“A billion here, a billion there, and pretty soon you’re talking real money.”
Now, there’s some debate about whether the late Illinois Senator Dirksen truly stated the phrase above in those exact terms, but one thing is certain: even if a billion isn’t exactly “real money,” $40 billion is. This is why, as an investor, when NASA Administrator Bill Nelson (a former senator) informed a Senate panel last month that pricing competition from SpaceX helped taxpayers save $40 billion on military space missions, I was immediately interested.
Some Quotable Senators
In his testimony before the Senate Appropriations Subcommittee on Commerce, Justice, Science, and Related Agencies, Nelson was discussing the budget requirements that NASA must meet in order to complete all of the missions that it has planned for the future. He informed the subcommittee, in particular, that: “The fact that we now have competition on getting to space — just for the military — has saved them $40 billion in launch costs,” General Hyten, [then] the Vice Chairman of the Joint Chiefs, told me last year.
Now, $40 billion is a significant sum, and it’s unclear how Hyten arrived at it. Nonetheless, for more than a decade, SpaceX has been launching government satellites at a large discount to the costs paid by space corporations such as Boeing (BA -0.89%), Lockheed Martin (LMT 0.36%), and Northrop Grumman (NOC 3.35%). Add in savings from SpaceX producing new products on its own, or with limited help from NASA, such as the Falcon Heavy rocket, the Starship reusable mega-rocket, and even a lunar lander, and the $40 billion number might be close to true.
Nelson’s disclosure wasn’t the only one he made throughout his testimony.
Nelson stated his idea to create a second lunar lander in the context of thanking Congress for approving a proposed 9 percent increase in NASA’s 2023 budget to $26 billion so that NASA would have two landers to select from “somewhere in the 2027 timeframe.” This second lander contract will be given on the basis of a fixed-price contract, which Nelson emphasized throughout his evidence.
Cost-plus vs. fixed-price
When it comes to government contracts, “the traditional way of doing things was always cost-plus,” said Nelson, referring to government contracts that compensate a contractor for the expenses it incurs, even if those costs exceed the price it bid, and then add a guaranteed amount of profit on top of that (the plus). The problem is that this kind of contract does not obligate a military contractor to perform effectively and under budget.
This has resulted in project delays and cost overruns, which have cost NASA and taxpayers money. Nelson used the example of a contract given to Bechtel in 2019 for $383 million to develop a rocket-launching platform in 44 months. As issues arose, the project grew into a $402 million contract to construct the identical launcher in 47 months. Unfortunately, this isn’t an unusual incident; in fact, Nelson told the Senate that cost-plus contracts have “been cancer on us in the past.”
However, according to Nelson, NASA is “dedicated” to improved cost management and has “been going to fixed pricing where we can… really clamp down on [cost-plus contracts].” A fixed-price contract compels contractors to bid a specific amount for a given service, and then get that fee when the service is completed – regardless of whether it really costs the contractor more (or less) than its bid to execute the task.
What does this imply for investors?
To be fair, this seems to be basic sense. We virtually always pay a set sum to fill our shopping trolleys when we go shopping. However, this is a novel concept for NASA. If Nelson is correct, and the cost of space launch is reduced, NASA will save money, and taxpayers will receive more bang for their space buck, potentially increasing public acceptance and support for NASA.
However, the shift from cost-plus to fixed-price has ramifications for space stock investors. Think about the fact that every federal contract that SpaceX receives at a subsidized price is a deal that rival companies like Northrop, Boeing, and Lockheed Martin lose out on. Furthermore, every contract on which these publicly listed space businesses must bid cheap in order to beat SpaceX implies less income for them.
Nelson says he would want to see more NASA contracts priced this way in the future. This suggests that moving ahead, Northrop may face a reduction in the operating profit margin that it now enjoys in its space sector of 10.6%. Lockheed may earn less than its current 9.3 percent margin, while Boeing, with a 5.8 percent margin in its military, space, and security sector, maybe even more vulnerable to margin contraction. NASA will continue to follow this strategy in the future. Investors in the space business should begin preparing for lower returns right now.
Source & Credits: The Motley Fool