AVAV designs, develops, manufacturers, and operates small Unmanned Aircraft Vehicles (UAVs) for the U.S. Department of Defense and other allied military forces. Ground units utilize the electric-powered, hand-launched UAVs for situational awareness, providing the war fighter with real-time video imagery for “over the hill” and “around the corner” reconnaissance. The U.S. army accounts for 85% of procurement and has more than 1,700 4.8-pound Ravens systems in its inventory, which consists of a controller, spare parts, and three UAVs, with a goal of acquiring 2,300 systems by 2017. The Raven costs $35,000 each and $250,000 for a whole system. The Company also produces a more rugged 13-pound Puma UAV, costing $400,000 per system, and the smaller 2.85 pound Wasp system as a back packable solution for Combat Controllers on the ground.
In its development pipeline, the Company is in advanced stages of producing the Switchblade. The Lethal Miniature Aerial Munition System (LMAMS) is a back packable, tube-launched, battery-powered drone that carries a small warhead and sends back live streaming video. The operator can designate a target using GPS precision and the drone detonates on the target with minimal collateral damage. The electric vehicle (EV) segment also produces industrial EV charging systems for commercial fleets as well as EV home chargers for the individual consumer.
Catalysts
State Department UAV Support Services contract – this contract is worth up to $1bn over 5 years. The State Department seeks to acquire a fleet of unmanned aerial vehicles to protect diplomats in Iraq and other high-risk countries. The contractor will deliver the drones through task orders and will provide pilots, analysts, navigators, and global logistics support. AVAV submitted bid and demonstration for this contract at the end of 12’. As noted on the conference call, a contract award decision is expected any day.
Accelerated Switchblade adoption –The Switchblade has had field success in Afghanistan and the Army is advancing development of the product, and possibly implementing an operational needs order for troops in Afghanistan
M&A - company is eventually takeout candidate
End of defense cuts
War / global unrest
Investment Thesis
Pure play small UAV producer with strong industry long-term growth profile
Strong balance sheet - $11.50 per share in cash, cash equivalents, and WC
Acquisition target – trades at .97 EV/S, in line with large defense companies; the large defense contractors may increase capital deployment for bolt-on acquisitions to capture incremental growth in a no/slow growth defense environment – Goldman projects 30-50% likelihood of M&A activity
Attractive upside/downside
Upside Price Target - $61.33, up 240%
Downside Price Target - $16.10, down 15%
Q313’ Earnings Miss
EPS - reported EPS for quarter of $.17 versus $.26 in last year’s corresponding quarter. This badly missed consensus EPS estimates of $.37, surprising analysts with 70% earnings shortfall.
Revenue – sales in quarter $47.1M vs. $72M last year. This fell 30% short of consensus revenue estimates of $89.02M.
Causality: as of the Q313’ CC on March 5th, it was 438 days since government fiscal ’12 defense budget was approved. By comparison, the longest time to complete an Army Raven contract in prior 4 years was 161 days – this uncertainty is creating large order disruption in short-cycle Defense companies like AVAV, where orders can be placed and fulfilled within the same quarter, leading to large lumpiness in earnings numbers
Company response – CEO Tim Conver: “We believe these are delays in order timing, and not lost orders”. In its remaining outlook for FY13’, the company anticipates no incremental orders from Government Fiscal Year (GFY) 12’ and lengthened its order cycle expectations moving forward. In addition, the Company is working closer with customers to determine contract timing.
Market reaction – AVAV shares fell 10% after the earnings release, and analysts lost confidence in management execution after such a big earnings miss
Positives
Share price very limited correlation with stock market
Insider buying – Arnold Fishman, AVAV director since 1998, just purchased $435,000 of common stock with personal funds over past 10 days, increasing Mr. Fishman's cumulative shares owned by 10.5%
Increased international sales – sales to international customers as of Q313’ surpassed total orders from FY12’
Book-to-bill ratio last quarter fell to .58x, indicating sequestration and decline in defense spending limiting new order flow
DoD defense cuts - withdrawal from Afghanistan, reduction in force – the GFY14’ budget cuts Army expenditures by 4%, Raven acquisition targets flat YOY through 2017
Delayed EV adoption – electric vehicles sales slower than expected, like in Nissan Leaf and Chevy Volt – recent sales numbers suggest pickup in EV units
Upside Target
Analyst consensus EPS estimates – FY 2014 – $.63
Extreme stand-alone peak target - $61.33 – based on triangulation of valuation measures (see note 1 below)
M&A price target - $41.04 – based on average Global Defense M&A multiples from Jan 2006-present, see note 2 below
Downside Target
Low price target – $16.10 – can fall to this level if sequestration forces order cuts instead of current sequestration impact of order delays
Replacement cost – at least $11.50 per share in liquid assets – the IP portfolio adds value as well - netting out the entire inventory and liabilities leaves $200M in very high quality assets consisting of cash, cash equivalents (mostly municipal bonds), and AR. Adding back inventory, highly liquid assets total $263M. The current market cap is ~$400M.
Risk Factors
Short term
Sequestration: spending cuts may cause cancellation of previous orders, leading to excess inventory and perhaps write-offs
Cash conversion cycle: the trend of rising DSOs and DSIs will likely continue over the next months as Congress debates defense spending budgetary issues.
Long term
Industry competition – Chinese manufacturers developed the ASN-15, a small UAV with similar characteristics as AVAV’s RQ-11 Raven, Chinese UAVs also cheaper than U.S. counterparts and will compete for international orders
Industry growth from commercial applications inhibited by FAA regulation of UAVs into National Airspace – small UAVs below 55 pounds projected timeline by 2014 but actual implementation may extend into 2015
Based on most recent data, the PPS target for each metric is as follows:
EV/S
35.64
EV/EBITDA
$46.44
Avg Price
$41.04
I do not hold a position of employment, directorship, or consultancy with the issuer. I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
State Department UAV Support Services contract – this contract is worth up to $1bn over 5 years. The State Department seeks to acquire a fleet of unmanned aerial vehicles to protect diplomats in Iraq and other high-risk countries. The contractor will deliver the drones through task orders and will provide pilots, analysts, navigators, and global logistics support. AVAV submitted bid and demonstration for this contract at the end of 12’. As noted on the conference call, a contract award decision is expected any day.
Accelerated Switchblade adoption –The Switchblade has had field success in Afghanistan and the Army is advancing development of the product, and possibly implementing an operational needs order for troops in Afghanistan
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