A turn for the worse

Satellite failures, accounting restatements, and covenant breaches at Spire

Spire’s stock has suffered recently from news out of the Space Services division. The company’s relationship with NorthStar has escalated into a legal dispute, and revenue recognition may have overstated the financials, leading to a covenant breach with its lender.

I’m not looking to buy more, but I’m also not looking to sell. One thing is clear, though: Spire has a ways to go in terms of transparent investor communication. The image below from Reddit is the most straightforward response I’ve seen and fails to mention NorthStar.

Image: Reddit

NorthStar

I won’t cover the details in depth (read this article to get up to speed), but as I understand it, Spire lost a satellite and failed to keep contractual service levels. The satellites are producing a semblance of usable data, but they are refusing to deliver it without payment; NorthStar is seeking an injunction to prevent Spire from turning off the flow of what little data is viable.

Bad news all around. It raises questions about how Spire treats customers; it could bring considerable financial repercussions (Spire is on the hook to replace the failed satellites); but the reputational damage is most important.

This is a direct hit to its ability to market and sell the Space Services solution. Space Services is an infrastructure business — it sells reliability. With Spire at fault for the failures and a major customer relationship on the verge of disintegration, it looks to be a losing proposition long-term.

Coming on the heels of Sierra Nevada’s decision to use Muon Space for their second round of satellites (a loss for Spire), the prospects for the Space Services segment seem to have deteriorated meaningfully in the last month.

That said, Spire’s other book of business seems ok (to the best of my knowledge). It has a lot of experience in the space and leadership focused on continuous improvement; there’s still an opportunity for success.

Accounting restatements & covenant violations

Spire hasn’t yet filed its 10-Q due to revenue recognition issues affecting $10-15M of Space Services contracts. As a result of the filing delay (and potential EBITDA impact), the company breached covenants with its lender, Blue Torch.

One can assume (maybe incorrectly) these problems relate to $14.5M of upfront fees paid by NorthStar. This basically eliminates the possibility that it was an intentional effort to mislead investors and juice numbers; I don’t think anyone was budgeting for a system failure.

Blue Torch could theoretically exercise control to get their money back, but that’s unlikely. They’ve worked with Spire on amendments in the past, and they don’t want to sell assets — they want income. Spire defaulted on a technicality — not from missing a payment. A penalty fee, warrants, and/or added protections make more sense to me, but what do I know?

My natural inclination is to apply a positive spin, so I’m beginning to think of this as an unfortunate consequence of an innovative business model. Space Services is a relatively new concept; operational failures are bound to raise some questions about revenue recognition, but no impact is expected to cash flows.

In time, I expect it will be reduced to a footnote in the company’s public filings.

Closing thoughts

While these are incremental negative data points, they do not materially reduce the probability of Spire producing fantastic long-term investment returns.

The company’s core differentiation — three unique, complementary data feeds only possible to collect from space — is intact. The opportunity there remains large.

It’s safe to say Spire is a moderately smaller business than previously reported (even if the revenue in question is deemed technically valid, it would be foolish to account for it; NorthStar isn’t staying with Spire long-term), but this is a game of expectations, and expectations remain low.

Certain periods of elevated uncertainty are bound to push nervous investors out, but I believe the fundamental investment case and potential for outsized returns hasn’t changed much.

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Note: I first wrote up Spire as Investment Idea #1.

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