It’s a Small(sat) World: Observing the Earth and Potential Returns in the 1st Vertical

Imagine a continuum of an industry’s present and potential customers, ordered by expected revenue per customer. Costs determine the extent the industry can meet the demand, and, in turn the revenue from this market continuum. Nascent industries like NewSpace possess high costs that may limit prospects and a few companies that tend to make one-off, highly customized products. As costs decrease either through innovation from within the industry (e.g. through reusability efforts and increases in business process efficiencies by companies like SpaceX or Virgin Galactic), or from developments outside the industry, (e.g. increased computing power by companies like D-Wave or Cloudera), the industry can extend its reach and tap customers (and capital) further down the continuum. (Please see “Above the Cloud” in the December 2012 issue of Thruster.) This extension may increase the size and thus diversity of the customer base in the 2nd of the “NSG 4-Screens.” Unfortunately however, the further a company travels down the long end of the tail, the less profitable each customer gets (though in no way impairing their aggregate value). One can picture the progression of an industry down the continuum as a wave, compressing companies behind it while creating a diversity of profitable niches ahead of and about itself. The dual shockwaves of accelerating advances in space accessibility due to miniaturization and private sector competition have put NewSpace in the midst of a transformation.

Satellites are part of the 1st of the “8-Verticals of NewSpace,” the sub-markets of NewSpace ranked by feasibility, and therefore the first to be disrupted by these shockwaves. One way the satellite industry is evolving is through the small satellite form factor. (Please see “Point to Point: Europe” in the October 2012 issue of Thruster.) This is spurring growth in a relatively new sub-vertical in NewSpace: space-based Earth observation (EO).

Hoyt Davidson, Managing Partner at Near Earth LLC, a Connecticut-based investment bank focused on satellite, telecom, and aerospace, spoke recently with NSG. Davidson, who spent the early part of his career in the 1990s educating Wall Street on the investment opportunities in the satellite sector, divides small satellite companies into two classes: “those focused on Cubesat form factors, for example, Cosmogia, and those simply making smaller satellites.” The Cubesat satellite design paradigm emphasises simplicity and modularity to reduce costs and spread technical risk across multiple devices. “The latter is exploiting advances in computerization and miniaturization to perform existing applications and serve existing markets with smaller, cheaper satellite systems. The former [focusing on Cubesats] are exploiting the same advances, of course, but to such a larger degree that it seems to be a difference in kind rather than just magnitude,” Davidson told NSG. Here, the trade-offs forced upon satellite designers by miniaturization and costs are producing fundamentally novel products. “These new companies are often searching for new market opportunities that value cost and frequency of information more highly than the quantity and quality of the information.”

One of these opportunities may be the market for financial data. Valued by Bloomberg at over $16Bln and growing at 3% in North America to 6% in Asia-Pacific, the financial data market is being eyed by San Francisco-based Skybox Imaging, which plans to offer high-frequency, low-cost multispectral video and still imagery of Earth in raw and processed forms for business intelligence and trading firms, as well as disaster response and humanitarian purposes. (Please see “SmallCap Review” in the May 2012 issue of Thruster.) Skybox raised $70Mln in Series C funding led by Canaan Partners and Norwest Venture Partners in mid-2012, joining Khosla Ventures and Bessemer Partners from the $3Mln and $18Mln Series A and B, respectively. Skybox’s satellites, SkySat-1 and the recently announced SkySat-2, are due to be launched this year. (Please see “NewSpace Timeline” in this issue of Thruster.)

Cosmogia (NSG sources indicate a potential Skybox doppelgänger), meanwhile, has been testing its Dove 1, 2, 3, and 4 satellites, which it is also planning to launch in 2013. In contrast with Skybox’s $91Mln in capitalization, the Cubesat-based Cosmogia closed a $10Mln round from Draper Fisher Jurvetson at the end of 2012. Draper Fisher Jurvetson declined to comment for this article, citing Cosmogia’s stealth status. (Please see “NSG Index Review” in the February 2013 issue of Thruster.)

The idea of commercial EO is not as far-fetched as it may seem. New York-based Muddy Waters Research, an equity research company and short seller, used satellite imagery in 2011 to show that Chinese lumber firm Sino-Forest did not, in fact, own any trees. More recently, equity researchers at UBS shook markets by using satellite images of Wal-Mart parking lots to forecast sales.

Yet there is cause for concern. Waning government spending may compress near-term prospects of the domestic satellite sector, which, according to Credit Suisse, accounts for more than half of annual revenues. Further, aggressive regulators could decouple the nascent cross-border NewSpace ecosystem (SkySat-1 and Dove 4 will hitch rides atop a Ukrainian Dnepr launch vehicle). The dark clouds of a demanding market environment are met, though, with the strong balance sheets of NSG PTCs producing ripe conditions for a fertile M&A environment. (Please see “Mergers & Acquisitions” in this issue of Thruster.)

However, excess returns aren’t found in market expectations. “I pay $250,000 a year for an 8.5 millisecond edge between New York and Chicago,” said a trader at a New York-based global macro hedge fund, which makes money by trading on broad systemic factors, such as industrial output and trade flows. “Knowing how many tons of coal a power plant in Hubei is burning or how many trucks are crossing [from Mongolia to Russia] on the M52 would be worth its weight in gold.” With JPMorgan counting 10,000 hedge funds in the United States managing approximately $2 trillion in assets, that’s a lot of gold.

As smallsats like Cubesats revolutionize the 1st Vertical, new uses are opening up as costs are driven down. NewSpace startups are racing to meet the information needs of the financial industry, and the more established satellite players are looking to buy rather than innovate. This is a recipe for a dynamic smallsat market, and the smart money is already being drawn to the first movers.

Arnav Guleria is a corporate finance advisor and a first-time contributor to Thruster.

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