Perspectives is a new feature in Confluence. We research emerging growth companies that capture our attention and whose progress will continue to be monitored. Note that these brief reports contain our initial research on the company and are not complete analyses or recommendations.
Red Cat Holdings (RCAT)
Price (10/29/21): $2.96
52-Week Range: $0.68 - $7.75
Avg. Daily Trading Volume (3-month): 5.1 million shares
Market Capitalization: $159 million
Enterprise Value: $95 million
Share Outstanding: 53.7 million
Float Shares: 28.4 million
Insider Ownership: 41%
Institutional Holdings: 17%
Revenue (LTM): $5.8 million
Net Loss (LTM): $14.4 million
Cash (as of 7/31/21): $66.1 million
Total Debt: $2.0 million
Introduction
Red Cat Holdings began to take shape in January 2020 when the fledging drone company made the first of four acquisitions that now operate as wholly-owned subsidiaries. Today this quartet gives RCAT a strong presence in both the consumer and enterprise segments of the drone industry.
Rotor Riot sells First Person View (FPV) drones and equipment, primarily to the consumer marketplace through its digital storefront and benefits from high visibility in social media. Fat Shark is a leader in FPV video goggles for the drone industry.
Teal Drones, Red Cat’s latest and most pivotal acquisition, was completed in late August. It enables RCAT to compete and win military contracts for drone technologies. Teal is one of a few companies approved by the U.S. Department of Defense for the deployment of drones in short range military reconnaissance.
Teal will anchor the enterprise segment at Red Cat that also includes Skypersonic, which provides drone products and software solutions that enable drone inspection flights that can be executed by pilots anywhere in the world. Skypersonic positions the company to aggressively target opportunities in the military and infrastructure inspection marketplaces.
A primary feature of Red Cat’s long-term strategy is its Dronebox service, a SaaS-solutions platform with flight intelligence. Dronebox offers secure black box storage, analytics and services that integrate numerous separate systems in a single platform for drone accountability and safety.
Red Cat expects military applications and infrastructure inspection services, provided through Skypersonic, to drive revenue growth. For the next step in integrating its subsidiaries, RCAT recently added a top industry professional, Geoffrey Hitchcock, to head the cross-subsidiary sales team.
Red Cat’s capital structure is uncomplicated with a fortified balance sheet. The company raised gross proceeds of $16 million in May and $60 million in July through stock offerings priced at $4.00 and $4.50, respectively. Notably the offerings had zero warrants.
2022 Outlook: Red Cat’s team has brought together several compelling pieces to form an integrated drone company in a high-growth industry still in the early stages of adoption. RCAT’s successful cross-pollination among its subsidiaries will set it up to take on challenges largely connected to three potential drivers. Any one of them can accelerate sales growth:
DoD’s Short-Range Reconnaissance program (Teal is participating in the second tranche of that program).
U.S. Infrastructure Bill (inspection opportunities).
U.S. ban of all Chinese drones from U.S. federal funds for 5 years (competitive advantage for Red Cat).
Red Cat’s revenue growth is highly unpredictable. However, once the dust settles from the Teal acquisition, and even with minimal sales traction from new catalysts, we anticipate that new interest in RCAT will steadily rise over the next 12 months.
Drone Industry: Opportunity for Disruption
Drones are commonly known as unmanned aerial vehicles, or ‘UAV’. They are considered pilotless platforms that can be remotely monitored by a human worker or piloted independently by a predetermined onboard computer. Drones are usually used in conditions where operated flight is deemed very risky or complicated, such as in military surveillance or inspection of bridges and other infrastructure.
The Federal Aviation Administration (FAA) forecasts a 300% increase in commercial drones from 2019 to 2023. In December 2015, the FAA announced that all drones weighing more than 0.55 pounds, must be registered with the FAA. As of March 2020, the FAA reported the registration of 1.6 million drones, of which 441,700 were commercial and 1.1 million were recreational, and the certification of 171,750 remote pilots.
According to BusinessInsider Intelligence, industry reports project that commercial use of drones will reach 2.4 million by 2023, a 66% compounded annual growth rate. Drones will be employed by the agriculture, construction and mining, insurance, and media and telecommunications industries. The drone services market is expected to grow to over $60 billion by 2025, from $4.4 billion in 2018. Consumer drone shipments are estimated to reach 29 million this year.
Drones are often utilized to collect data concerning ongoing and life-threatening military missions with the aid of their surveillance, intelligence, and reconnaissance capabilities on a real-time basis. Owing to the many advantages of drones in military areas, the demand for them is gradually increasing worldwide.
Military spending for drone technology is expected to flourish as a complete percentage of military budgets, presenting growth opportunities to particular drone manufacturers and software developers. Technology advancements and expanded applications are two big factors driving the growth across many business segments.
Chinese drone manufacturer DJI Technology has long been the dominant company in the U.S. market, with a whopping 76 percent, according to DRONEII.com in a March 2021 report. Apart from DJI, only three companies in the top-10 garner more than one-percent market share and none more than 4 percent.
For many years, DJI represented 90% market share after it essentially created the drone industry with easy-to-use, well-manufactured drones. As increasing numbers of people needed to build capabilities on top of the DJI platform, severe limitations became apparent; the issues surrounding the use of Chinese drones and drone components by U.S. companies further improve the prospects for U.S. producers.
Red Cat aims to scale hardware sales and grow its customer base through its enterprise and consumer segments. Its longer term strategy is directed at software development and cloud services for the drone industry, leveraging data and intelligence for customers to operate fleets more efficiently and effectively.
The chart below shows the handful of small drone companies that trade on U.S. markets that we consider to be the most suitable comparisons for Red Cat.
Red Cat - Peer Comparison (10/29/21)
Market Cap Revenues (LTM) EV/Sales
AgEagle Aerial (UAVS) $216 million $ 4.5 million 39.3
Alpine 4 (ALPP) $554 million $38.1 million 15.4
Draganfly (DPRO) $117 million $ 6.5 million 19.7
Parrot S.A. (PAOTF) $163 million $55.1 million 1.4
Red Cat Holdings (RCAT) $159 million $ 5.8 million 16.4
Recent M&A in the drone industry. Europe-based drone group Parrot sold two of its subsidiary companies to AgEagle Aerial Systems. The first was sensor specialist MicaSense earlier this year. And now fixed-wing drone maker senseFly is leaving Parrot’s portfolio. AgEagle has signed a definitive agreement to acquire senseFly from Parrot in a cash and stock deal valued at $23 million. Incidentally, Parrot sold MicaSense to AgEagle in January 2021 for the exact same amount.
Red Cat is open to additional acquisitions. CEO Jeff Thompson says if there are any pieces of the puzzle that will help the company to compete for and win large DoD contracts, RCAT would likely go after them, specifically in the software area.
In May, RCAT signed a letter of intent to acquire Belgium-based LuGus Studios, the developer of Liftoff, a flight simulation platform for drone pilot training. Liftoff enables student pilots to test and learn how to fly drones in a simulated environment without the cost and risk of flying a real drone. While the transaction may or may not be completed, RCAT and LuGus already have established a productive working relationship.
Red Cat’s Enterprise Segment
The company’s enterprise segment is building the infrastructure to manage drone fleets, fly and provide services remotely, and navigate confined interior spaces. It is developing a software driven, hardware enabled platform of services and solutions with the Teal Drones, Skypersonic and Dronebox operating in the segment.
Teal Drones is an innovator in commercial and government unmanned aerial vehicle technology. Teal manufactures the Golden Eagle, one of only five drones approved by the U.S. Department of Defense for reconnaissance, public safety, and inspection applications. Teal's approval from the Pentagon provides a strategic advantage as the military continues to expand its deployment of drones.
Concurrent with Red Cat’s acquisition of Teal, the company appointed Geoffrey Hitchcock as its senior VP of Global Defense Solutions. Hitchcock will target all military opportunities for the Teal Golden Eagle drone, given Congress’s ban of federal funds for Chinese-sourced drones and drone components, and seek to expand the Golden Eagle’s use into public safety applications.
Hitchcock was an Air Force Special Operations veteran with 22 years of experience in tactical ground operations and air integration and intelligence, surveillance, reconnaissance. He also spent over 16 years at AeroVironment (AVAV; market cap: $2.2 billion), initially as Director of Flight Operations, and later as Director of International Business Development, where he was responsible for major international market segments/regions and all sales.
Teal has ordered about 630 drone chipsets to be able to construct over 600 drones that Red Cat could have delivered in the next six months. Depending on if the company uses distributors, management estimates this represents anywhere from $6.5 million to more than $8 million in revenue. If it sells direct, it would generate about $8.4 million in revenue from drones currently being constructed.
Winning the second tranche of an Army contract, to be awarded by year-end, would add $2 million. Therefore over the next six to eight months, Teal could generate anywhere from $6.5 million to $10.4 million from these projects alone. That’s a wide range, which is part of the reason it’s so difficult to model Red Cat’s revenue.
To support the growth, Teal last month opened its new U.S.-based manufacturing facility in Salt Lake City, Utah, allowing it to scale production. The 13,000+ square foot facility will be largely focused on quality standards-based processing and manufacturing and will scale the operation to full capacity over the coming months.
While Red Cat believes that the facility could reach a production rate as high as 1,000 per month, it will take time to optimize processes before reaching full efficiency. Yet if only 75 drones per month are produced and delivered initially, that’s about $3 million a quarter at full price.
Skypersonic’s solutions enable drone inspection flights that can be executed by pilots anywhere in the world. Its patented software and hardware solutions allow for inspection services in restricted spaces where GPS is not allowed or available.
Skycopter is a miniature drone fitted into a cage to avoid damage to inspected areas and the drone. Skyloc is a stand-alone, real time, software system which enables the drone to record and transmit inspection data while being operated from thousands of miles away. Industry leaders like General Motors and Aramco are already customers of Skypersonic and Red Cat expects their customer base to grow significantly over the next twelve months.
Skypersonic was recently awarded a five-year contract with NASA to provide drone and rover software, hardware and support for its Simulated Mars mission, a series of analog missions simulating year-long stays on the surface of Mars. During the mission, the crew will conduct simulated spacewalks and simulated operations by remote piloting Skypersonic drones and rover in a simulated Martian environment. Skypersonic's Dronebox real-time transoceanic remote piloting platform will drive the piloting of both the drones and the rover.
While customers like NASA lift Skypersonic’s reputation, Red Cat CEO Jeff Thompson believes the company must first grow hardware sales for inspection drones. That’s where a big opportunity exists for services training and other recurring revenue streams connected to its Dronebox analytics and A.I. engine, all high-margin sources of business.
Upcoming Catalysts
Two major developments offer Red Cat substantial growth opportunities. These catalysts will drive the entire drone ecosystem:
U.S. Infrastructure Bill: The proposed bill features a drone infrastructure inspection grant program, and a drone education and training grant program. With 617,000 bridges in the US and 3.5 million miles of storm sewers, these two categories alone would expand the already $20 billion inspection space for drones. This will not only help states’ aviation agencies acquire drone technology to safely inspect critical infrastructure, but also bolster the workforce needed to manage it, and improve public safety.
Once passed, the bill represents a major revenue opportunity for RCAT because it’s an excellent fit for the Skypersonic-Dronebox platform.
Ban on Chinese Drones: Bipartisan legislation is pending to ban all Chinese drones from federal funds for five years. The entire segment of public safety and first responders in the U.S. currently goes to Chinese drone manufacturers. DJI is the dominant drone manufacturer, but a vacuum is opening up for hundreds of millions of dollars in revenue opportunities for U.S. manufacturers and suppliers. Red Cat is in a solid position to capture market share when this takes effect.
A member of the US Federal Communications Commission recently said that the agency should impose restrictions on Chinese drone maker DJI Technology because it poses serious national security risks. Describing DJI, the world’s largest drone maker, as “Huawei on wings”, Commissioner Brendan Carr called for the telecommunications watchdog agency to start the process of adding the company to its so-called ‘covered list’.
Brand Visibility Among Drone Enthusiasts
The company’s consumer segment provides a growing revenue base, strong brand visibility for Red Cat, and is an excellent source of professional pilots. With Rotor Riot and Fat Shark, this segment sells drones and related parts to enthusiasts and hobbyists which will continue growing as drones gain visibility.
Rotor Riot and Fat Shark brands are well known in the industry. Rotor Riot has a media platform with a social media presence that includes 233,000 followers and nearly 35 million views on their YouTube channel. Fat Shark is currently the leading provider of headsets and goggles for professional FPV racers and drone pilots. But competition in the market for head-worn display devices, including FPV HMDs, is expected to intensify as new and larger market entrants introduce products into these markets.
Red Cat sells FPV flight systems through Rotor Riot and Fat Shark. These products include flight design cameras, video transmitters, goggles, as well as the mounts, airframes and accessories to build or operate drone aircraft. The company also designs, develop, assembles and sells each of these FPV components individually and in packages. These products have become favorites in FPV racing and Rotor Riot sponsors several racing teams and pilots.
Red Cat acquired Rotor Riot and Fat Shark during calendar 2020. Prior to these transactions, RCAT did not have any revenue generating activities. The revenue mix for the fiscal year ended April 30 was about 75% from Fat Shark, and about 25% from Rotor Riot.
Reducing Complexity for Drone Fleets
In a true drone swarm, the drones communicate and collaborate, making collective decisions about where to go and what to do. This is still fully unrealized, though considerable R&D is being channeled into the effort.
Red Cat’s team is working to develop one-to-many autonomy for drone fleet operators. It is already one of the requirements for a U.S. Army contract next year, using one pilot to fly six drones, and RCAT claims it has been able to put 12 ‘birds’ in the air with one person in early tests.
Autonomy requires powerful software. The communication link is a critical part in making a swarm work properly. When 20 or 30 drones fly next to each other they have to be in close association and know each other. This requires artificial intelligence that enables software to get smarter. Red Cat uses its Dronebox to analyze flights to learn about what causes different outcomes from certain flight behavior, motor behavior, style frame or battery type under various conditions.
In the brief period that we’ve researched Red Cat, we have not reviewed their patent portfolio. However, the company believes the intellectual property from its four subsidiaries contains valuable assets. Possibly the most notable (and licensable) is IP related to eliminating the one-to-one ratio to a drone pilot.
Red Cat’s overriding mission is to develop a software platform that supports any drone commercial operator in whatever they do, whether it has five drones or a thousand drones in a fleet. Ultimately, the company envisions removing much of the complexity in drone flight operations.
See you next week, and thank you for your support.
Josh
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Disclaimer
The content provided in this newsletter is intended to be used for informational purposes only. It is important to do your own analysis before making any investment based on your own personal circumstances. You should take independent financial advice from a professional in connection with, or independently research and verify, any information that you find on our Website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. I was not compensated by Red Cat Holdings or any affiliates for writing and publishing this report and do not own shares of companies mentioned.