Red Cat Holdings: The Next Prime
$RCAT Bull Thesis
Disclaimer: All information presented is for research purposes & not financial advice. All opinions posted are my own. At the time of writing, I own shares & calls of $RCAT.
Other Articles in Series
Red Cat Holdings: Company Profile
Red Cat Holdings: A Flash in the Pan (Bear Thesis)
Summary
Market Growth
The Ukraine-Russia war & the threat of China in the Indo-Pacific (INDOPACOM) has surged investments & the political popularity of the military unmanned space.
Research analyst’s project the ISR/UAS industry to grow at a 6-7% CAGR over the next 10 years. The broader military drone market is expected to grow at an 11% CAGR over the next decade. [ISR Projection] [UAS Projection] [Military Drone Projection]
One thing all sources agree on is this industry will do 2-3x the current annual volume in 2033.
Red Cat has quickly established itself as a premier company in the industry and should continue to outpace industry growth.
Partnerships & Innovation
The Black Widow’s modular platform will allow for further innovation & development to stay relevant in a dynamic industry. The modularity of the platform will keep future development costs down and allow the team to continue to integrate key partnerships into their ecosystem.
Red Cat’s Futures Initiative [source] allows them to “leverage cutting-edge technologies to bridge critical gaps”. The unmanned space is constantly evolving. Instead of investing in technology that could be outmatched next year, the team has focused on forging partnerships in the industry.
The approach & design of Red Cat’s platform will allow them to maintain relevance and continue to capture market share.
Program of Record
Red Cat’s Black Widow secured a program of record (POR) called the Short Range Reconnaissance (SRR) program. A program of record is a coveted title for any company to hold and gives Red Cat a near monopoly on Army acquisition of the SRR drones.
Army programs record constrain the Army only to acquiring that system, signal to other US branches the best program to acquire, and instill foreign militaries trust in the system.
So not only will the SRR POR result in ~$50-$70M in annual revenue, but will serve as the catalyst for Red Cat to capture even more foreign & domestic sales.
Counter Arguments
Market Growth
Red Cat is still a small player in the sUAS space. Larger unmanned companies like Anduril & Aerovironment will continue to invest into R&D to compete with Red Cat’s platforms.
Larger traditional prime defense contractors (Lockheed, Raytheon, etc) will enter the market with more force to de-risk their traditional platforms that could be replaced by unmanned systems.
As the market grows, so does the competition. Red Cat will need to continue to invest more into R&D. That level of investment seems like something they’re resistant to funding on their own, based on Jeff Thompson’s comment “Well, the R&D budget is not going to go crazy just because we won SRR. So, I'm coming down on the Scrooge side of that, we've done basically five years of R&D.” on their recent town hall event. [source]
Partnerships & Innovation
Red Cat’s ability to integrate partner technology into their systems is impressive, but opens up a high level of risk into their business model by relying on third party technology to achieve critical functionalities.
Without owning the technology on their platform, Red Cat could be subject performance or profitability degradation. Should a partner discontinue their partnership, be acquired, or raise their prices to unfeasible levels they will either be faced with a gap in performance or declining gross margins.
Program of Record
Sentiment is shifting away from legacy systems & multi-year contracts that lock the DoD into underperforming systems. While the Black Widow is at the top of its class today, can it maintain that position tomorrow.
Should acquisition policy shift, the quasi-monopoly afforded by the current program of record is at risk to being open to competition.
Supporting Evidence
Market Growth
Ukraine-Russia War
Russia’s invasion of Ukraine has led to dramatic shifts in how military doctrines around the globe. [How Ukraine has redefined drone warfare] [US Joint sUAS CDD]
More important than how drones are used is how many are being used in Ukraine. It was estimated in May 2023 that Ukraine is losing 10,000 drones per month. [source] In order to support this level of loss, there has to be heavy investment in the industrial base behind it. Zelenskyy has stated Ukraine can produce up to 4 million drones in a year and is targeting to produce 1 million FPV drones in 2024. [source]
US Javelin Program
Keep Ukraine’s usage in mind, but let’s shift to another joint platoon level piece of equipment, the Javelin missile.
The Javelin is a platoon level anti-tank guided missile (ATGM) that is adopted by all branches of the US Military. It is also mounted on various platforms like the Stryker. There are also other ATGM’s assigned to different unit sizes.
It is estimated the US had 25,000 missiles in their stockpiles [source] Based on the 2021 Army Budget, each of these missiles cost ~$200k [source].
The Javelin missile fits many of the characteristics of the SRR drone. The Black Widow will be a platoon level system, that can be mounted onto platforms for swarm effects, and while not as effective as the Javelin could be used to disable vehicles.
America’s Usage
Now with Ukraine’s usage in mind and a rough comparison of the Javelin missile, lets examine how many SRR drone’s the US would need.
Defense One projected the US Army would need 3,000 drones + 1,000 / year to equip their platoons with SRR. [source] Lets assume each platoon is equipped with a singular system (2 drones / 1 controller), that is still 6,000 drones + 2,000 / year. This would equate to ~26,000 SRR drones over 10 years. Given what we just examined, these numbers feel way too low.
Let’s build out some projections for America’s usage
Assumptions
Political sentiment & threats in INDOPACOM will accelerate fielding to a 10 year timeframe
US will stockpile enough drones to handle a two front war
Given the additional mission profiles of SRR, DoD will stockpile 2-3x the amount of SRR drones compared to Javelins
That leaves the US needing 75-100k SRR drones or ~40-50k systems over the next 10 years. At $40k per system, that is ~$2B over the next 10 years or an average of $200M per year.
Based on Teal Groups estimate of $186B spent on UAS over the next 10 years, that is only ~1% of the total market.
The estimate above will inevitably be wrong, but it at the very least it proves current US estimates both within SRR and published are drastically low.
The estimates above do not factor in MRR which Red Cat addresses with the Edge 130 and FPV drones which Red Cat is working to address with FANG.
Takeaway
The amount of drones needed by the United States military and global militaries is going to explode over the next few years.
The market can handle many companies in the space and Red Cat is positioned well to capture a large share of the market.
Partnerships & Innovation
The drone industry & the military requirements are rapidly evolving. The use cases for drones are growing even faster.
Synthesized from various military documents, the various requirements I repeatedly see are
Networked Ecosystem
Integrated enablers
Swarm Mechanics
Integrated control among systems
Automated launch
Maritime operations (INDOPACOM)
Infantry integration
Automated targeting
Ease of control
Artillery guidance
Electronic Warfare (EW) resilience
Domestic production / Bill-of-Materials (BOM)
Dynamic Payloads
Lethal
Surveillance
[J-sUAS CDD] [Replicator Overview] [Replicator Hellscape] [Project Olympus] [Integrated Enablers]
Currently, Red Cat has forged partnerships or built the functionality to meet nearly all of these requirements. More impressively, they have built the experience in integrating 3rd party software & systems into their platforms. Drones are hard, integrations are hard.
A common theme among all the sourced documents is a networked ecosystem of systems. To succeed in the space, you need to be able to integrate DoD systems into your platform.
As requirements change and different suppliers are brought on board, Red Cat’s experience in designing a modular platform both from a component & software perspective will pay dividends in keeping their platform competitive.
Program of Record
Importance
Before committing to a program of record (POR), the Army spends significant amounts of time & money developing the system to ensure it meets all the necessary requirements.
The benefits of a program of record from an Army acquisition standpoint are enormous.
Duplicate systems cannot be acquired without approval if an active POR exists
Programs of record are fully funded in future years eliminating any concerns from a budget standpoint
Global Acquisition
Simply put, acquiring non-POR’s is complex for foreign militaries. The below figure from the DoD lists a POR on the far left of the scale, meaning it is the least complex & lowest level of effort to acquire. [source]
The largest impact of a POR extends beyond acquisition complexity.
As the largest military in the world, ensuring interoperability during joint operations is imperative. Purchasing a program of record ensures that a foreign military is on the same systems as the US.
Given the level of R&D and logistical support placed into POR’s also ensures & instills trust in Army POR’s.
Joint Acquisition
Joint operations & collaboration between all the US armed forces has been a priority since the 1960's. [history of joint acquisition]
In simple terms, this means is the equipment the Army uses needs to work with the equipment the Air Force (USAF), Navy (USN), and Marines (USMC). [JCIDS] In terms of sUAS the Army has developed a joint suas capability & development plan.
A notable example of a joint program is the F-35. There are three variants F-35A/B/C which has different functionalities for each branch. All variants are still built on the same block and have the same core features.
This is similar to how the Black Widow is designed as a platform capable of taking on different software & hardware to meet different requirements.
What this means is the suas systems selected by the Army are intended to be used by all of the branches. There is also implications of branches strategically spending R&D to prevent overlapping priorities.
This also means the Black Widow as program of record should have software & hardware modularity to achieve different objectives for different branches.
Black Widow was Built for Joint Services / Multiple Roles
Picatinny Rail / Modular Primary & Secondary Payloads
Infantry Uses (force multiplier for human interaction)
Primordial Labs natural language control
Athena AI Targeting & Tracking software
Autonomous Movement & Swarm Technologies
Sentien automated UAS operation for swarms
Palladyne AI for autonomous movement & networked systems
Tomahawk robotics for a centralized command platform
Maritime Application & Integration
Ocean Power Technologies integration
Stationary ISR
Reach Power / Hoverfly (Tethered)
Why This Matters
Establishing itself as a program of record, gives Red Cat a defined advantage in all procurement systems from the US Military to allied militaries.
This badge of approval will accelerate adoption of the Red Cat platforms across the globe.