Avio under the microscope

The good, the bad and the ugly

Issue 49. Subscribers 1,672.

This one is probably going to make me a few enemies but I think it’s nonetheless an important discussion. Considering the length of the main story, there isn’t a new section this week. It will return next week.

To my 23 new subscribers, enjoy your first issue and, as always, if you have any comments, suggestions, or tips, please reply to this email.

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Avio under the microscope

In June last year, Avio announced that it would receive €340 million in funding from Italy’s covid recovery fund, which was an element of the European Union’s NextGenerationEU economic package. The funding is to be used for a pair of Avio programmes. The first is a methalox first stage engine to complement the M10 upper stage engine the company is already developing for Vega E. The second is for a two-stage demonstrator that will likely serve as a basis for what comes after Vega E.

When the announcement was initially made, I was excited by the possibility this level of funding could bring to Europe. However, this week when the contracts were actually signed I began to question the size of the awards. €340 million in funding began to sound like an egregiously large amount to award a single launch company, especially when that company had already received significant funding from Europe for three separate commercial vehicles. Why not divide this funding among startups? Surely investing in small companies would spur significantly more economic growth and high-paying employment opportunities than giving the full €340 million to an established player that is unlikely to spur much economic growth or employment opportunities in the short to medium term. 

With all this in mind, I decided to take a long overdue closer look at Avio and how the company is utilizing the significant institutional support it enjoys.

A bit of background

Avio has a long history that dates back to 1908. However, for our purposes, I am going to look back to about 2003, when the first development contracts for Vega were signed.

2003 was an interesting time for the company. In addition to signing development contracts for Vega, the company's aerospace business was also being sold by Fiat Group to The Carlyle Group and Finmeccanica. At that time, the company was called FiatAvio and the two companies purchasing it did so through a special purpose vehicle called Avio Holding which The Carlyle Group held a 70% stake in with Finmeccanica holding the other 30%. Avio Holding purchased the entire share capital of Avio to which all the aerospace business of FiatAvio had been transferred as of 1 July 2003. The total value of the acquisition was €1.5 billion. At the time, FiatAvio had 14 manufacturing plants and 9 research centres which had a total staff of 5,000 employees. It's unclear from the press release exactly how much of that made up the company's aerospace business.

In 2006, the P80 and Zefiro 23 motors of the Vega launch vehicle were tested for the first time. 2006 was also the year when the company once again changed hands. The Carlyle Group and Finmeccanica agreed to sell Avio to Cinven for €2.57 billion. €1 billion in profit is not bad for three years of work. Finmeccanica however, did not entirely jump ship and agreed to reinvest in Avio alongside Cinven. At the time, the company was developing jet engines for the 787 and the A380.

By the start of 2016, Avio had flown six flawless flights, and it was, as I'm sure you've guessed, time for another change of ownership. Well, technically there was also a sale in 2012, but that was for the company's aviation business, which Cinven sold to GE for a total consideration of €3.3 billion. So Cinven had by then already made a profit and still had the space business. In October 2016, Cinven announced that it had agreed to sell the Avio space business to Space2 (a special purpose acquisition company that would allow Avio to be listed on the Milan stock exchange), Leonardo-Finmeccanica, and Avio's management (more on that later). At that time, the company employed 800 people. The sale was completed in March 2017.

Cost-cutting the cause of the Vega C VV22 failure?

The broad strokes of the Vega C VV22 independent inquiry findings and the PR circus that follow have been well discussed, so I won't go into detail on this issue again. If you'd like to read the full story, you can see an in-depth article that I published on European Spaceflight here. The following is additional information that I did not have when the original article was written.

According to sources familiar with the events in the days leading up to the publishing of the inquiry's findings, ESA and Arianespace had not initially planned to share that the nozzle throat that was the root cause of the failure had been sourced from a Ukrainian supplier. However, the day before the official release of the findings a sourced La Tribune article published this fact, triggering a revision of the official press release.

The La Tribune article is eye-opening! Not only does it question why ESA would allow Avio to source the component from a non-Member State when an alternative from ArianeGroup was available, but it also gives the reason why Avio made the decision in the first place. Put simply, it was a cost-reduction exercise. Avio went with the cheaper part to either reduce the per-launch cost of Vega C or, if you're more cynical, to increase profit margins. 

So, Avio went with the cheaper option, gave the supplier the wrong specifications, and then failed to pick up that the component was inadequate once it had been delivered. That appears to put the responsibility squarely on Avio, doesn't it? Well, that's not going to stop European taxpayers from picking up the bill.

According to Avio's 2022 financial report, ESA is awarding the company with a "dedicated support program" to the value of €30 million to cover the cost of the Vega C return-to-flight activities. The funding will be drawn from existing budgets already subscribed at the 2022 ministerial-level council meeting. €30 million that could have gone to three different launch startups as part of ESA's Boost! programme that could have represented several years of funded development and incredible economic value to member states. I can’t make this make sense!

A growing history of poor quality control

In November 2020, an Avio Vega rocket failed which resulted in the loss of the SEOSat-Ingenio and TARANIS satellites. Following an independent inquiry, it was revealed that the cause of the failure was identified as human error. Specifically, it was found that cables to two thrust vector control actuators aboard the AVUM upper stage were inverted during assembly. The failure occurred on just the second flight back following the vehicle's July 2019 failure when you’d think due diligence would be at its peak. 

The root cause of the failure of the VV15 flight was identified as a design flaw in the forward dome of the Zefiro 23 second stage that caused a thermo-structural failure. I'm not sure how to reconcile these findings. The VV15 flight was not unique. It was not the heaviest payload the rocket had ever launched nor was it a particularly unique orbit. So, why after 14 flawless flights with two of those payloads being 600 to 700 kgs heavier than that of flight VV15 would a design flaw suddenly show itself? Interestingly, the findings of the independent inquiry looking into the failure stated that it had also looked at the inadvertent activation of the Zerfiro 23's neutralisation system as a cause of the failure. However, the inquiry found it to have been "unlikely." Then why bring it up? The VV15 failure resulted in the loss of the UAE’s Falcon Eye-1 optical imaging satellite and the space insurance industry’s largest single claim ever.

To review, at least two out of the three failures of Vega launch vehicles have been the direct result of poor quality control. What's more interesting is that this has all occurred within eight flights of the family of launch vehicles with the first 14, as I have said, occurring flawlessly. Could it also be a coincidence that just over two years after new owners take over the business the first failure occurs? When the sale went through, Vega had been launched nine times over five years without a single failure. Following the sale, only three out of six years have not included a failed Vega launch.

Stock buybacks

Moving away from the product for a bit, let’s take a little look at some of the company’s financial activities.

Since Avio went public, the company has authorised stock buybacks on two different occasions. For the uninitiated, a stock buyback is where a company uses its own funds to purchase outstanding shares from shareholders, reducing the total number of shares outstanding.  

The first of the two Avio stock buyback initiatives was approved by the board of directors in April 2019 and the second in April 2021. On both occasions, the company gave a set of four “objectives” for the buyback programmes.

1. Pursue an efficient use of liquidity generated by the ordinary business activities through a medium-long term investment in own shares. Translation: we have money that’s sitting around doing nothing, let's buy some of our stock as an investment.

2. Offer shareholders a way to realize their investment. That’s fairly self-explanatory. 

3. Use the own shares as an exchange currency in extraordinary operations, acquire financial means for acquisitions and/or in deals involving the exchange of shares, or for other ends as deemed useful for Avio from the financial or strategic point of view. Translation: so we can use the shares for investments, mergers, and acquisitions.

4. Use the own shares, including those already bought, for incentive plans, also in the future, for the benefit of Directors, Employees, and Associates of Avio or its subsidiaries, or also as additional compensation to shareholders. Also fairly self-explanatory. 

Avio’s stock buyback activities began in August 2019 and, according to public filings, the company purchased approximately 214,500 shares at a cost of over €2.6 million euros in the back half of that year. Not completely egregious, but it is interesting that the company felt this was the prudent course of action when just a few months earlier, in January 2019, it had received a €10 million loan from the European Investment Bank. According to an Avio press release, the loan was intended to “support the development of space propulsion technologies for the new Vega C and Ariane 6 launchers and expand the industrial capacity of the Colleferro plant in order to meet the production volumes expected for the coming year.” Do loans like this not have clauses to prevent a company from turning around and using it as a backstop to conduct stock buybacks? My main gripe with Avio’s stock buybacks, however, is what they did in 2020. 

In late 2019 the first signs of the Covid-19 pandemic were emerging in China and by February 2020 cases were being reported in Europe. On 16 March, the Centre Spatial Guyanais and Arianespace made the decision, following the prescriptions of the French Government, to temporarily suspend all launch activities from Kourou.

As panic and the ruin of small businesses ripped through Europe, 2020 public filings show that Avio spent €6.3 million on stock buybacks that year, purchasing 454,530 shares. 

In 2021, the company did not file any stock buyback reports. However, in 2022 the company was back at it with the purchase of 539,796 shares at a cost of €5.7 million. 

Avio has, as a result, forked out approximately €14.6 million to buy back its stock between 2019 and 2022. However, when you look at the company’s €1 billion order backlog, it sounds like a drop in the bucket. This is misleading as the backlog figure includes flights not scheduled to lift off for another four years in addition to development contracts. If you look instead at the company’s net profit over the same time frame, Avio brought in €51.9 million and that is thanks largely to the €27 million the company earned in 2019. In 2022, when the company spent €5.7 million on stock buybacks, it earned just €1 million. Projected forward, Avio is expecting to bring in a net profit of €2 to €6 million in 2023. Meaning its net profit for 2022 and 2023 combined will likely not be sufficient to have covered its 2022 stock buybacks. 

Now I am no financial expert, but it does appear that Avio is living above its means thanks to generous financial contributions from the Europe taxpayer. This is a hard pill to swallow but one that would be manageable if the company was producing a world-class product for European customers that were lining up to make use of its services. 

In Orbit S.p.A. 

In Orbit S.p.A. was founded by Avio CEO Giulio Ranzo in October 2016 as an investment vehicle with which he, along with 50 Avio managers, went about acquiring an approximate 4% share of Avio’s capital. Six months later, in April 2017, Avio was listed on the Milan Stock Exchange, and In Orbit became a significant shareholder in the new company, currently holding a 4.07% stake in Avio.

Avio utilizes this as a marketing tool, stating in presentations that it is "a public company managed by investors." However, I am always skeptical about the convergence of altruism and capitalism.

Without the marketing spin, the setup results in Ranzo being on the board of directors that voted for stock buybacks and the largest stakeholder of In Orbit. This, in my opinion, represents a conflict of interest as any decision that affects Avio’s stock price affects Ranzo’s net worth. I’m also not sure why Ranzo and the rest of the management team don’t have shares directly in Avio. Why use In Orbit as an intermediary?

On the current Avio board of directors, the only overlap between the two companies is Ranzo. However, if we go back a few years, Vittorio Rabajoli served on the Avio board of directors from 2017 to 2020 and is chairman of the board of directors of In Orbit S.p.A in addition to holding the fifth-largest stake in the company. That means that Rabajoli was around when the Avio board of directors agreed to the first stock buyback initiative in 2019. However, according to the Avio Corporate Governance and Ownership structure report for 2021, he was not on the board of directors when it voted for the second stock buyback.

Now two members of the board of directors could not have pushed through the vote alone in 2019 and Ranzo could not have done it alone in 2021, but it does, in my opinion, represent a clear conflict of interest. Additionally, after reviewing the minutes from the 2019 and 2021 shareholder meetings, it appears that neither Rabajoli nor Ranzo raised this conflict. 

Propped up by European institutional payloads

Say what you will about Ariane 6, and I have said a lot, at least the vehicle has managed to already attract significant commercial interest. Yes, it is largely driven by the record-breaking Amazon order but at least it isn’t relying on European institutional payloads to have any relevance in the market. Can the same be said for the Avio Vega vehicles?

According to Avio, the company has a backlog of 17 flights which includes two in 2023, four in 2024, 2025, and 2026 and three in 2027. It's interesting to note that, to date, Avio has only managed to launch three flights per year three times and has never launched four missions in one year. With a return to flight for Vega C expected in late 2023 and one of the last two Vega flights expected to be launched this year, it will be interesting to see if Avio can ramp up quickly enough to reach a record-breaking launch cadence in 2024.

In reviewing the 17 backlogged flights, it appears that just four come from commercial contracts: KOMPSAT-6 and 7, THEOS-2 HR, and CO3D. The rest are from the likes of ESA, CNES, ASI, and the European Commission which are all but obligated to use a European option. If we assume a per-launch cost of €37 million, which appears to be a ballpark figure for Vega C flights, that’s €148 million in net revenues over four years. The profit on that €148 million would be significantly smaller, especially considering the fact that gross profit on each Vega C flight is likely to shrink now that Avio is sourcing the Zefiro 40 throat insert from ArianeGroup.

Once you factor in institutional payloads, development contracts, and defence contracts, all of which come from the European taxpayer's pocket, suddenly you have an order backlog of €1.014 billion. What really gets to me about this is that many of these institutional payloads could have been made available for competitive bidding for a number of commercial launch startups that are aiming to have vehicles operational by 2025 onwards. Instead of giving startups a chance to grow and compete, European institutions have given these contracts to the incumbent that has a growing track record of dubious quality control and a clear focus on profits and stock prices. And this is all before the considerations of the absurd amount given to Avio from the European Covid recovery fund that surely could have been better spent. What am I missing here?

CEO remuneration

The great thing about a public company is that a whole bunch of documents that we would otherwise never have access to are public for anyone to enjoy. In researching Avio I found myself looking through remuneration reports, curious to see how much CEO Giulio Ranzo earned in good and bad years.

Ranzo's base salary has remained unchanged for several years at €448,000. According to the Economic Research Institute, the average salary for a CEO in Italy is currently €270,604, just for a little context. It's the bonuses where things start to get really absurd, though.

In 2019, Vega failed for the first time, with the cause of the failure being determined to be a design flaw. Apart from the failure, Avio managed one successful Vega flight that year. For his efforts, Ranzo received on top of his base salary €697,597 in bonuses and other incentives and €16,014 in non-monetary benefits like car allowances and life insurance for a total salary of €1,171,601. For reference, the company made a net profit of €27 million that year.

In 2020, not only were we at the height of a pandemic where Avio employees were being brought into the office as essential personnel, but the year also featured another failure, this one due to human error, and just one successful launch. Despite this, Ranzo received on top of his base salary €583,000 in bonuses and other incentives and €15,518 in non-monetary benefits for a total of €1,046,518. In 2020, Avio had a net profit of €14.9 million.

2021 saw the CEO receive €492,822 in bonuses and other incentives and €11,181 in non-monetary benefits for a total of €952,003. Finally, under €1 million. Avio had a net profit of €9 million that year.

We don't yet have the latest remuneration report for the 2022 period, but considering Avio managed a net profit of just €1 million last year, it should be interesting to see if those bonuses persist. 

Getting out from under the thumb of Arianespace 

Let’s go back to that €340 million. Firstly, some clarification. In June 2022, the total amount for the two projects was €340 million with €217.5 million set aside for a two-stage demonstrator and €120 million for a methalox first stage engine to complement the M10 second stage engine currently under development. The agreement also provisioned €11 million to allow Avio to begin work on the development of the first stage engine before the contracts were officially signed. Just as a reference, at the end of 2021, Avio had a net cash position (the amount of cash and cash equivalents a company has after deducting its total debt and other liabilities) of €57 million. But they couldn’t possibly start work on the new engine without an €11 million advance, right? 

On March 13 of this year, Avio announced that the contracts had been officially signed and that the company would be receiving €285 million in total with €181.6 million reserved for the two-stage demonstrator and €103.7 million for the rocket engine. So why the difference? Talking to European Spaceflight, an Avio spokesperson told me that the amounts were different because “there remains a provisional amount for potential follow-on work not yet defined.” Avio also clarified the meaning of the two programme acronyms that were used in the press release but not explained. STS stands for Space Transportation System and HTE High Trust Engine.

Now back to the reason for the huge award. Up to this point, Avio has received funding for the development of Vega, Vega C, and Vega E through ESA contracts. Arianespace is the launch service provider appointed by ESA in charge of marketing Ariane and Vega launches. Avio is thus, from what I can gather, obliged to utilize the services of Arianespace to market and manage the launch of Vega, Vega C, and later Vega E rockets. Sources I have spoken to that are familiar with the situation have told me that Avio, ASI, and the Italian government are increasingly uncomfortable with this arrangement. So, how do you get out from under the thumb of Arianespace? Well, you fund the development of your rocket and you find a new launch facility.

In August 2022, CNES announced that it had selected seven operators to launch from a new commercial facility being built on the grounds of the old Diamant launch facility at the Guiana Space Centre. One of those seven companies was Avio. At the time I questioned Avio about its plans for the facility and if it was seeking to split from Arianespace. In response, a spokesperson stated that its current relationship with Arianespace was “satisfactory” and that it had no plans to “market and manage Vega launches.” 

A press release from Italy's Ministry of Business and Made (it sounds better in Italian) announcing the signing of the two contracts gave me another clue. The press release states that the technology developed will be "part of the future families of European space launchers." In other words, not Vega. 

Avio, as a result, now has a launch facility and funding to pursue a launch system that is not under the control of ESA or Arianespace. Why a demonstrator, though? Why not push to develop a complete launch system? Well, because the mechanism they’re using to fund the work requires Avio to utilize the entirety of the amount received by 2026. If you pull out much of the payload infrastructure and focus simply on developing a working first and second stage that only needs to be good enough to complete one flight you may just be able to do it within the three years they’ve been given. Developing a complete launch system that could be brought to the market in three years would be next to impossible.

Now, the above is speculative based on as much information I could find but it sure does seem to fit, doesn’t it?

Conclusion

I’m not sure this piece needs a conclusion. You either think that what is happening is the normal operations of a commercial enterprise or you think, like I do, that European taxpayers should not be fitting the bill for bloated executive bonuses. 

I’ll end simply with this. Prior to Avio releasing its 2022 financial results on 13 March, the Avio stock price was at around €10. Following the announcement, it took a small hit ending the day at €9.84 before recovering on 14 April to above the €10 mark. However, that recovery was short-lived with the stock ending the week at €9.04, the lowest point in its history. This could well be just a bit of market volatility or it could be that investors are finally starting to rub off some of that well-maintained Avio veneer.