Not Starlink. Not Starship. Not Grok. $561 Million of SpaceX's $4.4 Billion Profit Came From an Unexpected Source.

Earlier this week, Space Exploration Technologies (NASDAQ: SPCX), better known as SpaceX, surprised Wall Street with an impressive third-quarter earnings report. Elon Musk's space exploration and artificial intelligence (AI) company generated $14.6 billion in revenue and reported $4.4 billion in net income, reversing a loss of $1.1 billion in the year-ago quarter.

At first glance, these results suggest SpaceX reached an important profitability milestone. But a finer detail buried in the company's 10-Q deserves closer attention. SpaceX recognized a $561 million gain associated with its equity investment in The Boring Company, another business founded by Musk.

Although this is legitimate under accounting rules, this gain did not generate any cash for SpaceX. Let's explore what exactly happened, why it matters, and what investors should watch as SpaceX accelerates its infrastructure spending.

Image source: Getty Images.

How SpaceX recorded a profit without receiving any cash

To understand how this accounting adjustment works, imagine you bought a baseball card for $100. Several months or years later, someone else purchases the same card for $200. Based on that transaction, you determine that your card is now worth $200. You're technically $100 "wealthier" on paper, but you haven't actually sold your card or received another $100 in your bank account.

This is essentially what happened with SpaceX. The company owns a stake in The Boring Company, Musk's tunneling and transportation business. In September, The Boring Company raised $3 billion in Series D financing. Investors purchased shares at a $20 billion valuation, giving SpaceX fresh insight into the value of its existing investment.

Under generally accepted accounting principles (GAAP), SpaceX can measure this investment using its fair value. As a result, the company recognized a $561 million unrealized investment gain. An unrealized gain simply means an asset has increased in value, but its owner hasn't sold it.

SpaceX recorded this increase under Other income, allowing the gain to flow through its income statement and contribute to reported profitability. There's nothing inherently suspicious about this accounting treatment. However, investors should understand that the gain doesn't come from the company's operations in launching rockets, selling Starlink subscriptions, or providing AI computing services.

SpaceX's profitability can be measured a different way

As referenced, SpaceX reported $4.4 billion in net income during the third quarter. By excluding the $561 million Boring Company gain, the company's normalized net income would be closer to $3.8 billion. However, this is technically an imperfect way to measure profitability because it doesn't account for differences in tax effects when recognizing investment gains versus not recognizing them.

I think a better way to judge SpaceX is by looking at operating income. Operating income measures the money a company earns from its core business segments after operating expenses, but before interest, taxes, and other financial items.

The table illustrates SpaceX's operating income by business unit compared to last year.

Data source: Investor relations.

These figures illustrate how SpaceX's operating performance is genuinely improving. However, there's another wrinkle investors need to understand: Accounting profits are not the same as free cash flow.

SpaceX is spending unprecedented sums expanding its infrastructure. During the third quarter alone, the company spent $19.6 billion in capital expenditures (capex), including $16.4 billion attributable to its AI business. For perspective, that investment was larger than SpaceX's entire reported revenue for the quarter.

Moreover, the company spent $48.1 billion in capex through the first nine months of the year, compared with $13.1 billion in operating cash flow. Simple math shows a $35 billion deficit between cash generation and infrastructure spending.

Of course, this doesn't mean SpaceX is running out of money. The company's historic IPO and debt financing provide enough liquidity to fund its various build-outs for the time being. The main takeaway here is that the company is spending considerably more on infrastructure than its operations currently generate in cash.

Is SpaceX's noncash gain a red flag?

At the end of the day, SpaceX's accelerating revenue and improving operating margins are encouraging. My thought is that the $561 million noncash gain from The Boring Company is a normal accounting adjustment rather than evidence of misleading financial reporting.

With that said, investors should look beyond the company's headline profit going forward and focus more on operating income, capex, and free cash flow. Those figures will ultimately tell us whether SpaceX is building a financially sustainable industrial conglomerate or simply spending too much to pursue its ambitions.

Adam Spatacco has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.