primes, we are hearing differing industry participant views, as vertical integration comes with a risk of market share leakage due to competitive dynamics as well as risks of margin cannibalization. It remains to be seen whether further horizontal acquisitions that would allow for portfolio expansion, scale in manufacturing, sourcing, and overhead absorption will transpire instead. In addition, questions remain on whether some of the high-quality technologies in otherwise distressed SPACs will find new owners this year. Finally, it is important to remember that the multipolar geopolitics of the current world is leading to buildout of competitive regional capabilities.