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John Engle
John Engle
Articles (258) 

SpaceX: Raising Funds Under a Cloud of Suspicion

Elon Musk’s rocket business turns to equity as demand for debt dries up

December 18, 2018 | About:

For the third time this year, SpaceX is tapping capital markets. This time around, the satellite and rocket launch company is seeking $500 million in equity, principally from existing shareholders. In addition to its current launch business, SpaceX has two extremely expensive projects: the Starlink satellite network and Starship manned rocket (formerly named the BFR). Each of these projects will cost billions of dollars, so it is no surprise SpaceX is looking for funding.

While this latest funding round will bestow an even higher valuation to SpaceX, the company is currently facing serious questions of governance and future profitability.

A new up round

The latest funding round was announced on Dec. 18, barely a month after SpaceX raised $250 million in debt. According the Wall Street Journal, which broke the story, fresh funds will come principally from existing shareholders, with asset manager Baillie Gifford the only new big-name participant.

In its last equity funding round in April, SpaceX was valued at $27.5 billion. As of this latest round, the company is now valued at $30.5 billion. That is a monumental valuation for a company that does not make consistent profits in its contract launch business currently.

When it tried to raise debt in November, the company tried to portray itself as profitable, but it was soon revealed this was only the case if one excluded a number of critical expenses from the calculation. SpaceX is struggling to make its core business profitable now. Just think how much harder it will be as competitors continue to proliferate over the next few years. Furthermore, satellite launches will likely face a lull in 2019.

Equity filling the gap

In November, SpaceX tried to raise $750 million through a leveraged loan. Ultimately, it was only able to scare up $250 million. SpaceX did its best to spin the reduced loan as a positive. As the Wall Street Journal reported at the time, the company asserted the decision to cut the size of the raise was taken internally and not a function of demand:

“The SpaceX loan was issued late Monday at 99 cents on the dollar with a coupon of 4.25 percentage points above the benchmark London interbank offered rate. That was at the high end of original guidance.

In a gesture to investors in the late stages of the debt sale, SpaceX tweaked certain terms, generally making it likelier that the company will be on solid financial footing before it does things in the future like issue more debt or make certain investments.

Despite shrinking the size of the loan, Bank of America received more than $750 million in orders from investors for the debt, according to a person familiar with the situation-enough to sell the loan at its original size. SpaceX decided to go with the smaller loan because it is comfortable with its cash-generating ability, the person said. ​Issuing less debt could also make it easier for SpaceX to revise the terms of the loan later if market conditions improve, investors noted.”

This explanation rang rather hollow at the time. Bank of America (NYSE:BAC) led the debt offering on a "best efforts" basis, hardly a positive sign in itself. Furthermore, the interest rate was set at LIBOR plus 425 basis points - the high end of initial guidance. If indeed there was wide demand for SpaceX paper, the company would never have had to submit to such a high rate - or to the extra bondholder protections to which it acquiesced.

In light of the move to raise equity to fill the $500 million gap, SpaceX’s claims about demand for its bonds are even more dubious now.

Tunneling finances

The announcement of the latest equity raise came on Dec. 18, a day after the Wall Street Journal reported SpaceX founder and CEO Elon Musk had made use of company funds, materials, facilities and personnel to support another of his private ventures, the Boring Company.

According to the Wall Street Journal exposé, SpaceX investors were not aware of this activity:

The arrangement alarmed some longtime investors in SpaceX, including its largest outside backer, Peter Thiel’s Founders Fund, some of the people said. The investors learned in recent months that despite the diversion of SpaceX resources and staffing to the fledgling Boring startup, it was Mr. Musk who was in line to receive almost all of any future profits, these people said.

The investors questioned SpaceX about why their investment dollars into a company ostensibly devoted to launching satellites and carrying humans to Mars were instead partly used to start a separate company that principally benefited Mr. Musk. When the Boring Co. was earlier this year spun into its own firm, more than 90% of the equity went to Mr. Musk and the rest to early employees, the company has said.

In internal meetings this year, Founders Fund partners debated what to do about the diversion of SpaceX resources. Their concerns reached a SpaceX board member and other company officials, the people familiar with the matter said.

The SpaceX board never voted on devoting resources to Mr. Musk’s new venture.”

That is hugely worrying from a corporate governance standpoint. Evidently, SpaceX’s own board was circumvented by Musk, who is also CEO of electric car company Tesla (NASDAQ:TSLA).

Eventually, the Boring Company handed over 6% of its equity to SpaceX, but it is not clear who approved this move or how the equity was valued. It looks more like backfilling than a genuine exchange of value.

It is ironic that the Boring Company, a tunneling startup, could be at the center of a case of financial tunneling, a kind of fraud involving "the transfer of assets and profits out of firms for the benefit of those who control them." Musk will have to come up with a better justification for his actions than what he has said so far:

“Totally false. Buried in this incredibly misleading WSJ article is the actual statement from Thiel’s Founder’s Fund: ‘we have no concerns whatsoever.’”

Whether one major investor is comfortable with the move and the retroactive payment in equity is irrelevant. The fact corporate governance - and possibly the law - was violated is what counts. We would not be surprised if the Securities and Exchange Commission comes knocking. We are not saying this is a case of fraud with certainty, but it does appear to have hallmarks that would warrant a serious investigation.

Verdict

Despite the headline that SpaceX is raising $500 million, it is far from a done deal. After all, capital markets have evidently grown somewhat more dubious about Musk’s empire, Baillie Gifford’s perverse commitment notwithstanding. Only last month, the company could fill just one-third of its debt offering.

Of course, the November bond flop was not an isolated incident. In fact, the last equity raise - in April - also came up short. The company authorized issuance of shares worth up to $507 million, but it only managed to bring in $214 million.

SpaceX has two massively expensive projects it does not have the resources to fund. The Starship project alone could cost upward of $10 billion. A few hundred million in new equity is not going to make much of a dent. What that means for SpaceX is clear: To fund its promised growth, it will need to raise billions more, which means massive dilution. The current valuation is already stratospheric, so stretching it much further seems highly unlikely. Shareholders are bound to see punishing dilution over the next few years.

This is a company worth avoiding.

Disclosure: Short TSLA via long-dated put options.

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About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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