TL;DR
Red Cat Holdings (RCAT) is in the final two to be considered for a multi-year Army drone contract that could be worth ~$450 million; ~3.3x current market cap
Strong probability the company wins the contract given current contractor's (incumbent) battlefield issues and arguably inferior drone design
Additional exposure to other programs/contracts means a no-contract win does not mean the company’s future is not bright
Massive tailwinds for American-made drones to be built and put into field use as a direct result of the Russia/Ukraine war and military build-up of China
Disclaimer: I/we (“Cedar Grove Capital”) currently do have a stock, option, or similar derivative position in Red Cat Holdings (RCAT) at the time of writing this article. All information provided herein by Cedar Grove Capital Management, LLC (“Cedar Grove Capital”) is for informational purposes only and does not constitute investment advice or an offer or solicitation to buy or sell an interest in a private fund or any other security.
Background Context
A world-renowned video game popularized the saying, “War. War never changes.” For the ones who get the reference, good on you.
However, while war technically doesn’t change (death, destruction, chaos, etc.), the rules of war and how they are fought, do. Over time, more technologically advanced weaponry has been introduced onto the battlefield to improve precision, and intelligence, and reduce overall loss of life.
The war in Ukraine, brought on by Russia, has completely derailed combat as we know it with hard-hitting tanks and massive advances in infantry units being destroyed by something as simple as a 5lb drone.
This explosion in drone interest comes as global warfare is entering a third age of drone warfare, defined by autonomy, saturation attacks, increased precision and range, and full-spectrum drone warfare across land, sea, and air.
In early 2024, Ukraine’s Minister of Digital Transformation stated that Ukrainian drones had destroyed or damaged 73 tanks, 10 howitzers, and 369 Russian personnel, all in just one week.1 As much as 50% of Russia’s modern T-90 tank combat losses are attributed to small first-person-view drones.2
This level of success has not gone unnoticed. Countries worldwide have seen just how effective these unmanned aircraft systems (UAS) have proven to be and are rapidly expanding defense spending to buy more.
Despite all the success, that does not mean there haven’t been issues. When the Ukrainian war first broke out, Ukraine heavily utilized cheap Chinese commercial drones for tactical missions. Just a few months in, however, Kyiv began noticing problems: Chinese drone maker DJI appeared to be leaking data on Ukrainian military positions to Russia.3
Chinese drones also proved susceptible to powerful Russian jamming and electronic warfare attacks. Then, in July 2023, the People’s Republic of China (PRC) began restricting drone sales to Ukraine while continuing to supply Russia.4
The weaknesses in using Chinese-made drones — or technology for that matter — are a top cybersecurity concern for government/military officials. A recently House-passed Countering CCP Drones Act5 would prohibit DJI drones from operating on U.S. communications infrastructure, which–while not an outright ban–would effectively render the drones unusable in the U.S.
“Congress must use every tool at our disposal to stop communist China’s monopolistic control over the [US] drone market.” -Rep. Elise Stefanik (R-New York)
It can be expected to be passed sometime in 2025 should Congress approve.
Because of the U.S. limiting exposure to Chinese-made drones, which already account for ~70% of the market,6 hundreds of companies are rising to fill the void and produce American-made drones.
The U.S. Army has already launched its Short Range Reconnaissance (SRR) program 2 years ago which is exactly why I’m writing this trade for you.
Red Cat Holdings (RCAT), through its Teal drone-making products, is 1 of 2 finalists (out of 37 originally) for a nearly $450 million drone contract. Given the company currently has a ~$136 million market cap, you can see why this is a pretty significant deal for the company.
Should they win, the rewards could be multiples of what it’s worth today. Let me break it down for you.
Side note, if anyone is interested in looking more into defense spending, I put out a thematic research report on the industry with an emphasis on NATO and the U.S.
U.S. Army Short Range Reconnaissance (SRR) Contract
This trade has been one of the most intense connect-the-dots situations I think I’ve had to do. I combed through 5 years of U.S. Army aircraft defense budgets to try and piece together what exactly was going on and to what extent.
It was a lot to the point where I looked like this guy from Always Sunny in Philadelphia 👇🏼.
But in the end, I believe I have flushed out the contract as best as possible, outlined the flaws of the original research that was posted on Twitter ~2 weeks ago, and also provided financial reasoning behind the contract (no)win valuation.
This post is different than all the other ones I’ve done. For this post, I’ve made it into a downloadable PDF presentation and the accompanied audio for paid subs is what goes along with that. Forgive my lack of crazy formatting but I just wanted to get it across to you all in a very succinct and straightforward way.
I really hope you enjoy it as this is a new, first-of-its-kind presentation format I’ve done but also because the upside is pretty massive.
I implore you to read the presentation with the audio in the back and please be aware that earnings come out on the 25th of July (Thursday). Click below to access the PDF.
If you enjoyed today’s research, please make sure to ‘like’ this post, it helps with the algorithm. If you think someone you know might like this pitch, please share this post.
Until next time,
Paul Cerro | Cedar Grove Capital
Personal Twitter: @paulcerro
Fund Twitter: @cedargrovecm
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