DD: $RCAT (Red Cat Holdings) – Investing in the future of drones


DD: $RCAT (Red Cat Holdings) - Investing in the future of drones

TL;DR: Government contracts in hand, scaling up production, strong cash position, big revenue growth projected by CEO, much more to come. Look at the GIF, it can’t be any clearer.

TL;DR they’ll say… So I turned the company’s logo into a cartoon cat and made an animated GIF of it blasting off to the moon. Watch the GIF, Share the GIF, Interpret the GIF, Spread The Word of the GIF.

$RCAT To The Moon

GIF LOCATED HERE: https://media.giphy.com/media/X9kQmICsWOQeN5996x/giphy.gif

For transparency, as I can already hear people reflexively saying “stop pumping your bags”, I am long RCAT shares and long RCAT calls. I’m not writing this just to pump bags, but because I think I’ve really found something here. Current Price at time of writing this is $1.95 a share, but price is a very different thing than value, and if you look at the price action over the past year you may conclude that this stock is clearly headed towards zero, but your crayons may be lying to you. There may be more to the story here than some pattern of candles and lines. Maybe the invisible hand of the market isn’t infallible, and there are actually fat fingered hands on the scale. It may be dramatically undervalued at the current price.

$RCAT DD:

RCAT is a holding company that consists of 4 wholly owned subsidiaries all of which are U.S. companies in the drone industry. Teal Drones, Skypersonic, Fatshark, and RotorRiot.

The domestic drone industry is poised to see tremendous growth in 2022, 2023, and beyond, due to the U.S. and other NATO countries coming to the conclusion that the current state of the drone market being dominated by Chinese drones is a national security threat, and that a domestic drone production capacity is of national security importance; also massive infrastructure spending from the recent infrastructure act that passed will likely add to a large increase in revenue, because drones will be used for infrastructure inspection. Essentially the government has decided to subsidize the growth of the American drone industry, while edging out the market dominating Chinese. However, the primary revenue driver in RCAT is from their subsidiary Teal’s military grade drone model, the “Golden Eagle”, being used mainly for short range reconnaissance by militaries and other government entities, but has commercial applications as well. This drone model is proven, and arguably the frontrunner on a short list of a handful of models approved for government purchase. They have a history of selling this drone to the Department of Defense and recently were awarded a 5 year purchase agreement with the U.S. Customs and Border Security, part of the Department of Homeland Security. Also The Army is going to award big contracts for this class of drone reportedly near the end of 2022 and Teal is well positioned to receive a lion’s share. According to the CEO, the business development team has been doing demonstrations for other NATO militaries as well, and additional sales are likely. The trend in militaries is to get a drone in every soldier's rucksack and Teal wants to sell it to them, and militaries have deep pockets. Recent insight into revenue projections look outstanding with only existing contracts, and Teal has recently expanded into a new manufacturing facility announced in September, and subsequently announced that they decided to double the size of the space due to traction from sales and expected future contracts (likely the Customs contract they received days later). RCAT already has in hand a large amount of capital and has begun the process of scaling up production. In my opinion the stock is a steal at this price, when I consider the balance sheet and the Teal revenue projections from existing contracts, and the potential of additional contracts and the potential of the other subsidiaries, especially Skypersonic. It should pay off handsomely if I'm willing to hold and wait through the ramp up of production and the growth of revenues from additional contracts, and infrastructure spending.

So why the concern about Chinese drones? China is seen as a potential adversary, and has been known to force its citizens and companies to act as spies for the state. With drones having use cases in military reconnaissance, domestic security, and infrastructure inspection, allowing China to have thousands of eyes in the sky, behind enemy lines, and access to all the data they collect about critical infrastructure, is of potential military importance and a matter of national security; likewise Chinese dominance of the knowledge and production capability of drones is something the Western World cannot abide. For this reason the U.S. government has put Chinese Drone manufacturer DJI (current market share leader) on several lists restricting sales to the company, blocking investment from Americans, and preventing some government money from being spent on DJI drones. Also there are Bipartisan bills in congress, likely to pass, which are aiming to ban the use of existing government fleets of Chinese drones, and to ban all federal dollars from being spent on Chinese drones, which would open up a new market for Teal in the public safety and first responders category. There are government departments with fleets of Chinese drones that will need replacement, likely meaning more orders for Teal in 2022. The CEO estimated that there are 100’s of millions of dollars of potential revenue due to DJI not being allowed to sell to government entities.

On the 12-20-21 earnings call the CEO gave the first glimpse since acquisition into the subsidiary Teal Drones’ production numbers and estimates of the upcoming ramp in production. These numbers given were before the announcement of the large contract award from Customs & Border Security on 12-22-21, although the CEO was likely to already know about that contract’s imminent award. The CFO said he expects continued sequential revenue growth going forward, and he expects gross margins to improve. When I do some basic calculations about these revenue and production projections I see great potential value here from just the Teal Drones contribution alone.

The CEO said that Teal will be doing $1 million per month revenue starting in Jan 2022, “moving up further down the year“. Then went on to say that production will reach 200 to 300 per month over the next 12 months, and that the new production facility will ultimately be able to produce thousands per month; since previous PR from before they decided to double the size of the new facility said it would be able to produce thousands per month, I assume that it’s more than several thousand per month. He effectively said that they are gathering everything from robots, to parts, to people, in order to ramp production as fast as possible but it was going to take some time.

Teal's “Golden Eagle” drone is a serious piece of hardware that sells for $14,400 each, so if I start with the January rate of $1 million per month, that is roughly 70 drones produced per month. At this point they recently made the transition from pre production and have started to ramp up regular production in the new facility. Even at only 70 per month this rate would contribute $2.25 a share to the value of RCAT based on 12 months of this low starting rate (10x sales multiple). However, the CEO is expecting that after 12 months the production will be up to something near 250 drones per month. Essentially he is saying that within 12 months the revenue rate extrapolated into an annual revenue will be at least $43.2 million per year by the next year, but will likely continue increasing rapidly each month along the way. At the 250 drones per month rate, $43.2 million annual revenue with a multiple of 10 times sales would contribute $8.02 per share of value to RCAT stock from just the Teal subsidiary, over 4 times the current stock price. Often a growth stock with a spectacular growth rate will rally enthusiastically and can fetch even higher multiples. Even at the start of 2022 after many high multiple growth stocks have sold off hard for the past year, higher multiples can still be found on growth stocks like PLTR at 21x sales, CRWD at 33x sales, BLNK at 61x sales, and NNDM at a huge 235x sales, and many more examples on and on. At an enthusiastic 25x sales multiple at the 250 per month annualized revenue of $43.2 million, it would contribute $20.06 per share of value, over ten times the current price.

The ramp up in production will of course be gradual, and the higher production rates are still a long way off into the future, but when I calculate revenue out to 1000 drones per month being produced each year, I find tremendous value potential:

Production of Teal's "Golden Eagle" DroneContribution towards RCAT value, annualized rate, at 10x sales multiple
70 per month$2.25 per share
250 per month$8.02 per share
500 per month$16.05 per share
750 per month$24.07 per share
1000 per month$32.10 per share

In addition to these stellar revenue projections, RCAT’s capital position is healthy. They have the capital necessary to expedite the ramp in production which will allow them to be awarded and fill large contracts. Their cash and investments position at the last earnings report was nearly $60 million dollars with 53,835,579 shares of stock outstanding, that comes to roughly $1.11 per share value from just their cash and investments position alone. So at the current stock price of $1.95 a share the market is essentially valuing the combination of all of the company's subsidiaries at only $0.84 in additional value per share!

Another RCAT subsidiary Skypersonic is ideally suited for the infrastructure spending coming soon, and could quickly become another significant driver of revenue growth, but at this time pales in comparison to Teal’s contributions towards revenue from existing contracts, so I won’t bother to estimate them, but no doubt adds significant value to the stock. Skypersonic has a drone that uses AI software to conduct infrastructure inspection, and has the ability to navigate in GPS denied environments. They also have technology which allows for transoceanic remote piloting operation, and multiple drones per pilot. They received a NASA contract, not for much money but it validated and gave credibility to the technology. The takeaway here is that NASA essentially said to Skypersonic: “Hey we like that technology you’ve got there, we’d like to use it for our simulated mars mission”. RCATs PR said:

"Red Cat is honored to have Skypersonic working with NASA on this important scientific Mars project. We believe our patent pending remote pilot capability is a game changer in the drone industry."

The infrastructure bill passed this past fall, but contracts likely won’t start getting awarded until mid 2022. Skypersonic should benefit greatly from the infrastructure bill. In the PR released by RCAT about the Infrastructure Act they said:

“The Company notes that drones already play a vital role in many of the programs covered by the bill, including railways, roads and bridges, storm preparation, electrical grid strengthening and sewage maintenance. With more than $280 billion earmarked for these programs alone, the Company believes there is significant opportunity to expand its existing relationships with the Federal Government beyond the Company's "existing relationship with the Department of Defense and NASA to provide essential services within infrastructure programs.”

The other subsidiaries contribute additional revenue and potential as well.

Fatshark – Fat Shark is a leading provider of First Person View (FPV) video goggles primarily used in the sport of drone racing, but has potential crossover sales and potential synergies with Teal and Skypersonic for use in military & commercial applications.

RotorRiot – Online retail store front, a reseller of FPV drones and equipment, primarily to the consumer marketplace. Rotor Riot enjoys high visibility in social media through its Facebook page and its sponsorship of a professional drone racing team that has won numerous championships. The CEO mentioned in the earnings call a resolution of supply chain problems, best sellers back in stock in the online store.

How RCAT has been trading recently:

RCAT uplisted to the Nasdaq in January 2021 during the speculative meme stock fervor and quickly ran up to an ATH of $7.75 a share. It then went through a long downtrend, like most growth stocks did during 2021, popping a few times along the way. It briefly rallied back to $7.46 after the announcement of the Teal Drones acquisition, but faded, and had a large volume gap up day that faded back into the downtrend when they announced that Skypersonic got a NASA contract. The last earnings report gave a glimpse into the future growth of Teal and resulted in a large volume pop to the upside that has since faded. Volume has been low because almost nobody has even heard about this, and it has been at the mercy of shorts during tax loss selling season. Ever since the earnings report and recent contract award, some bullishness has arrived and there have been spurts of large blocks of shares being bought, but struggles to drive higher on low volume.

Obligatory disclaimer:

This is not financial advice. This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. This does not constitute professional and/or financial advice. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of any information from this DD.

Links:

Red Cat Holdings https://www.redcatholdings.com/

Investor Relations: https://ir.redcatholdings.com/

Q2 2022 Earnings Conference Call https://ir.redcatholdings.com/news-events/ir-calendar/detail/9725/q2-2022-earnings-conference-call

Q2 2022 10Q

https://ir.redcatholdings.com/sec-filings/all-sec-filings/content/0001554795-21-000420/rcat1208form10q.htm

Short video on Teal’s drone the “Golden Eagle”

News story about Chinese Ban

US puts drone maker DJI and seven other Chinese companies on investment blocklist

Edit: Removed higher production number estimates from the chart to be more conservative about expectations.


submitted by /u/LeifTraderson
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