Yet Another Value Podcast - Cedar Grove's Paul Cerro on what makes $RCAT drones unique + odds for winning SRR contract

Episode Date: August 27, 2024

Paul Cerro, CIO of Cedar Grove Capital Management, joins the podcast to discuss his thesis on Red Cat Holdings (NASDAQ: RCAT), a drone technology company integrating robotic hardware and software for military, government, and commercial operations. Cedar Grove RCAT thesis: https://www.cedargrovecm.com/p/red-cat-rcat-trade-worth-up-to-200-prcnt Chapters: [0:00] Introduction + Episode sponsor: Ycharts [2:28] What is Red Cat $RCAT and why are they so interesting to Paul [6:26] Why is $RCAT relevant in the drone market? What is unique about $RCAT drones? [13:29] Capabilities of $RCAT drones and how much they are selling them for (to the military) / what specifically going on with $RCAT drone that US Government is using them vs. going with commercial drone [21:21] What is the SRR Contract and why is this a big deal [25:40] Odds that $RCAT wins this SRR contract [30:00] Economics if $RCAT wins the contract / what margins would look like [33:12] Valuation: market already baking in best-case scenario in terms of them winning? [36:17] What does the company look like if they don't win the contract / how much is Paul's bet on $RCAT winning the SRR contract vs. betting on Red Cat in particular [40:05] Are the odds in the stock price right now that they win this contract vs. what Paul thinks the odds are that they win this contract / in Paul's opinion, what he thinks the market is missing [45:22] Is there correlation between the NATO contract and SRR contract? [50:39] Final thoughts Today's sponsor: Ycharts This episode is sponsored by our friends at YCharts. A typical day in the life of a financial advisor calls for back-to-back client meetings, juggling portfolio management, and the consistent desire to improve client relationships. YCharts’ report and proposal tools could be the missing piece to help you effectively handle these time-consuming tasks. Now more than ever, clients want to hear from their advisors. And with user-friendly templates at your disposal, generating impactful client reports can be easily integrated into your everyday routine, helping you free up time and focus on what matters most: enhancing client interactions and growing AUM. Click here to start your free YCharts trial and level up your game with YCharts: https://go.ycharts.com/yet-another-value

This episode is sponsored by our friends at Ycharts. A typical day in the life of a financial advisor calls for back-to-back client meetings, juggling portfolio management, and the consistent desire to improve client relationships. Y-charts report and proposal tools could be the missing piece to help you effectively handle these time-consuming tasks. Now more than ever, clients want to hear from their advisors. And with user-friendly templates at your disposal, generated impactful client reports can be easily integrated into your everyday routine,

helping you free up time and focus on what matters, enhancing client interactions and growing AUM. I've said it before, but almost every post I put up includes charts from Y charts because, look, they're really simple, they're really pretty, and it takes almost no time to create them. So join the thousands of users who rely on Y charts by leveraging personalized proposal reports to truly showcase your value ad. Click the link in the show notes to start your free Ychurch trial

and tell them I sent you. All right, hello, and welcome to yet another value podcast. I'm your host, Andrew Walker. If you like this pot, it would mean a lot if you could break. subscribe review wherever you're watching or listening to it. With me today, I'm happy to everyone for the first time, Paul Serro. Paul is the founder. Well, I'm just going to call it the Cedar Grove Empire since you've got so many different Cedar Grove stuff going on there. But Paul, how's it going? Yeah, not bad, not bad. But yeah, I appreciate you calling it an empire.

Hopefully it ends up becoming that one day. How many different things are part of the Cedar Grove Empire at this point? So, I mean, there's the holding company, which is the Cedar Grove Capital Holdings. And then there's um we have uh there's cedar growth consulting which is just for me to be able to like do off side consulting work and then there's also the uh cedar grove capital management which is like what you've been reading about for research slash the investing portion of everything um so there's a there's a few things going on right now but uh hopefully we'll see how big that eventually becomes the next five or 10 years cool well uh before we start talking about

all that. Just a reminders to everyone, nothing on this podcast is investing advice. That's always true, but maybe particularly true today, because we're going to be talking about a company that it's got a decent market now, 250 million-ish, but, you know, if we had been talking nine months ago, this was a penny stock that's run up on some enthusiasm and everything. So it would have been very small. It's still quite small, a little bit more on the liquid side. So people should just remember, you know, please that comes with a lot of extra risk. Please do your own work, consults, financial advisor, keep all those risks in mind. I'd definitely encourage you to read the 10-K year because it lays out a lot of those risks pretty clearly. But anyway, Paul,

the reason you kind of reached out and we wanted to get you on the show is, the company today is Redcat. The ticker is R-C-A-T, and you had an interesting event-driven trade on them, which the stock has started to work, even though the event hasn't kind of fully played out there, but maybe I'm getting ahead of myself. I'll turn it over to you. What is Red Cat and Mario? they sue interesting. Yeah, so Redcast, I actually brought on to this by another fellow Twitter analyst or whatever you want to call it. I don't know how you label people like that. But anyway, I found, I actually found the idea on Twitter. And it just really caught my eye because I was this thought, was it Mike with a bunch of maybe his phone number behind it?

It was Mike. Yep. So like, I know, because I DM him about it because I just wanted to ask questions because so context, I'm very big on defense, defense in general, defense, weapons contractors, et cetera. So, like, I, in that nature, you're kind of spending more time on the big boys, right? Your Lockheed Martins, your Lachian, your general dynamics, North Thernerth, et cetera, or in Raytheon. So when I was reading his post, it was about a little guy. I was like, oh, how little is this guy? I mean, you look at it, it's microscopic a little if you're trying to compare the big boys to

what's going on with Red Cat. So, you know, I DM them asking him much of questions, and, you know, I decided like, hey, if if this is, I already know what the general, like, thematic direction is for defense spending, and not just the U.S. by the world. Let me see what I can deter from his original analysis, which I ended up spending the whole weekend on.

And in my original research when I posted it, I drew a comparison to that one guy from Always Sunny in Philadelphia, who's, like, going crazy, combining all, like, the red lines everywhere, as if he's trying to, like, draw some, like, murder mystery crime scene thing. And when I went through it, I spent the whole weekend, I was so hyped up on caffeine. And I found out, like, in my own, I guess, understanding, like, what the numbers are and et cetera, et cetera, for these contracts, these weapons contracts, that Red Cat, who specializes in drones was going for. And I'm like, okay, this is interesting. And that's when I kept going deeper and deeper and deeper into it.

But to sum it up, it's Red Cat Holdings is a U.S.-based drone manufacturer, an unmanned drone manufacturer. So they're the people who like create those like little drones that you can kind of maybe even see it comparable to like DJI, but they have military purposes. And their whole trade is essentially them benefiting from a U.S. Army contract that at the time of my post was worth. multiples of the entire market cap. And they were chosen to be one of the last two people to potentially win this contract. So the more I dove into it, the more I checked the numbers, the more looking at the capabilities of Red Cat. It's got more and more interesting to me. You know, it's one of those trades where it's not solely dependent on them winning this contract, but the upside is mainly driven from this contract because at the same time,

their core business is still growing. So there was a factor of like, okay, my downside is limited because the core business is still growing. But if any investor on the long side is right, they're going to be right big. And I felt like that was a pretty good risk reward. So that's why I ended up taking that trade and running up the research and posting it. So I guess a few things. A, I should just note to people, I'm going to include a link to Paul's right upon this in the show notes. B, I should note to people, you can go look on the Redcat website and see their invest in relationship deck. And if you do, you know, I have to say the CTO here has a just absolutely pitch perfect mustache. You really got to get in front of that. It's not a huge

mustache. You know, you're not, it's just like very tight. And I think people should be aware of that and all the investment implications there. But let's talk. So I want to come back to the contract in a second. But, you know, you mentioned, hey, defense, you're big into defense spending. Like, when I just look at Redcat and they have an off cycle fiscal year, but you know, If I look at their financials, they spend $5 million a year on R&D, and they're making drones. And I just look at that and say, hey, okay, cool, drones, contracts, like, why are these guys the ones, forget this particular contract, but why isn't Lockheed, like, $5 million a round in ERIS Lockheed? It's not like this technology can be that proprietary. So why are these guys, like, even relevant?

Yeah, so, you know, to answer that question more fully, I would need to take it. a step backwards to answer that question. So broadly speaking, it's not a secret these days that there are some tensions between the West and China, Russia, North Korea, etc. It's unfortunately becoming a more geopolitical, I guess, tit-for-tat situations right now, at least as far as economically, right? But then there's a lot of worry that that could spill over into further instability, which would then result in direct confrontation of armies. this modern day and age isn't like World War II anymore it's not like Korea it's not like Vietnam there's there's you're not sending hundreds of thousands of soldiers head to head anymore

and trying to take like one hill like in Korea or something like that right modern modern warfare has really really um developed the future of what combat will look like without actual boots on the ground if not if not necessary and what does that mean right So Russia kind of really put that into perspective when it just invaded Ukraine, right? Everybody thought Ukraine was in a fold. Honestly, that was one of them, and luckily they haven't yet, which is great. But the real point is how unprepared the West is on a military basis for the global instability that's happening and will continue to happen. So the broad base theme here is that if they need to develop weapons, it's not just going to be boots on the ground.

It needs to be weapons that can be used from deep within your own country that you don't have to be within a line of sight with you and me right now. Better weapons with vehicles, with aircrafts, with missiles, with ammo, with reactive arms. There's a whole list of largerness of things. So when it comes to the broad-based spending, NATO is going to be a very big part of this play, has been very much reliant on America to be its, sharp end of the knife on things, right? We were spending, you know, almost trillion dollars on, almost $1,900 billion on defense, more than the next, like, 26 countries combined. And they were always relying on us, even other countries were. And then, unfortunately, the time has come where America's like, hey, we really just can't be the only ones who

keep spending money because if push comes to shove, if we have, hypothetically speaking, if we go to war with Russia for some reason, you know, we can't be the only ones. being able to do that, right? You got to spend money. So there's been this huge, huge uptick since 2022 of these NATO countries who are supposed to be spending a percent of their GDP already, but haven't, that are now really ramping up. So you have a general shift in overall, I guess, worldly views of how dangerous the future is going to become, or could become, I should say. And so there's a whole, like, increased level of defense spending, broadly speaking, U.S., NATO, African countries, East Asian countries.

I don't think anybody would disagree with anything you just said, right? But that's overall, right? Like, that's the rising tide. And maybe a rising tide lifts all boats. But that rising tide, like, that would make sense for why you buy Lackey Martin. That would make sense for why you buy a bunch of it. But I guess my question would still be like, these guys, a $5 million R&D budget to make drones, like how were they even one of the last?

to for this big contract or like, how are they even competing? Because again, it's a rounding area. It seems like this should be something that's getting scooped up by a bigger player or a mid-em-sized player. Like, how is this kind of minnow in here? What's unique about their drones? Why are they even involved in this? And that's the real difference, because when you have a good upcrease of defense spending, it's this thing that's going to naturally go into existing programs. So the split here between this is, we'll highlight just the drone part. You already have a the big boys who handle like the bigger drones, right? These are like what you and I have probably grown up knowing as like the predator drones, right, who carries the sidewalk, like the missiles

that are on the wings and they can hit, you know, Al-Qaeda in a cave from, you know, a couple miles up in the air from 200 miles away from the guys controlling it and like somewhere in Iraq or even Nevada, right? Those are what the big boys handle because those are, those require more R&D, more spend, more manufacturing, they carry heavier payloads. They have a proven track record of making those heavy hitter drones, for instance. When it comes to Red Cat, right, Ukraine basically showed the world that they could do devastating damage if you just had a simple drone that you could almost kind of like go to your best buy and arm it, right? So when you're talking about a small R&D budget, which is quite literally a rounding error, wouldn't even show up

on like Lockheed's bank statement. It's mainly because there is a direct need based on a proof of concept that smaller drones and masks can accomplish a lot versus spending the $5, 10, $15, $20 million per drone attached with the payload, depending on what the situation is. So when you're talking about the need for it, you have the big boys and the big things. You have the little guys handling a lot of the little things. And the real push there is that there's a whole, based on the recent acts that were signed into play, we're actually trying to stay away from foreign-made weaponry. And I would say it's kind of like for obvious reasons.

It's kind of rhetorical of why you don't want a foreign power and making your own weapons. And this is why the Americans are actually pushing up American-made weaponry. So they're promoting the Redcats. They're promoting the skidios. They're promoting a couple hundred other military manufacturers. And Duro is one of them, right? Very hot in the BC space, air environment.

with their suicide switchblade drones. So there's so many companies that are now rising up to fill the need of what the future of warfare looks like from a drone capability, and then also filling in the gaps of what would have been a foreign power, aka China, making these drones and making these drone components so that America and its allies don't have to worry about someone else having leverage against them when it comes to weapons. that makes some let's the so just for people so the drones as you said these are small drones like if you think about one of those drones you know it's like a square with four legs sticking out

in each of the legs as like a little propeller rotator on the top like that that's kind of that that is the front image of their investigation right but when you think about these drones so what are the capabilities of these drones that they're making and then the real thing I want to ask is if you and I were they're probably not going to sell one to us, but like how much are they charging from one of these drones just to put it in contest? Because as you said, a predator drone millions of millions of dollars. Like how much are they charging for one of these? It's actually not much. So if you, so what was a part of this contract, the initial price when it was coming to the first tier was looking at about $20,000

a pop. It wasn't, it's not much, right? You talk about the big scheme of things. Now with unfortunately what's been happening in Ukraine being tested on the battlefield, the, the, I guess you say the V1 versions are not holding up very well in the battlefield. They're getting shot down nothing, right? So in order to make them more combat effective, they have to increase the specs, increase the capabilities of not being jammed, increase the capabilities of not being shot out of the sky, et cetera, et cetera. It increases the cost. So when you look at it, you're looking at about $40,000 or $30,000 per drone now,

which has the increased capabilities, which is a part of the program. So it's not like you're going to Best Buy buying your $1,000 DGI drone, which is what Ukraine was basically doing in the beginning of the war. These are now filling what the increased needs are in an ever-changing combat environment, which gets more and more expensive as time goes on because the capabilities will become greater and greater as time goes on and the battlefield changes. Just so, do you have a specific number of how much these drones cost, though? I'm just curious because I know they come down massively over time. That's going to kind of lead into my next question. It's okay if you don't, but 20K to start. But I would guess it's way down by the time they fulfill the next contract.

Okay. So the part two of the contract is actually a combination of part two. It was originally part two and part three. So they've actually become one. And in that situation, that's where the new increased costs, which is based on my estimates, granted I've spent so much time trying to figure this out, is about $33,000 per drone.

Okay, 303. Increased, $33,000. Okay. When I'm thinking of these drones, because I remember a few years ago, a few months ago, and you still see this, like, Ukrainians were literally building drones in their, like, backyard, you know, just hundreds and hundreds of, so why does the U.S. government need, like, a $33,000 drone here versus, hey, why don't we go to Best Buy? and by, you know, for $33,000, by 300 of these drones.

And then, you know, what will install some tech and stuff on them. But why, what is it specifically about going with like a Red Cat versus kind of just going with that commercial drone and then just installing some tech onto it? Oh, yeah. Because if you think about it from a very, from a cost perspective, what you just mentioned makes the most sense, right? You're getting more value for your buck. The problem there is deciding who your friends are.

And I say that in the context of if you go, and buy DGI drone. DGI is a Chinese-made drone. And that's exactly what Ukraine was doing. They were going out and buying these $1,000, $2,000 drones to use as reconnaissance vehicles to scope out Russian positions, right? And then the problem there is you almost needed to trust who your host was in order to use them effectively. And unfortunately, the Chinese were not being very trustworthy with their products. And what I mean by that is there were actually every time a Ukrainian drone would go up, that was DGI, Chinese, there were reports that the Chinese would actually be sending Russia information

about the whereabouts of who is manning these drones so that Russia would just, you know, pop in some coordinates and drop a bomb on them, you know? So there's a situation where you can't even trust the people who make it for you because they're just ratting you out because they're actually not your friend. No, that makes, it makes total sense like, because kind of one of my worries, and I think you're addressing, but one of my words is, you know, the, the SpaceX thing where NASA would always use, everything was custom NASA, and then SpaceX was like, why do we need a $30,000 custom space calculator on our aircraft? Let's just use a normal

calculator. And like that turned to work out fine. So it's kind of wondering, oh, why, you know, $33,000 drone versus $100 drone. But I do, I guess it does make some sense. Now, I'm sure you could get a U.S. producer to mass produce these domestically for maybe 200 versus. 100 China, but you still might kind of want, if you're going to flood them with thousands, you still might want to know that it's proprietary, that you've, who's making it, that you've got control of the nest work. Anything you want to add there? Well, yeah, I mean, that's a big component, right? You've got to be able to just to trust, trust people, right? Especially talking about weapons. Secondly, is the capabilities that keep

changing just keeps adding to the price, right? You might need thermal imaging on a camera, You're not going to be using some $200, $300 GoPro attached to a DGI, right? Or whatever the stock, the camera is for DGI. You'll need thermal imaging. You'll need potentially infrared being able to see, like, hopefully through thinner walls, right? The ability to have the radio frequency is not being jammed, right? That's how a lot of them are getting shot down because the Russians would basically just send out some telemetric beam that, like, shuts off their radio frequency. and then these drones would fall out in the sky because they can't connect to the driver, right?

So they were just falling out of sky left and right. So the more capabilities that keep happening, the more expensive things naturally get. And you can actually, as an easy example, comparing it to, you can kind of almost see, like, how are you going to get injured? I think you're like, kind of similar to my age. I'm sturdy. So I imagine we're kind of in the same ballpark. A little bit older than you. I think we're both 30.

We're both 30. But I'm sure you can imagine, like, you know, when Operation Iraqi Freedom happened, Humvees back in the day were the most bare-boned vehicles with a 50-calibre machine gun on it. Over time, you know, over the next 10, 15 years, Humvees became a very, very expensive piece of equipment because it got more and more upgrades added to it, right, to withstand IEDs, to have like reactive armor, to have this and that, et cetera. So over time, the prices are just going to naturally go up because the needs on the battlefield will just naturally change things, right?

So the first contract being $20,000 a drone, second part of the contract being $32,000 a drone, there could be a future version that could be $50,000 a drone because we just don't know what the requirements will be a month from now, a year from now, five years from now that the U.S. military and its allies are going to need in the battlefield. And that's just the fact of life, unfortunately. This episode is sponsored by our friends at watch arts. A typical day in the life of a financial advisor calls for back-to-back client meetings, juggling portfolio management, and the consistent desire to improve.

proof client relationships. Y-charts report and proposal tools could be the missing piece to help you effectively handle these time-consuming tasks. Now more than ever, clients want to hear from their advisors. And with user-friendly templates at your disposal, generated impactful client reports can be easily integrated into your everyday routine, helping you free up time and focus on what matters, enhancing client interactions and growing AUM. I've said it before, but almost every post I put up includes charts from Y-charts because,

look, they're really simple, they're really pretty, and it takes almost no times to create them. So join the thousands of users to rely on Y-charts by leveraging personalized proposal reports to truly showcase your value ad. Click the link in the show notes to start your free Y-church trial and tell them I sent you. So let's go to this big contract where you can talk about. This is the S-R-R contract. We can talk about the NATO contract later, so let's just put that to the side for now. But the big contract that we're getting set about is the S-R contract. You know, you identified in your article originally, but then in the August earnings call, which I think got people really excited. They came on and said, hey,

it's between us and one other person for the SRR contract. So I'll back up and just says, what is the SRR contract? We started talking about, but let's just make sure we fully define. What is the SRR contract and why would this be such a big deal? Yeah, so the SRR contract is a U.S. Army short-range reconnaissance contract for supplying with unmanned drones that can fit in a soldier's backpack. It needs to be that small and that light so that if you and I end up going to the front line somewhere, we can just whip this thing out, have it fly out into the air, and then be able to provide reconnaissance for whoever troops are needed, right? That's essentially what it is. However, I don't want to make this seem like it's a Ukrainian war situation

because it actually was a program that was pre-COVID, but because of COVID, like it actually was launched in 2018, but because of COVID, it was delayed. So there was a company who's called Skidio, who won the first part of that contract. And unfortunately, they're the ones who made the drones that are being used in Ukraine that are getting shot down left and right. It's not a fault to them. It's just the battlefield changes. Oh, I mean, just to, if you go, like, a lot of times I'll read the Institute for the

Study of War. I like to read their daily recaps. Oh, nice. Okay. Just everything, like, everything you're saying is right, right? Like, the Ukraine-Russian War is the first modern war. and like post-modern war, 2000s war, like,

they're learning so much from how drones, the internet, all this, they're learning so much from it. Like, if you're saying, oh, they ordered this contract in 2018 and this stuff's getting shot down, like, yeah, that sucks, but guess what? It's a modern war. Like, we've never tested or seen how these things work.

So it's very much kind of what you'd expect, and you'd hope our leaders are learning from this modern war to prepare, hopefully we don't ever have one, but our troops for whatever the next war is. like that is what they should be doing. Yep. And that's just the fact of life. I mean, no, I can't imagine anybody who actually will answer a question saying, I like war.

I don't know anybody who says that, right? There's no winners in war, right? They're like, yes, technically there is, but really there's not. And the problem here is that in the modern warfare of modern battlefield of Ukraine right now, drones have really proven that most modern equipment is not, That's not necessarily useless, but it's not as dangerous as they once thought, right? There's articles that came out in the beginning of the invasion where they said that tanks might not even be useful anymore as line penetrating vehicles because they're getting blown up left and right from, you know, one person on the rocket launcher now, you know, last month, which blew my mind because it was caught on camera and you maybe see it on your own time. There was a Russian attack helicopter.

I think the price tag on that one was like $12 or like $14 million. dollars, a $2,000 suicide drone, one, flew into it and blew it up. The impact that a $2,000 drone can have on a $12 million piece of attack equipment is insanity, right? You can't lose $12 million vehicles left and right and expect to be able to sustain yourself in a war. This doesn't work that way. But you can make a $2,000, $20,000, a $30,000.

drone, and if I can think you take out a $12 million attack helicopter, you're winning, all right? So it's really proving themselves in a situation like that. And that's why this reconnaissance program, I have to stay here because I don't want to get cared away. It's for reconnaissance. There are different programs that are attack drones or suicide drones, etc. But for the sake of this contract, it's just to be able to fit in your backpack for me to whip out on the front line and start spying on enemy positions. That's what it's, that's what for just for connoissance yeah okay so great so that's sort of four SSR short range reconnaissance uh let's talk about it you know they come on the August call and they say

hey we're one of two players left in this scenario I want to scope out two things number one if they win what are they what are kind of the economics but I guess the second thing is like they've come out and said it but you mentioned you were digging through all these documents like what have you seen in your due diligence that because to mind knowledge again. I only spend a day researching these in prep for the podcast. I, you know, I didn't like dig through the Department of Defense RFQs or anything. So like what have you seen to confirm that they are one of the last two, that they have a shot at winning this, all that type of stuff. Yeah. So luckily we've known that they've been the last two for a while

now. They just reiterated that on their recent call like, hey, there hasn't been an announcement. We're still in the running. So because everyone's basically wrong. That's the catalyst right now is are you in it still? Yes, no. And if you are, you know, what's the timing, right? That's how, that's how we're all leaning towards. The interesting part is that with their reiteration of being in this contract still, they're estimating that by the end of September, they're hoping to hear back from the US Army in decision. They had their final submissions for the drones in May. So the US Army, this whole time, has been testing their drones along with their competitors, which is Skidio, who is the current incumbent.

So they've been testing them out, and that's what they're hoping to get a decision by the end of Q3. The real part of my diligence is, so it's slightly annoying because your diligence can only go so far, right? Because when you're competing for these weapons contracts, you actually don't know what the final version is that they've submitted for these contracts, right? because they're always going through iterations, right?

Oh, you know what? If we might need to make this drone have, you know, flying capabilities and not just VTal capabilities, right? Maybe it needs to have a three-pound payload, not a five-pound payload, or vice versa, right? Or maybe the imaging of this camera needs to be just a little bit better or it needs to incorporate this, etc, et cetera, et cetera. So, like, things keep changing. So you actually don't know precisely, hey, you know, this drone is what was submitted, and now we can label that against this. drone, which was submitted, because it's all confidential, right? The military does not advertise what exactly its hardware is made out of and what the requirements are. So the unfortunate part

is you are limited to what you can assume was submitted. However, what you can tell is that based on the prior versions, kind of who was doing a little bit of a better job prior to submissions. And as of right now, you can arguably say that Red Cat had a, arguably, better drone for what was needed, the next leg up for what was needed. The other point here that I want to label is that when it comes to weapons contractors, usually incumbents typically stay within the program. They've been picked once. They've been vetted. Yeah, they've been vetted. they've been they've proven themselves to whoever general agreed to you know sign off on the on the

budget etc the problem here which is very interesting in this case is that skidio again when in the first part to no fault to them your drones are not doing a very good job on the battlefield right so when you're talking about um the ability to command that incumbent leverage it's not looking so hot right now and again it's not because they didn't do a good job it's just because you know you make drones for what you thought the battlefield was going to be in the changes. So it's going in favor Redcat is depending on how they, you know, kind of portray and pitch themselves, it's like, hey, listen, you kind of gave this company a shot. They did the job. Unfortunately, it didn't work out. Why not go with us where, you know, we have certain certifications that have been

approved by the government as well. We've tested it and proved it that, you know, the border patrols buying them, NATO countries are buying them, you know, give us a shot, right? They're kind of arguing for that case. And that's kind of what helps shift the narrative of, oh, they actually might have a shot here because a little bit more can be on their side versus if it was, you know, any other contract, then they might not win it, you know? So let's say best case scenario, right? Red Cat wins. Yes. Yeah. What do the economics of it look like if they win this contract? Like, you know, I could say we're playing for a government contract and it could be a $10 million for your contract.

I'm like, cool, this is a $200 billion market cap company that doesn't move the needle. Or I can be like, hey, we're playing for the contract. It's a $10 billion contract. You're like, wow, it's a really big contract. Okay, cool. Yeah, so the real meat and potatoes here is that it's about a 10-year contract. And each year, based on the budgetary outlays in their annual budgets, they have to kind of list out up until 2009 right now what the year.

unit demand will be for these drones. So we can kind of estimate on a yearly basis what it's going to be. So it's not like an even number every year. It kind of ebbs and flows. But if you're assuming that the drone costs stay the same, you can kind of estimate what it's going to be like. The total value is just under $500 million. So when you're talking about a company that's trading for like half of that,

one contract alone granted it's over 10 years is was double what the company is right now right a little bit more so big upside the problem is how does it has a market value that because you have a contract that you yeah you'd win that's worth multiples of what you're worth how do you value that and that and that gave out different scenarios of how that works one so one contract you think if they win it it's going to be about five hundred million dollars a problem you know that Exactly. And over what timeframe? 500, almost 500 million for 10 years. And that's just for the hardware and like the actual, like replacement parts. I was just like 500 million per year or in total over the country?

Total. Total. Yeah. I guess my. It's sort of trying to hear of it because 500 million revenue sounds good against a 200 million dollar market. Right. But this is government contracted like I haven't looked at Lockheed Martin in a while, but government contracted drone on a small scale. what are the margins going to look like on that contract? Yeah, I mean, they'll be profitable on it. I mean, they're already, like, reducing their cashburn already with the contract that they have. I don't know the specifics of what it would be like, but you're talking about,

you're talking about each other that you're still making. It's still going to be profitable for them, right? And if you're, if you're increasing the volume, which is exactly what's going to be happening here, that's one of the bigger points, I guess, from a, like, a structural, like, balance sheet perspective is that they're going to get a ton of money up front because they need to get money up front in order to start production of these. So the balance sheet's going to be more than capable of handling it.

And then if you think about it, the longevity of the contract over 10 years and they're making money on each drone just in this one contract, you're talking about a company that's going from, you know, a small thing out of Utah to then becoming a really big player and what would potentially be the future of drone marketing.

So it's not like, so unfortunately don't have like the exact numbers. Again, I don't know what the final iteration was for the drone that they submitted. So I don't know what the United Economics are. But from what they've hinted on their earnings call, it could be very profitable for them, I'm sure they win it. I guess what I worry about is it sounds like a big number. And they win a government contract, right?

But they win a government contract for a drone, which is, you know, it's good work, but it's not the highest margin, most complex. Like, there's a reason they're benefiting the south of smaller players. They win it in, you know, let's say it's 50 million of annual revenue for 10 years. Like, that's a great revenue stream. You've got your foot in with the government. That's great proof of concept. But you might make sense as an acquisition to someone who can just like rip out all your GNA and just provide all that.

But, you know, if it's, it might be 50 million of revenue annually, it might be like $6 million and we're, it's a 200 million market cap company right now, right? So I'm kind of like, hey, you know, the market cap at this point seems to be baking in a high probability of them not only winning this, but using this as the stepstone to either a future acquisition or continued work as you mentioned, like the Humvee start. out as the cheapest and then you keep adding on adding on, like this starts out as cheap you should keep adding out and adding on, maybe one another contract and I, I threw a lot out there, but I guess I'm kind of wondering like the market is a competitive place, two months ago, like this was a lot lower. Maybe the market had not a lot as scribes this, but with the company coming and pounding the table and everything, like is this really alpha opportunity here or is this more it's already baking in a kind of best case scenario in terms of them winning?

So when it comes to the actual contract, not much has changed in the sense of what that value of the contract would affect, how it would affect the valuation of the business as it did a month ago versus today. That stayed, in my opinion, that stayed the same. But what got interesting, which is why I put out a recent report on it, is that they announced a newer acquisition of a company called Flight Wave. And Flight Wave also makes unmanned drones as well. That was the recent acquisition that they made in June, I think it was.

Maybe it was late May or early June. And what was interesting to me is that we didn't have any information related to that acquisition. They just said, like, hey, cutting edge drone technology really rounds out our portfolio of products within our drone company. There's no numbers really behind it of like what that should be. But on the earnings call, what was interesting is that the CEO, Jeffrey, he was saying that potentially for calendar year 25, which is, their end fiscal year 25. They're in it right now. It ends January June 2025 or so, yeah. Right. So he was

estimating anywhere from $10 to $20 million just from that product. So what I got interesting for me is that if your confidence in the contract has it changed, right? That's still say the same. The floor of what the valuation is without winning that contract has also moved up because now we can assume what a future backlog could be for these drones in the coming years, right? So now we think about your downside, it's a lot less, even though the stock has moved up,

you know, 40, 50% in, what, a month and a month? What is the downside if they come out end of September and they say, hey, we gave it an honest effort, you know, we think our tech was the best, but the government is going with the incumbent here, as they normally do. Like, what does the company look like in that scenario? Yeah. So, I mean, it's definitely going to be lower right now. But it's going to be, if you, if you weigh out the options, it's kind of like you're going to feel short term pain, which is going to be like reverting back to what you probably saw the prices about a month ago. But you have short term pain, but the actual like core business is still growing, right? And that's going to be leading into the other programs that I know you mentioned in the beginning of our call about was like the NATO programs, right, or additional U.S. military programs. So it's not just contingent on this one. It's just. that this one is the only, like, live one that we can apply a hard number to, a semi-hard end date to, and figure out what the longevity is for that contract. That's kind of like why so

much is leaning on this. But that doesn't mean it's the end-all, be-all, because in the weapons contracting space, deals come in left and right all the time, whether it's people in Ukraine, whether it's Germany, England. The Border Patrol has even bought their drones, right? That's just the, again, reconnaissance drones to watch the borders, right? So there's always going to be aces and deals coming in that we don't know about right now, which is what they've hinted about on the last call, but it's the most important one right now, which is the SRR contract. So it's not the end-all be all, it's just the nearest term catalyst that we can apply some level of confidence in it.

Let me ask you it to you in a different way. How much of this to you is a binary where you are betting on SRR, them winning, and you think, you know, the stock is undervalued once you start. factoring in the SR contract and all the baltons and the add-ons and the proof point there versus how much are you betting on, you know, Radcat in particular, their technology, their management team, their everything that they can, even if they don't want SSR, like this opportunity space is huge and you think there's something unique about their technology management team and everything that they can go and can capture and continue to capture slices of this.

Yeah, you know, I think it's hard because, you know, I try not to be biased, right, because you You live in America, right? You want to support your country and the abilities a country has to defend itself. That means representing the companies that are American-made, Red Cat being one of them. So there's a part of me that says, you know what? I want to just believe that they can get the job done in the future, even if they don't win it, which I do, which I do believe they can. But as an investor, you know, you don't want to have capital tied up because you want to wait for the hopes and dreams of what a company could be, you know, two, three years down the road, right? So there's a function of, like, I think I'm more in it as a binary trade, right?

They either win it or they don't, right? If they win it, great, I make the additional alpha that I've outlined before and then I'm out. Or if they don't win it, it's kind of one of the things where, and I've got to be honest here, depending on where the dust settles might motivate me to either just cut my losses and move on or stick it out because if it's not that bad, it might be one of those things where, okay, great. Maybe the market's going to be, maybe markets deciding that the future of this company was not contingent on this one contract and that the future is still bright once they start announcing future contracts, right? So it's, it's one of those things where I'm still

navigating myself, but in the moment, it's pretty binary. So we're talking August, let me have today, right, August 21st, right? The stock is, as you mentioned, it's around quite a bit and most of that is they come out on the Q2, or sorry, not the Q2, they come out on their earnings call and they reaffirm everything about the contract opportunity. They mentioned the NATO contract, but we haven't really discussed everything. And most of that is the stock moved there. So as we're talking, August 21st, the stock at 3, if I had to be like, Paul, what do you think the odds in the stock price right now are that they win this contract versus kind of what

do you think the odds are that they win this contract? Yeah, no, I think the market is really pricing in that they're going to win. And it is an interesting point because I actually tweeted about it too. So in their transcript, you know, they announced additional hires for GNA to fuel future growth, right? And if you look on their careers page, I think at the time that I tweeted about it, they have, I think, 29 or 30 open jobs, open positions for the company. If you go to LinkedIn, the amount of people that are currently employed, at least on LinkedIn, was 23, I think. Or maybe it was like, I may have reverse. It was like 30 and 23.

Either way, they're expecting to hire. a lot of people, which you and I can, I just attest to, you normally don't do unless you're figuring in some type of future growth that would require that many people to nearly double your headcount, at least on LinkedIn, right? So it's, it's one of those things where I think the market is pricing in what the commentary was on the transcript. They're also like digesting if they saw what I saw, right, with you improving headcount by double. Otherwise, why would you do that. And then if worse, worse comes the worse, the fallback, the downside is not just the core company being okay, but also the NATO projects, the future US Army contracts like

replicator, et cetera. So it's also, I suppose the caveat too, I got in this a month ago. So like my downside is a lot more protected than if somebody were entered today. But that doesn't necessarily mean it's still not a good trade. It just means that the extra margin of safety probably isn't as well as it was a month ago. But that doesn't mean it's not as as, you know, just so like, yeah, I guess my pushback would just be like, you know, if I'm today looking at this with fresh eyes and saying, hey, you know, the market is a competitive place. What is the alpha opportunity? And you're saying the market's already pricing in the contract, then it feels like there's not really like if the market's already pricing in the contract. The market's, it's priced in. Right. It feels like there's not really alpha if you're saying the market's got this priced in at this point. Oh, yeah. Sorry. Let me, let me. redo that. So they're assuming that it's going to win, but they're not actually pricing in the actual, like, full value that at least I've estimated it to be. So while the market has moved up, was it 30% in two weeks, I think, or 20% in two weeks, something like that. I think it's 30%. The actual value that I've applied to this contract win is still 100% more than it is today. So I guess what you're saying is the market. even though the market is quite optimistic about this win, you think the market, I mean, I've certainly seen these before too, where it's like, hey, the market is pricing

this win as a $10 million win, but it's a $30 million win because the market is underestimating our margins or the market is underestimating how big the win is or the market's under estimating the follow-on work. So that's kind of where you think the difference between you and the market is at this point. Yeah, because I think based on that last starting transcript, or a lot of starting call, the math has changed. And the math has changed for the positive, because the goalposts have been moved, right? I mentioned the flightway of acquisition. Now we have hard numbers, I mean, they're estimated, but estimated numbers on what that backlog could be, right? So that

increases the potential automatically. Then you have the ability of what they mentioned before, the NATO contracts that they said they're already running for that would be decided by the end of the year. Then you have like replicator program, which is a very crazy initiative that is arguably more important, but they're still being decided too. So when you think about how much alpha you have left, because of that one call, the goalposts have moved upwards, which allows any investor if they want to get in to, again, limit their downside because more stuff is happening in the background, but that contract is still there. So while the more stuff is happening in the background, tack on the contract win, you're still looking at a healthy premium to what's going to be going on. The issue, again, is just what is the reality if they actually win it? And push comes to shove, I think it's definitely over 50%.

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So people can go read the Q2 transcript if they want to do more diligence on this. And obviously, I've encouraged people to do diligence, do their own work on everything. That's how I said the podcast. But I just want to ask, so the company comes on the Q2 and they say, and you've alluded to it here, hey, not only we're up for this SRR, but NATO has a contract. And the NATO contract could be, from memory, I think, they're pitching as it could be about five times the size of the SRR contract. And obviously that seems very early stages.

But I just want to ask real quick on the NATO contract, is there correlation with the SRR project, right? Because I could imagine a world where you say, yes, whoever went the SRR contract is going to be by far in the lead for the NATO contract. I could also imagine a world where you say, no. Whoever wins the SRR contract, there's no bearing on the NATO project. like there's a legacy incumbent here, the U.S. department, like they contract on a lot of different areas. NATO might want to do a European-based person, or they might want someone separate than the U.S. government for, like, that might be good diversification discipline for them. So maybe R-KAT's more likely to win it if they don't win this contract because they want to have like kind

of systems that work together, but that aren't run by the same person. So I threw all the option at you there. Like, how would you think about that from the NATO perspective? Yeah. So I think there's there's an immediate need for weapons right now. And then there's also a long-term need for weapons. And you don't, again, you never want to go to just one source for things, right? Like, again, the big, the big guys, they do certain things very, very well. And that's why the world will go to to go to them for stuff. Right. So if you go to gel dynamics, usually go for a neighbor's tank. Right. If you go, if you want missiles that are well made, you know, you go to Raytheon as an example. They don't exclusively do that, right? They all kind of touch you base. and even like collaborate on things. But when it comes to drone, the need for drones right now is so abundant that you just have to be able to buy them from so many different places

because the capacity constraints to be able to manufacture them unfortunately are limited right now. You can still ramp them up, but if you're talking about, you know, 15, 16, 17 NATO countries that are like, hey, okay, we all need drones right now.

You can't just get it from one person. You literally just can't. So I love the example you brought up because they're competitive right now, Skidio. they so again first part of the contract was not great they did a very very poor job the most recent iteration that's on their website which everybody can go check out the Ukrainian military has already put in orders for them so the Ukrainian military is already like okay hey I know you I know you screwed up the first time

but we like what you've done with the second with the second iteration you know we'll buy thousands of them and then you have the the ability for that they actually took advantage of was like They actually hired a team specifically to be in Ukraine as a liaison to help them with the Stadio drones. I haven't heard anything from Red Cat doing that, but that's an example of like, okay. I think Red Cat, sorry, I've got their deck somewhere. I'll try and pull it up. Red Cat has in their December deck, it is page, ah, rats, I can't find it.

Yeah, yeah, Redcat has their, in their December debt, it's page 22. I'm looking at it now. they did send people over to a Ukrainian training facility to test some of their stuff. So Redcat's certainly done something. And I mean, look, it's tough for me to tell anyone, hey, go participate in a war zone. But I guess if you're making drones or anything that's like on kind of the cutting it, you need to get some experience over. You need to get some of it tested or learnings from Ukraine because, again, that is the most modern

oversight. So they've definitely had a team over there. I think that was November, 2003 is when the photo. was taken so yeah i think the difference is that the one is being used for testing but then for studios purposes they actually literally actually have hired people to be stationed yeah yeah in ukraine permanently uh at least all that conflict is going on so it's it's it's like same same but different um but no so it's so it's the ability to be able to like contract out to multiple manufacturers because the capacity the capacity the strengths are

very much real but the demand is even more intense um and then also you never want to have If COVID's proven anything, you never want to have supply chain hiccups if you're relying on one person, right? Because you never know what's going to change and you don't want to be reliant on one thing, especially when it comes to combat. So that's why I think we're going to come to the future. There's going to be a lot of winners in this space, mainly because innovation is going to be needed to be able to do this. The future conflicts don't just stop with Russia. The replicator program, which I mentioned in my article, is that that's the U.S.'s responses to China with what they believe will be. in an invasion of Taiwan in the next two to three years. And drones are a very, very, very important

part of that, which is why they're spending over a billion dollars on that one program. Look, I think we've covered a lot. Again, I just remind people, this is a smaller company, 200 million-ish market cap. Obviously, there's a big binary, as Paul kind of discussed, that's coming up in your future. So people should just include a link to Paul's article in the notes, but people should really keep that very heightened risk in mind and do their own work and all of that. Paul, I just wanted to include that disclaimer, but we covered a lot here. Is there anything you think we should have mentioned that we didn't hit or anything like

we kind of glanced over that you think is worth mentioning here before we wrap it up? Yeah, I think a few things. So one, the broad-based theme of defense spending is going to be going up into the right. Again, it flows into different categories, drones being one of them. even if you're just interested in learning about it, learning about these companies and learning about the weapons that they make is just a really cool topic to learn about if you're interested in that. So, worst case scenario, you learn something cool.

Best case scenario is if you decide to take the risk, right, which I'm not recommending anybody do unless you've done your homework, it can be a very rewarding bet as long as you understand what the risks are. And there are risks here. But either way, it's very interesting. space is interesting. The company that are operating it is interesting. It applies to all of us because it involves our security, it involves our safety. So take that for what it's worth, but it's interesting overall. Okay, that's a great way to wrap it up. I will wrap it there.

Paul, thanks so much for coming on. Again, there will be a link in the show notes and looking forward to having you on in the future. Yeah, thank you again. A quick disclaimer. Nothing on this podcast should be considered an investment advice. Guests or the host may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks.