Investors love new industries and concepts. There’s nothing better than getting in on the ground floor of a life-changing new product or technology. And Virgin Galactic (NYSE:SPCE) stock certainly checks that box.
We’ve never had a chance to put money directly into space travel like this before. Sure, there are companies that make components such as engines for space shuttles. But that’s simply been inputs into the government’s space vehicles. SPCE stock is the first publicly traded company fully devoted to commercial-scale human space travel.
Unfortunately, it appears that Virgin Galactic isn’t ready for the prime-time. It’s lacking basic things — such as a reassuring safety track record and revenues — that you’d expect from a public company.
It also came public by a disreputable type of transaction that should make you do a double take.
The first massive problem with Virgin Galactic is that it came public via a special purpose acquisition company (SPAC). These structures are laden with fees for backers, but tend to cause great harm to the general public.
Here’s how they work. A firm raises a pool of capital by selling shares at $10 each. These shares come with a warrant that give holders the rights to buy more stock at an attractive price if shares rally. Hedge funds and other sophisticated investors usually buy the SPACs at this stage. Eventually, the SPAC sponsor finds a company to buy with their pool of capital, and the shares are converted into ownership of the acquired company.
In this case, the SPAC sponsors acquired Virgin Galactic. The next stage of the SPAC shuffle is to try to get the stock price over $10. In doing so, the hedge funds get to make a major score with their freebie warrants. After the hype wears off, retail investors get stuck owning the SPAC stock as the hedge funds exit stage left. The vast majority of SPACs follow this pattern; you’ll find plenty of SPACs that turn into penny stocks or go entirely bankrupt. Meanwhile, very few trade over $10 today, despite the (until recently) raging bull market.
Why are SPACs so bad? For one, the incentives are aligned badly for retail investors. For two, a respectable company would prefer to go public by initial public offering. If you have to go public via SPAC (or reverse merger) it usually indicates your company is of low quality. Otherwise an investment bank would underwrite your offering and you’d get a far higher valuation that way.
A Bloomberg article warned that: “The surge of offerings in [SPACs] lays bare a troubling harbinger due to the vehicle’s challenged history and potential to inflate the value of marginal assets”.
What’s Wrong With Virgin Galactic?
Virgin Galactic stock admittedly shot up a lot more than the usual SPAC before the dump got going. But the usual SPAC pattern is now playing out, with Virgin Galactic stock plunging 50% in recent weeks. It’s not hard to see why it had to go public via a SPAC rather than a real IPO.
What investment bank would want to underwrite a firm like Virgin Galactic? Its flaws are numerous. For one, the company has had serious safety problems in the past including a fatal crash in 2014.
Virgin Galactic also has no revenues. There used to be a day when companies were embarrassed to go public when they weren’t profitable. For example, the state of Massachusetts declared Apple’s (NASDAQ:AAPL) 1980 IPO to be “too risky” and barred its residents from buying the stock due to its shaky financials.
Times have changed. Now Virgin Galactic can use this SPAC maneuver to go public with no revenues or proven business model whatsoever, and retail investors are left shouldering the risk.
What’s the Business Model?
Virgin Galactic presents a fancy model to the public of what its business might look like in the future. The company’s lead spokesperson, Chamath Palihapitiya, likes to go on TV and describe how great the space business could be. In theory, it will be a hardware business with software-like margins. In other words, the holy grail.
But, as of now, there’s scant evidence that the hardware is all ready to go, or that customers are actually eager and willing to fly at the prices and quantity that the company is counting on.
The company’s backers also claim supersonic point-to-point flight is a major upside option for Virgin Galactic. But the price per flight would appear to be in the six figures. If the Concorde supersonic plane was not economic, it’s hard to imagine a far more pricey supersonic option being a major success either.
There’s other practical issues to consider as well. For one, the company doesn’t even have all of the required Federal Aviation Administration approvals. It hopes to obtain those later this year. Ideally, however, you’d demonstrate a working business model — including basic things such as permits — long before selling stock to the general public.
My Verdict on SPCE Stock
Virgin Galactic is a great trading vehicle. If you like volatility and use smart money management, go ahead and have a blast with SPCE stock. After dropping 50% in a few weeks, it’s probably due for a bounce.
But there’s no reason for long-term investors to be involved in this company one way or the other. Virgin Galactic utterly fails to meet the criteria for being a prudent investment. Meanwhile, on the other end of the spectrum, this is simply too risky to bet against. As we saw with Tesla (NASDAQ:TSLA), a multitude of red flags is not necessarily enough to bring a stock crashing down.
Virgin Galactic is the perfect story stock. People are captivated by the idea of going to space, and this is the only way to trade the dream for now. Competition is coming from far more credible rivals like Blue Origin soon enough, but for now, Virgin Galactic has the skies to itself.
As a result, the stock price will go up and down based on people’s hopes and fears, rather than anything to do with the actual business. Betting on that is a gamble, nothing more or less.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he had no positions in any of the aforementioned securities.