Virgin Galactic valuation: Space plus speculation makes for a tough equation to solve for investors

Virgin Galactic, the first publicly-traded space tourism company, released its earnings report for 2019 on Tuesday: $3.8 million in revenue and a loss of $210.9 million. And then the asteroids hit the fan.

Investors weren’t pleased, with shares dropping 15.5% to $28.75 by Wednesday’s close.

By Thursday, analysts at Credit Suisse and Morgan Stanley—two of the only three firms covering Virgin Galactic—downgraded it. The stock went into another tailspin, down about another 15% by midday. Although that still left the price at nearly double its value at the close of 2019.

Indeed, Richard Branson’s space company has come to be a favorite topic among traders and investors, with some even referring to Virgin Galactic as the ‘new Tesla’ given the chatter, awe and scorn it inspires.

Also like Tesla, short sellers have shown interest in Virgin Galactic since it went public in October 2019. Short interest, or the number of shares of the stock sold short but not covered, had grown from almost 12 million shares at the beginning of the year, to more than 19 million by Feb. 14. The percentage of float shorted was 24.1%, according to Morningstar. Short sellers may have magnified the gains—as they bid up the price as they bought shares to cover their positions.

But the week’s whiplashing again raised a fundamental question for all investors, no matter long or short: how do you value a space stock, when the company hasn’t started sending customers to space? Last year’s revenue of $3.8 million came from carrying payloads for others and engineering consulting.

Virgin Galactic now has a roughly $4.7 billion market cap (down from $5.6 billion the day before, for anyone keeping track). Valuations that seem unconnected to revenues or earnings may not be unusual these days, but they raise the question of what a company’s true worth is. The answer: It depends on who’s figures are at hand.

“An investor might look at a business value differently than if you were doing it for, say, a divorce or calculating fair value for accounting purposes,” said said Katie Swanson, a CPA with Wilson Toellner CPA.

Investors look at public companies in different ways, but always with an eye to what the future will bring. A mature corporation could be judged on earnings, for example, while investors might look at revenue growth as well as how many users or customers are being added. In either case, comparisons to other companies might also play a part.

Virgin Galactic’s revenues are minimal, there are no clear competitors with public financial data. Valuation then rests on estimating the future. Formally known as net present value, someone calculates how much an investment today could be worth if it grew to given revenue and operating profits at a point in the future. That means some math and a lot of estimation.

As Virgin Galactic CEO George Whitesides told Fortune last July, “It’s a new product. You can’t just divide by years and say that’s the market. It’s like saying, ‘What’s the market for cell phones?’ and taking the first three years of sales [as the baseline].”

“Everything is a financial model or number you’re plugging in” explained Noland Langford, founder of Left Brain Investment Research. “It’s all speculative. There’s not anything concrete there.”

For example, with an established ticket price of $250,000 and an estimated number of customer flights per year—from “several hundred” in the near term to between 1,000 and 2,000 further out, according to Whitesides— annual revenue might run between $75 million to $500 million.

“There are a lot of people that can afford Gucci loafers, but they’re not walking around in them,” said Langford. “I think there’s going to be an unbelievable amount of inertia. It’s so ‘The Jetsons’ that people may think, ‘I wonder how safe it is?'”

Tyler Hardt, founder and managing member of Pelican Bay Capital Management, put together for Fortune a different example of a financial model based on ticket price, number of passengers seats per vehicle, and estimated flights per day.

He assumed five ships, with six passengers a ship, the same $250,000 per ticket, and between 0.5 and 2.5 daily trips. That could make for annual revenue of nearly $1.4 billion at the top end, if each ship were ready to operate every other day.

Because judgment and assumptions are part of the valuation process, there is no single objective number that everyone might agree on.

After calculating a range of potential revenue, Hardt projected costs using a 2011 figure of $400 million per ship and then salaries for pilots and support staff, 30% of revenue going to fuel, 5% in miscellaneous, ongoing costs of the launch and landing area, vehicles depreciation, and taxes. “If you put this all together then Virgin Galactic is worth $400 Million to $2.9 billion,” he estimated.

And yet, markets are not purely rational. Whims play a big role in the value of shares.

“There is the minute-to-minute valuation in the stock market, driven by the actual company performance, formula traders, large mutual funds, a fear of what’s happening with disease coming out of China—all of those factors impact the investors’ sentiments to one degree or another,” said David Larsen, managing director at valuation and governance consultancy Duff & Phelps.

Don’t forget computers either. Automated trading has the ability to turn things upside down. “There are a lot of computers chasing momentum,” meaning trading software looking to take advantage of shifts in how a stock performs, Hardt said. “Say you get a bunch of retail investors buying it? The computers can take over [and drive up the price].”

All investors need do then is wait for the countdown and watch share prices to launch into outer space. With an unknown date for a return to the ground.