In his 2013 letter, longtime value investor Seth Klarman (Trades, Portfolio) warned that current valuation levels of the market at that time had become unmoored from any sound fundamental analysis or methodology, and instead were indicative of a “speculative froth” that had suffused the markets. Klarman noted that far too many market participants had learned nothing from the 2000 dotcom fiasco.
Klarman noted the price of many stocks was a reflection that the market was “mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course."
He also warned that in bull markets, it is never difficult to assemble analysts and investors who form a “coalition of willing” that is motivated by “flash mob speculation.”
When one examines the latest frenzy surrounding the meteoric rise of Virgin Galactic Holdings Inc. (SPCE, Financial), Klarman’s comments come to mind. Will his warnings yet again prove prophetic with regards to the pioneering spaceflight company? Or is his thinking too “old school” and too stodgy to appreciate and understand the new method of stock valuations for the incipient space age? What would "Star Trek’s" Spock have to say about all this?
Last Tuesday, Virgin Galactic reported a fourth-quarter net loss of $73 million on revenue of $529,000; FactSet had forecast revenue of $748,004. Overall, the company reported a net loss of $210.9 million for 2019. The loss in 2019 comes on the heels of net losses of $138 million in 2017 and $138 million in 2017. The company’s earnings before interest, taxes, depreciation and amortization loss of $55 million far exceeded the consensus estimate of $47 million. Fourth-quarter revenue of $529,000 was well below the $800,000 in revenue from the previous quarter.
Given these dreadful numbers, how does one explain the price of the stock? The shares have increased almost 200% over this past year. The price has increased over fourfold since early December. After Tuesday’s close, the stock dropped precipitously to $28.75; it is currently trading at $20.88. Even at it its current price, Virgin Galactic trades at almost 1,000 times the Street’s 2020 sales estimates of $7 million, which, given last quarter’s half-million in revenue, seems utterly far-fetched.
Nonetheless, some analysts continue to believe Virgin Galactic’s price in the $20 range still bears some relationship to the company’s long-term “value.” Last Thursday, Morgan Stanley analyst Adam Jonas, who has been one of the biggest boosters of the stock, wrote, “We do struggle to identify significant thesis changing/accelerating events since the time of our initiation in early December of 2019.” Jonas further noted that, “A modest correction is overdue, and frankly, healthy, in our opinion.”
Jonas’ price target assumes the company’s space tourism business will generate almost $1 billion in revenue by 2030, even though its revenue to date has been negligible. This is quite an inductive leap of faith. University of Florida finance professor Jay Ritter agrees. Ritter says Virgin Galactic reminds him of the internet bubble that burst in 2000. He stresses that investors haven’t performed even a modicum of due diligence and the share price is based on mere speculation. “There is a lot of risk here,” Ritter said. “The most likely outcome is it will never turn a profit.”
After the stock plummeted, Jonas’ Morgan Stanley colleague, Matthew Sharpe, cut his rating on the shares to equal weight from overweight. Despite the company’s history of consistent losses, Sharpe nonetheless still finds the stock is not overvalued at $20.88. He wrote:
"In our opinion, the stock is nearly fully discounting a highly successful space tourism business at scale, a moderately successful space tourism business with early credit for the hypersonic opportunity, or a combination of both."
Any silver lining behind the clouds? For the skeptical, fear not. The company states that it has received 7,957 "registrations of interest" from potential customers since December 2018, which it says is double the 3,557 registrations of interest it reported for its previous quarter. How are these registrations an accurate measure of potential revenue? No analysts can say.
This novel financial measure of Virgin Galactic’s future earnings potential resembles some of the accounting chicanery that ultimately exposed WeWork’s outrageous valuation as nothing more than a house of cards.
What are paying customers getting for their quarter of a million-dollar tickets?
At 45,000 feet, the capsule detaches from the carrier aircraft and uses its rocket engine, thrusting at Mach 3, to soar vertically to its apex. Once it reaches its apogee, customers will experience weightlessness for about four minutes before the unpowered space craft glides back down to earth. That might be a sensation worth the $250,000 for some, but who’s to say all the thrill seekers will board the Virgin Galactic rocketship?
There are a number of other companies that will be offering the same space ride. Jeff Bezos’ Blue Origin and Elon Musk’s SpaceX are already ramping up to provide a similar service. Virgin Galactic has no moat that will guarantee it a competition-free, uninterrupted revenue stream for the foreseeable future.
So how would the imperturbably rational Spock, devoid of the human emotion of greed, characterize the current valuations of Virgin Galactic? More than likely, he would call it "highly illogical.”
Disclosure: I have no positions in any of the securities referenced in this article.
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