by Chris Mecray

The summer of 2003 was clearly tough for the global space market, as commercial players struggled to hold on until some semblance of a recovery kicks in–and faces are turning a disturbing shade of blue. While Europe started off the summer on an improving note with a restructuring of its rocket’s program financial support, the United States stagnated as the Defense Department’s (DoD) desire for two affordable (not to mention ethical) launch providers has started to get some push-back from the contractors, with implications on the commercial side.

As the European Space Agency (ESA) started the summer by consolidating responsibility for its Ariane 5 launch program, the United States was struggling to maintain its two launch providers after catching one of them allegedly conducting corporate espionage. Boeing’s possession of proprietary Lockheed Martin documents during the 1998 Evolved Expendable Launch Vehicle (EELV) competition put the U.S. Air Force in a serious conundrum, as it worked through how to punish Boeing enough to sting, but not enough to seriously cripple its launch business. In what some view as a pre-emptive move, Boeing also announced $1.1 billion in charges related to its space program, with more than $800 million of the charges due to the company’s updated assumption of no commercial EELV launches for at least five years. At the time, Boeing maintained that it would remain committed to the launch business and would revisit commercial launch competitions when it felt the market could afford the cost of reliable launch vehicles.

Soon after the charges were taken, the U.S. Air Force ruled against Boeing, stripping the company of seven launches and $1 billion in revenue (although not much, if any, operating profit). These launches, plus the go-ahead to build its own West Coast launch facility and garner the next three follow-on launch contracts, were passed on to Lockheed Martin. The new launch facility, financed by Lockheed Martin, will indirectly add to the DoD’s cost of maintaining both launch providers. The U.S. Air Force plans on leasing the facility for each mission. This will be an inconvenience at a time when both companies are looking to the government to make them whole on already realized losses.

The final part of the punishment was the ominous sounding, but largely symbolic, indefinite suspension of three Boeing space divisions from government contracts (an exception was made in late August for the award of a GPS satellite launch on an Atlas 2). This has created a political game of chicken between Boeing and the U.S. Air Force that could have longer-term repercussions on the commercial launch market.

The next lot of EELV contracts (third lot) consists of 15-20 missions and is planned for selection at the end of the year. While in reality it would not be possible for Lockheed Martin to sustain the entire lot of contracts, Boeing still must kowtow to the U.S. Air Force and prove itself penitent enough to get the suspension lifted. This has led to an interesting strategy, with Boeing defense employees undergoing a day of ethical cleansing, while on the corporate level Boeing has been making very different noises to indirectly apply pressure on the DoD.

Within a couple of weeks of the decision, Boeing’s Executive Vice President, Jim Albaugh remarked, "I don’t know if we are going to be in the launch business over the long haul," with the final call depending on the ability to make a profit. A sound business strategy to be sure, but also a warning to the government regarding the cost of squeezing Boeing too hard. This attitude change was further reinforced on the corporate level by a recent decision to create an independent group to review the business plans of its top programs, hinting that it could drop programs that are not proven return-viable.

The commercial satellite market faired somewhat better this summer. The service providers in North America saw some rationalization with Intelsat’s proposal for picking up six of Loral’s satellites (four in orbit, two planned), while Echostar was rumored to make an offer for Loral’s remaining assets, including the satellite production facilities.

Boeing did receive some encouraging news on the commercial satellite front this summer, as ICO asked the company to finish work on its 10 remaining satellites on order. Also, earlier this summer XM placed an order for an additional 702 satellite (its fourth) to make up for the lost capacity from its first two.

The only caveat on these orders is that the chances for completion are not a slam-dunk. ICO (with McCaw’s backing) is looking to restart its effort to put up a global data network to support personal mobile devices. Although the ICO system appears more advanced, it is still similar to the failed Iridium venture. The XM order is based on the collection of insurance money for its first two birds, which the insurers are reluctant to pay out given the $1.6 billion in possible claims they face on the six troubled Boeing 702 satellites in orbit.

The bottom line is that rationalization of the launch market, both domestically and globally, will continue to lag that of hardware and service providers, with governments picking up the tab. As evidenced by Brazil’s launch tragedy this summer and the U.S.’s struggle to maintain two providers, national interests and pride will continue to ensure that the launch business will remain a marginal commercial operation for the foreseeable future.

Christopher Mecray is a research analyst with Deutsche Bank Securities Inc. The following comments should not be considered a recommendation concerning the purchase or sale of any security mentioned herein.