Red Cat Holdings Update

Anomaly in the market?

This article is a follow-up to the Economics of Warfare, which I have linked below.

Red Cat Holdings (RCAT) is an American defense company that develops drones, primarily in smaller sizes (think hobby drone instead of a Predator).

Compared to titans like Northrop or Lockheed, Red Cat is a smaller corporation with a market cap of $364 million. This article primarily focuses on an abnormality in the stock's behavior that may signal the announcement of a large government contract.

On November 14th Red Cat submitted an S-3 form to the SEC, announcing a secondary stock offering of $100 million into the market. Typically these secondary offerings show signs of weakness in the company’s future, as it dilutes existing shareholders’ stake in the company (famously utilized by Mark Zuckerberg, The Social Network covers it, an excellent movie.)

However, it isn’t clear that Red Cat is in immediate need of this money to stay in business.

Additionally, according to the balance sheet, Red Cat doesn’t possess a monumental amount of debt.

Frequently, unexpecting secondary offerings result in the stock price dropping, since it not only projects poor financial health, but also increases the number of shares in the company without any increase in value. Middle school math can tell you that if you keep cutting a pie into more and more slices, your slice will become smaller.

As such, it is abnormal behavior when this happens (Reminder that the secondary offering occurred on November 14th):

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With an immediate 25% increase following the announcement, it is clear that there is something missing. Such as another release from the company for a town hall meeting on November 19th at 4:30 pm.

Link: Red Cat to Host Town Hall Meeting for Investors, Analysts, and Members of the Media

We don’t have all the details, but the meeting will be focused on the future of the Black Widow program. The Black Widow program is part of the Arachnid Family of Drones from Red Cats subsidiary Teal. The Arachnid line of products focuses on reconnaissance and lethal strike capability. The Black Widow is a Short Range Reconnaissance (SSR) drone.

Black Widow drone

Some background information is necessary at this stage to understand the reason why the meeting being focused on the Black Widow drone is so important, and why the $100 million SRO could potentially be hugely beneficial for the company. Currently, Red Cat subsidiary Teal is one of two finalists in the U.S. Army’s Short Range Reconnaissance Tranche 2 (SRR T2) Program (Teal press release).

Considering that the Black Widow is the purpose-built SSR drone, a meeting concerning the future of this drone is likely to contain information on the current state of the SRR T2 program.

This would also explain the secondary offering, as government defense contracts can demand a large number of units deliverable immediately. This is aggravated in the drone market, particularly with renewed efforts to outfit the military with enough drones. Although the contracts will more than pay enough to produce these drones, a starting capital is required to kickstart this process. This offering would give Red Cat enough capital to produce drones on a large scale. The SRR T2 program would be a major win for Red Cat.

Now, to actually get this money they will need to win the contract. Going against Teal for the contract is Skydio’s RQ-28A drone.

Red Cat’s management is acting like a company getting ready to take on major production on the scale of holding the SRR T2 contract, and there are several reasons for Skydio to be unlikely to win the contract.

1. The Black Widow is purpose-built for the SRR T2 contract, while the RQ-28A is a multipurpose drone that Skydio is attempting to use for this contract (same obstacle avoidance as other models with upgraded sensors)

2. Limited adaptability with the operation of drones. For example, while the Black Widow is intended for recon, it can also carry a lethal payload. In comparison, Skydio sent a letter to the army requesting them to stop dropping grenades from their drone in testing.

3. Bad info: If you google “Red Cat Black Widow” you get a plethora of information about the drone and applications. In comparison, almost all of the information I found about Skydio was from other news sites talking about how they are finalists in the contract. While this alone isn’t a killing blow, poor communication to the public is simple enough that the abject failure may be a sign of more problems in the company

Because of these critical issues, the Black Widow is likely to beat the RQ-28A in the SRR T2 contract.

In addition to fulfilling this contract, Red Cat is likely to benefit from another aspect of the movement toward modernization with drones. While the military could purchase 100,000 small drones today with no problem, they wouldn’t be from America. It would probably be Chinese. The Chinese drone industry is very large and developed, and as such it is important for the US to build up companies to combat them in terms of production. As Red Cat both develops and produces all drones domestically, it would be in the best interests of the government to enrich Red Cat, along with companies like it, to the point where they can out-produce the Chinese drone industry.

Going into the meeting this Tuesday, it is very likely that Red Cat will be announcing their win in the U.S. Army’s Short Range Reconnaissance Tranche 2 program. This is based on the secondary offering on November 14th and the apparent superiority of the Black Widow over the RQ-28A. The stock will be volatile leading up to the meeting as investors decide whether they think the meeting will announce the win on the contract.