Dylan Jovine is rolling out another artificial intelligence-focused ad recently… but this one’s all about AI in the defense market, and particularly in satellite defense. It’s all in a pitch for his Behind the Markets newsletter ($49/yr), and this is the key bit:

“… right now the U.S. Military is going ALL IN on a tiny AI firm.

“The U.S. Cyber Command already bought its AI software on October 26, 2021…

“The U.S. Navy bought its AI software on January 12, 2023…

“The U.S. Army bought its AI software on June 12, 2023…

“The NSA bought its AI software on November 23, 2023…

“The U.S. Air Force bought its AI software on December 1, 2023…

“And my research indicates that another branch of the U.S. Military could be ready to sign a major contract with this firm…”

He teases us that this deal will be truly massive, for a $20 billion satellite defense system that uses AI to protect satellites from the weapons that China and Russia have been putting into space. And he says that when this big new deal is announced, it will send the stock soaring… in his words:

“Now why is this such a big deal?

“When the U.S. Army inked a $900 million contract with this tiny AI firm…

“Shares soared 260% IN A DAY.

“… my research indicates this tiny AI firm is about to receive yet another major defense contract…

“But this contract could be 22 times bigger.

“And if that happens…

“I expect shares in this tiny AI company to explode.”

What else aer we told about this one?

“Right now you still have a chance to scoop this AI stock up for just $2…

“Before it potentially becomes the biggest supplier of AI software to the U.S. Department of Defense.

“And it’s all because of a fast-moving situation the White House considers a new ‘national security threat.'”

That “fast-moving threat” part is mostly Russia, which he says just put a nuclear weapon into space…

“It’s a clear violation of the 1967 Outer Space Treaty – which bans nations from placing weapons of mass destruction in orbit.

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“And worst of all…

“According to the New York Times, America ‘does not have the ability to counter such a weapon’….

“As the U.S. Deputy Secretary of Defense puts it: ‘China and Russia seek to turn space into a warfighting domain.’

“North Korea has threatened to attack U.S. satellites as well…

“Now, in case of a full-blown war… an attack on U.S. satellite infrastructure would be devastating.

“This threat is too big for America to ignore.

“That’s why the U.S. Space Force is about to spend $20 billion on a new AI-based satellite defense system.”

So that’s the basic spiel. The Space Force will be spending heavily on building a new distributed satellite defense system, and Jovine is “convinced” that they will “go all in on this tiny firm.”

Here’s how he describes the technology:

“…the Space Force has shifted to a new strategy…

“Instead of launching a handful of these massive satellites…

“It’s about to launch thousands of tiny satellites…

“All equipped with cutting-edge AI software.

“These satellites are much smaller and faster…

“That makes each satellite a harder… and less worthwhile target.

“And all those satellites will receive a major ‘AI upgrade’…

“Ultimately, the Pentagon is doing more than just launching a new satellite constellation.

“It’s building a “distributed AI”… spread over 1,000s of satellites… which can:

1. Track space-based missile attacks…
2. Switch services over to other satellites when the network is under attack…
3. And finally, relay communication between satellites and ground systems…”

And he believes “none of this would be possible without this tiny firm’s AI software,” which is already running on satellites right now… but also says there are other big buyers out there:

“It’s not just about selling this AI software to the U.S. Space Force.

“Remember, the U.S. Pentagon has requested $145 billion to get its troops “AI-ready”…

“Palantir – one of the biggest defense contractors – bought their AI software on November 15, 2021.

“L3Harris – another major defense contractor – bought their AI software on May 9, 2023…

“Amazon Web Services – the biggest cloud computing provider on the planet – bought their AI software on December 11, 2023.”

So… who’s that?

Thinkolator sez this is another tease for BigBear.ai (BBAI).

And yes, all those clues fit… but not necessarily as Jovine describes them. BigBear.ai did “expand its relationship with AWS” to help deliver its AI-driven warehousing solutions and software to AWS ProServe customers, and that was announced on December 11 of last year… though I don’t know that really means “Amazon bought their AI software,” exactly.

And Palantir and BigBear.ai did announce a strategic partnership way back on November 15, 2021, aiming to work together to extend their capabilities… though from the actual work they’ve collaborated on since then, at least that’s publicly known, it sounds like it’s mostly Palantir helping BigBear handle big defense projects, not the other way around

The L3Harris deal is another collaboration, they call it a “teaming agreement” for the Navy, to combine L3Harris’ ASView system for controlling autonomous surface vehicles with BigBear’s AI forecasting computer vision.

You get the idea. BigBear.ai is collaborating with a lot of defense contractors, and working with tons of military customers… but it’s not exactly filling their coffers with cash at the moment.

The challenge for BigBear.ai, ever since they went public through a SPAC merger (late 2021), has been in generating revenue or earnings growth that is anywhere near as exciting as the “.ai” at the end of their name. They do have some relatively steady government contracts, though they’ve mostly been contracts on which they’ve lost money, and they talk about building capacity for larger contracts in the future, particularly with the military… but they had $145 million in revenue in 2021 and $155 million in 2022, and that stayed flat at $155 million in 2023, so the top-line growth isn’t setting anyone’s hair on fire… and they’re still pretty far from being profitable.

There are only a couple analysts covering this small-cap story, so we should take predictions with a grain of salt, but those analysts expect them to be close to flat on an EBITDA basis for several more years (losing a little more this year, with a few million in positive EBITDA in the next two years). And the SPAC deal was late enough in the hype cycle that they didn’t get nearly as much cash as they had hoped for back in late 2021 (many of the SPAC holders redeemed for cash instead — in retrospect, a smart move, so instead of starting out in December of 2021 with $326 million in cash and a cleaned-up balance sheet, they received about $50 million in cash and bumped their $100 million in borrowing up to $190 million). They’re still carrying about $190 million in long-term debt (I didn’t look up the debt terms, but they’re probably pretty friendly), and they had run the cash balance down to a dangerous level last year… but they did a secondary offering, including some more warrants at much lower prices, and those warrants were exercised, so they’re back up to about $80 million in cash. That’s not likely to be a crisis anytime soon, since they’re not really burning cash at a dramatic rate, and firms with steady government contracts are generally a good credit risk, but if business doesn’t pick up or become a bit more efficient then they’re really just treading water, losing a little cash, gradually ballooning out their share count through those secondary offerings and warrants and stock-based compensation, and becoming a little bit less valuable per-share.

Investors are probably pretty skeptical here, since the company came in at the low end of their guidance for 2023, and then used yet more shares to acquire another company, Pangiam, but management still says they’re optimistic about having built a new foundation… here’s how the CEO put it in their last quarterly press release:

“After joining in October 2022, I spoke openly about needing a foundational year to overhaul our operating structure, wind down contracts that did not meet our business objectives, reset the strategic priorities of BigBear.ai, and manage uncertainty in a volatile macroeconomic and geopolitical environment. In short, we had to do the hard work to get our house in order.​ We stand here in early 2024 knowing that we did what we said we would do. With the completion of the Pangiam acquisition and incremental cash proceeds of $54M from warrants exercised in Q1 2024, we are well positioned for healthy growth in the year ahead.”

There’s probably some potential if they can scale their relatively small contracts into larger orders and stop losing money fulfilling those contracts, though it’s hard to imagine that they would play any substantial role in a much larger Space Force contract (their biggest deal yet, with the Army, is for $900 million over ten years). Trying to win or fulfill a much larger contract would probably also involve ramping up their cost structure to handle more work, government contracting is not necessarily a very “scalable” business, it almost always takes a lot of people to build and manage government systems, even if they’re primarily software-based (that was part of the challenge for Palantir early on, too, though they seem to have gotten big enough, and built enough of a commercial business, that they’re starting to see some benefits of scale now).

I still haven’t seen enough to get me interested in BigBear.ai at this point, not with their continued cash burn and share issuance, tight balance sheet, and lack of revenue growth, but that’s not exactly an outlier opinion — the stock has been in decline most of the time, other than when the “AI story” takes hold and it gets bid up for no company-specific reason for a couple weeks, and it’s now trading at about 1.5X sales, and at a market cap of about $350 million, still similar to their $296 million order backlog. The hear-term hope for traders is probably that we have seen BigBear react dramatically to market enthusiasm and headline excitement… even if that might be primarily because it’s got “.ai” in its name… and who knows, maybe that excitement will come calling again.

The positive sign, as an actual operating business and not just a “story stock,” is that they saw the challenge when they brought in their new CEO (they were on the verge of being delisted at that point, so it was pretty obvious), and they have been trying to right the ship and build a sensible operating business that can pay for itself. Maybe they’re at that point with the Pangiam acquisition, it seems to have led to a lot of contract wins (mostly in TSA projects, they do biometric traveler scanning), maybe not, but I’ll probably wait until they prove it before I get interested.

If they announce a $20 billion contract win with the Space Force, sure, the stock will soar. I just don’t see that as a particularly likely outcome, not for a company that has been stuck at about $30-40 million in quarterly revenue for three years — though it’s certainly possible that they could participate in any large AI contract for the Pentagon… or at least be worthy of a press release mention. The Space Force is actively spending money on expanding military satellite capabilities, including a new “warfighter space architecture” and upgrading missile defense capabilities, and the next phase of military satellites is intended to be much more redundant, with hundreds of smaller satellites in orbit — those contracts are mostly going to the usual suspects so far — Northrop Grumman, Lockheed Martin, L3Harris and Kratos… along with SpaceX and RocketLab. Maybe some of those turn into AI projects along the way, or incorporate AI, but that doesn’t appear to be the heart of the matter at this point, at least in the eyes of this non-expert.

Still, the Space Force budget keeps growing — around $30 billion in the latest fiscal year, with most of that probably going to defense contractors for satellite work — so I suppose almost anything is possible.

And Jovine pops a couple other teaser ideas into the ad for us, too…

“AI Satellite Pick #2: A “Backdoor” Way to Play Elon Musk’s Most Profitable Venture

“I’ve discovered a “backdoor” way to play SpaceX…

“It’ NOT a Reg-A deal… a risky SPAC… or anything like that.

“You don’t need to be an accredited investor either.

“You can claim a stake in SpaceX’s growth with a few clicks right from your brokerage account.

“And with rumors about SpaceX spinning off Starlink – its massive satellite network – as a separate IPO…

“This could be an incredibly lucrative play for investors.”

SpaceX is one of the largest private companies in the US, so it is a mainstay of the “private stock” funds and is sometimes available for purchase on a lot of the secondary private market websites… but if you’re talking about a fairly easy “back door” it’s probably one of the more accessible private stock funds. The oldest of those is the Private Shares Fund (PRIVX), which is an interval open-ended mutual fund, meaning you can only redeem your shares once per quarter, with some limitations… but the newest is probably what Jovine is talking about, that’s the closed-end fund that went into “meme stock mania” immediately upon its IPO, about six weeks ago, though it has come back down a bit now — that’s Destiny Tech 100 (DXYZ), which as of the IPO owned a few dozen private stocks, but was extremely overweight in SpaceX (about 35% of the fund). There are other major investors in SpaceX, but they’re not as concentrated — Alphabet was close to a 10% owner of SpaceX early on and still owns a big chunk, but even if SpaceX soars in value when they IPO their Starlink satellite constellation (as has been rumored from time to time), that wouldn’t move the needle for the $2 trillion Alphabet… and some Fidelity funds are big investors in SpaceX, but that is watered down because those funds are massive (I don’t think any of them even have 0.1% of their assets in SpaceX, but haven’t checked recently).

So PRIVX and DXYZ are the easiest ways to get some access to SpaceX, and DXYZ is easier and more levered to SpaceX than its older cousin. The challenge is that while PRIVX is an open-ended fund and is bought and redeemed at their estimate of Net Asset Value, which is tricky enough given the fact that these are all private companies who don’t have market prices, DXYZ is a closed-end fund that trades wherever investors want to buy it. Right now, according to estimates as of the IPO date that the net asset value of the portfolio was $4.84 per share, the stock is trading at close to 3X net asset value — it shot up to $100 or so in the first week or so of trading, roughly 20X net asset value, so that was super-stupid and driven by meme stock mania and a low share count, but don’t let the fact that it has drifted down to $25 and now $14 per share make you think it’s now “reasonable”. Most closed-end funds trade at a discount to net asset value, but most closed-end funds also report their net asset value every day or every week, and it’s fairly easy to monitor — DXYZ is so far just planning to update the portfolio once a quarter, so investors right now are probably both flying blind and overpaying dramatically.

This is an appealing type of investment, buying into late-state venture-funded companies, at least if you look at theoretical historical performance for that sector… but for whatever reason, it hasn’t been an idea that has ever worked for retail investor — the blame can go to the exploding venture capital business, which has kept companies private for longer and brought many fewer “IPO pops” to these funds in the past decade, or to the extremely high fees, or just to the fact that the few small, publicly available venture funds have never been big enough to be “in the room” and have access to the best deals. I bought a tiny slice of PRIVX many years ago, and given the interval nature it’s not worth bothering to try to redeem those shares, so I just keep it in my portfolio as a reminder about how wasteful this kind of investing is — yes, the idea of “buying the future” is fun, but the future isn’t ever likely to be owned by a $100 million fund, run by fee-thirsty managers.

The CEO of the Destiny Tech 100 fund sold about 20% of his stake in April, when the shares were in the process of falling from $50 to $30 or so. That looks to me like it was a smart move. Maybe if investors lose interest and it falls to something near net asset value, and they begin to share more information with investors, it will be worth taking a second look… but given the serial failures in this space, including Firsthand Technology Value (SVVC), what is now called SuRo Capital (SSSS), and Private Shares Fund (PRIVX), all of whom had (or have) similar plans and strategies, I wouldn’t expect a dramatic long-term winner. This is the history of those funds over the past decade, just for some perspective (that’s the S&P 500 in orange):

And one more…

“AI Satellite Pick #3: NASA’s Secret AI Chipmaker

“NASA is developing a new generation of space electronics.

“Including radiation-hardened microcontrollers which can withstand extreme conditions (like a rocket launch).

“Recently NASA made history…

“By launching one of those microcontrollers into space for the first time.

“And it chose a secretive company to supply the chips for this historic achievement.”

OK, there are quite a few companies who make radiation-hardened chips for satellites and military use… which one?

Some more clues…

“Big tech firms are going all in on this chipmaker too.

“Microsoft handpicked it to design custom-made AI chips.

“Google uses this firm’s chips for its Tensorflow machine learning platform…

“Apple signed a deal to use this firm’s AI chips through 2040 and beyond…

“The list of corporate clients reads like a “who’s-who” of big tech.

“And yet… most investors have no idea this firm even exists….

“It’s NOT Intel… NVIDIA… TSMC or any other major chipmaker you’ve likely heard of.

“Best of all, it’s 17 times smaller than NVIDIA…”

OK, that doesn’t necessarily mean “teeny” — if you’re 1/17th the size of the now-massive NVIDIA, which is by far the largest semiconductor firm in the history of the world, you’re still a $100+ billion company.

So which one is this? Thinkolator sez Jovine is teasing last year’s hottest IPO, Arm Holdings (ARM)… which is now the second-most-crazily-valued stock in the semiconductor world, at about 37X revenues.

Which might end up being justified in the end, if ARM remains the go-to provider of baseline chip designs for much of the world. This is a very high-margin company, they essentially provide the foundational structure for a lot of semiconductor design, and charge royalties to companies who want to build chips on that platform… along with providing some chip design work of their own. They’re not building radiation-hardened chips for NASA… though they are designing them, and a variety of (mostly small) chipmakers have built them — but as investors, none of that matters very much. There’s a investors.com/research/the-new-america/arm-stock-chip-designer-expands-beyond-mobile-devices/">good, brief history of the company and how it works from Investors Business Daily here, if you’d like to catch up, but space and defense electronics are not likely to ever be a huge part of Arm’s business — they rely on the massive volume of chips produced for servers, consumer electronics, cell phones and the like for most of their little slice of the chip world’s revenue, and it’s a bit of a circular business, because they have to keep investing in R&D for new projects and new designs to fuel the next generation of royalties and IP licensing deals, so that could change, but it probably won’t shift to being very exposed to the satellite or defense business anytime soon.

The big bet on ARM is that the demand for AI chips will lead to lots of companies designing their own AI processors, and that they’ll use ARM’s designs for a lot of those projects, building a new wave of licensing and royalty revenue. That’s working pretty well, and certainly Apple, Microsoft and Alphabet are all using ARM, they’re all among ARM’s biggest customers (as are Taiwan Semiconductor, Intel, Samsung, and most of the biggies you could name offhand), they get about half of their revenue from their five largest customers — and 25% just from Arm China, which handles most of their licensing and work in China. But this is very much a volume business when it comes to really meaningful revenue — more than half of their royalty revenue comes from smartphones and consumer electroonics, just because so many millions of those items are sold each year.

It’s a great business model, and has been a foundational company in the semiconductor world for decades, but I think it’s a pretty risky stock just because it’s valued so richly (37X sales, 75X forward adjusted earnings, 100+X GAAP earnings), and because it’s still 90% owned by Softbank, which means there could be a steady leak of new shares into the market if Softbank decides to try to take its profits. Still obviously attractive given their solid growth and high profit margins, but I wouldn’t buy it at this price… and I certainly wouldn’t buy it because of any marginal connection to chips used in satellites, which will very likely have zero impact on ARM’s revenues over the next few years.

So I guess I’m keeping my wallet in my pocket today, when it comes to these sexy teaser picks for “satellite AI”… but that’s must me, you get to make the call when it comes to your money. Ready to jump on the potential at BigBear or Arm, or buy into an expensive “venture” fund for exposure to SpaceX? Have other ideas for profiting from the next space race? Let us know with a comment below…

P.S. We haven’t seen a lot of reader reviews on this one lately, so if you’ve ever subscribed to Behind the Markets please click here to visit our Reviews page and share your experience with your fellow investors. Thanks!

Disclosure: of the companies mentioned above, I own shares of Alphabet, Amazon, the Private Shares Fund, and NVIDIA. I will not trade in any covered stock (or fund) for at least three days after publication, per Stock Gumshoe’s trading rules.