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Make your fortune on the final frontier

The next great space race will be led by private companies – the rewards for investors could be astronomical, says Seán Keyes. Here, he tips two pioneering stocks to buy now.

For the space industry, getting a human being to Mars is the Holy Grail. Last week, one of the few stories to drag the public's attention away from the hubbub of the Olympics was the news that the $2.5bn Curiosity rover had touched down safely on the surface of the red planet.

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One of its first acts was to transmit colour pictures of the Martian sunrise, adding yet more fuel to the fantasies of ambitious space entrepreneurs such as Elon Musk, who dream of the day when a person might enjoy the same view with their own eyes.

But before any of us sets foot on Mars, there are some rather more prosaic challenges to overcome such as how to ship snacks and clean underwear to astronauts in the International Space Station (ISS) without bankrupting the entire space programme.

It's a challenge that Musk signed up for in December 2008. Musk's rocket company, SpaceX, backed with a substantial chunk of his fortune, had just signed a deal with American space agency Nasa to deliver vital supplies to the ISS. At the time, no company had ever built a rocket that was capable of docking with the station, let alone returning intact. On 25 May this year, all that changed.

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SpaceX's Falcon 9 rocket and Dragon capsule carried 1,100lbs of supplies, from dehydrated noodles to laboratory equipment, into space before returning safely to earth six days later. When the astronauts got their delivery, the SpaceX control room erupted in cheers. That seemingly mundane mission validated its $1.6bn contract with Nasa and marked the birth of a new era the privatisation of space.

Space is already huge business. According to the Space Foundation's annual report for 2012, the overall space economy' grew by 12.2% last year to $289bn. But Falcon 9's success heralds a radical change. For decades, the space industry has been dominated by Nasa, which is publicly funded. But it's a burden that the Barack Obama administration is no longer prepared to shoulder. It has decided that, while the science of space exploration may be sound, the economics is broken.

Its plan is to get the government out of the low-earth orbit business by retiring the space shuttle programme, and relying on private industry to build the technology to ferry people and cargo into space. That leaves Nasa free to focus on frontier projects, such as developing technology for the most ambitious space missions.

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The private-sector space industry is already expanding rapidly. It grew by 22% last year, according to the Space Foundation. With Nasa pulling out of routine' space business, that's only going to continue, with billions in contracts set to be handed out in the years ahead.

Private rockets are also profiting from a global boom in demand for satellites, driven by our insatiable appetite for extra bandwidth. A few private companies and the investors who back them could really win big as they colonise low-orbit space in the months and years ahead.

How government got lost in space

Space exploration was a purely government-run enterprise for decades, but competition was intense. In space exploration's heyday in the 1950s and 1960s, the cosmic PR battle between America and the USSR led to incredible feats being achieved with only basic technologies. When it came to space, the Cold War brought out the best in the two superpowers.

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But when the USSR collapsed, Nasa was left unchallenged. The US agency began to justify its gigantic budget by looking for expensive space technology projects. Instead of creating the best technology to reach a goal, it created a goal to justify the technology.

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The space shuttle was a prime example. It cost $209bn and was intended to ferry cargo into low earth orbit at a cost of $1,400 per kilo. The true cost was estimated at $60,000 per kilo, or $1.5bn per flight (all inflation-adjusted). The shuttle then needed somewhere to go, so the ISS was created in 1994 at a cost of $100bn.

It's a huge engineering feat and a heart-warming symbol of human cooperation but it'll probably never come close to recouping its costs in research output. Of the six astronauts on board, five work on maintaining the station while just one conducts scientific research.

Normally, economies of scale and new technologies drive down transportation costs over time. That's how shipping containers created the modern trade system and passenger jets made air travel commonplace. In space transportation, though, inflation-adjusted costs have actually risen since the early days of the space programme.

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This isn't simply because we don't send all that much cargo into space. A lot of it is to do with Nasa's contracts. To attract investment in such a risky business it uses cost-plus' accounting, meaning suppliers (such as United Launch Alliance, a joint venture between Lockheed Martin and Boeing) are guaranteed a certain profit on top of whatever costs they incur.

So, unsurprisingly, the suppliers' costs haven't fallen over time. Money is not the problem Nasa's current budget, adjusted for inflation, is about the same size as in the 1960s and 1970s. But space travel has become so expensive that today's budget couldn't even fund a manned moon trip.

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The hope is that increased private-sector involvement will reinject competition into the mix, creating a leaner space industry with more variety, more innovation, and more successes. This should also draw new investment and get more bang per buck from existing investment.

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It seems to be working. The new entrants into the market see lots of potential to lower costs through more efficient production processes. SpaceX, for example, assembles rockets horizontally and then levers them into place, whereas Nasa assembled its rockets vertically, expensively, and on site.

Several private space companies are now looking to build reliable and safe rockets to send people, cargo and satellites to space at a fraction of their previous cost. SpaceX and rival rocket firm Orbital Sciences are targeting a $20m cost per astronaut on their next generation of manned rockets. That compares to the $50m you currently have to pay to the Russian government for a trip in their Soyuz rockets.

As well as the aforementioned $1.6bn contract awarded to SpaceX by Nasa for ferrying cargo, Orbital Sciences has won a similar deal worth $1.9bn. That first $3.5bn round of spending buys Nasa 20 missions. The space agency has confirmed that commercial rockets will be required to service the ISS until at least 2015.

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The other big growth area in space lies in the business of getting new satellites into orbit. The satellite launch industry's revenues grew by 10% last year, slightly above the average growth rate of 9% seen over the past five years. Satellite manufacturing revenues have grown at a similar rate. Private rocket companies have benefited greatly from this Orbital Sciences, for example, has delivered 125 commercial satellites to orbit.

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Yet the satellite boom could accelerate further over the next year. The US Department of Defence has recommended lifting restrictions on commercial satellites. It wants these satellites to be treated as civilian products, handled by the US Commerce Department. It's a boost for American satellite companies and the rockets that launch them.

Investing in space is, of course, a risky business. The rocket providers involved will have to find customers beyond the US government and satellite manufacturers. The industry's reliance on the government is a particular worry. For one thing, American public support for the space programme is weak, although polls show it was ever thus (and the recent successful mission to Mars may reverse public opinion for a short while).

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A bigger worry is the threat of political gridlock. Oddly (given their ostensibly pro-market' views), the Republicans in Congress opposed Obama's privatisation plan, presumably out of sheer belligerence.

The hope is that improved technology will lead to cheaper flights, in turn creating greater demand. This is crucial as ultimately there will need to be a significant increase in the number of launches if the industry is to cut prices per launch dramatically. Space tourism is one promising potential source of revenue.

Getting to the edge of space is far less expensive and technically challenging than launching a mission to Mars and the demand for jaunts into space is there. The big question is when engineers will be able to bring down the price per seat to a level that would make for a profitable business.

Entrepreneur Richard Branson hopes to find the answer to that question in the next couple of years. Last month he confirmed that he'll be on board Virgin Galactic's first space tourism flight when it takes off next year, accompanied by his two children (both adults).

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Virgin says it already has around 530 paid-up passengers, all keen to take a ride on its SpaceShipTwo' craft when flights commence from the world's first custom-built spaceport in New Mexico. And Branson's not the only one. Amazon chief executive Jeff Bezos has bought up land in remote west Texas to build a launchpad for his mysterious space travel startup, Blue Origin. Microsoft co-founder Paul Allen is building the world's largest airplane to carry his Stratolaunch rocket to the edge of space.

Private companies haven't yet achieved the ultimate in space manned flight. But so far they've surpassed expectations. It may not be too long before the pinnacle of space travel is no longer measured by the great achievements of the Cold War. We take a look at some of the companies set to profit below.

How cash prizes spur innovation

Cost-plus contract rules made spacecraft expensive. Is there a better way to reward innovation in the risky space business? Google is taking a different approach it's sponsoring a competition with cash prizes on offer. The Google Lunar X Prize is $20m, to be awarded to the first privately built and operated vehicle to land intact on the moon.

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Prizes are a smart way to encourage and nurture new space technologies. Rather than betting big on one solution, they encourage novel and diverse approaches to problems. They're not a new idea they're tried and tested. Prizes are the reason why some of the most difficult problems in history accurate navigation on the open seas, food storage, transatlantic flight were solved by ordinary individuals working in obscurity.

The key is that prizes generate a lot of research bang per prize buck. The Orteig prize, claimed by Charles Lindbergh for the first airborne navigation of the Atlantic Ocean, was worth $25,000, but attracted total investment of $400,000 and kick-started the global aerospace industry.

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The Ansari X prize is looking to pull off the same trick. It has already drawn $100m of investment to tackle the problem of developing a reusable space passenger carrier all for a $10m prize. By running a series of prizes to reward different milestone technologies, Nasa could draw on the talents of the private sector to build a mission to Mars.

Two plays on the space sector

The space industry is starting to get noticed by investors. The Space Foundation index, designed to track the stock market performance of companies who make their money from space, has risen by 18% in the past year alone. The index includes companies that get at least a proportion of their revenues from space-related business, such as aerospace giant Lockheed Martin, ammunition and rocket propulsion systems manufacturer Alliant Techsystems, and communications group Harris.

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However, we're more interested in companies that can offer purer exposure to the new commercial space race. It's all very well buying a big conglomerate, but there's every chance that its other divisions will have a larger impact on its share prices than its space exposure particularly at a time when US defence budgets are under pressure. So we've looked at two companies that should stand or fall according to their success in space.

Orbital Sciences (NYSE: ORB) is a rocket maker that fills the gap between giants such as Lockheed Martin and the small space start-ups. It was founded in 1982 and has launched more than 60 rockets since then. The company is following hot on the heels of rival rocket maker SpaceX in the race to build a cheap replacement for the space shuttle.

Its $1.9bn contract with Nasa to supply the International Space Station (ISS) depends on the success of its upcoming Antares rocket launch. About a third of Orbital's $1.5bn revenue this year will come from government contracts, such as the programme to resupply the ISS.

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Another third comes from dealing with launches for satellite companies and the rest from military customers. Orbital differs from its rival SpaceX in that it doesn't build its rockets from the ground up. Instead, it oversees and engineers a supply chain from America to the Ukraine and Italy.

As Orbital moves from focusing on research and development (R&D) for the Nasa deal, to actual launches, this should be good news for profits. "R&D has propelled Orbital to its enviable position in the space industry. But what seems to be underappreciated by investors is that, once the Antares/Cygnus R&D costs fall away, the company's earnings should take off", says newsletter-writer Paul Hill. he has a price target of $22 a share for Orbital more than 64% above today's price.

Avanti (LSE: AVN) is a satellite communications company based in Shoreditch, east London. Demand for satellite data is rocketing due to increased usage of satellite TV, high-definition broadcasting, satellite radio, broadband internet, mobile telephony, global positioning systems and space exploration. All of this is part of a single, massive trend people are consuming a lot more data, exponentially more. And satellites are the cheapest way there is to beam data quickly around the world.

Avanti recently launched its second satellite, the Hylas 2 (on an Orbital Sciences rocket, I might add). Hylas 2 greatly expands the company's capacity and allows it to press aggressively into the North African and Middle Eastern markets. Avanti is not pausing for breath already plans for Hylas 3, scheduled to launch in 2015, are well underway.

The company has experienced management, robust demand for its services and should benefit from lower costs as competition in the private rocket sector cuts prices.

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