This article was originally published on January 25, 2017. It has not been updated or revised since then, but we are seeing the same ad from Dr. Moors circulating heavily again (still with a January 2017 date), so re-post it here for your information. The stock teased has been quite volatile but currently is up about 40% since this story first ran, beating the S&P 500’s 18% return.
The latest bit of promotional bloviation from Dr. Kent Moors is all about national defense, and about how the US Navy can protect itself from Chinese attacks in the South China Sea.
Which is a bit of a change of focus for Moors — he has generally positioned himself as an energy industry expert, following his days studying energy policy and consulting with governments while a professor a Duquesne (he’s retired from that now, but was still working there when his first newsletters were launched a few years ago by Money Map). So he pulls out lots of claims about being a national security and intelligence insider, with medals from the government and personal experience on the ground during the Vietnam war as his bona fides.
I have no idea whether he has real expertise or unique “secret” contacts within the intelligence community or not, of, frankly, whether or not he’s really an expert on defense technology… so you’ll have to make your own call on that.
But what we can do is identify what Moors says is the Pentagon’s plan to counter China’s anti-aircraft-carrier missiles and deter China from attacking US carrier groups as the fight over borders in the South China Sea heats up (with lots of US mutual-defense-pact allies, including South Korea and the Philippines, claiming the same territory as China… partly because of the oil and gas in the area).
The big fear factor that Moors pulls out is the Chinese DF-21D missile, which is a “carrier killer” missile that Moors says is too fast to be defended by current missile defense systems like Aegis. And he says that money is pouring into small defense contractors who can provide different or better defenses. Here’s a bit from the ad:
“… behind the scenes, the Pentagon has been secretly placing big bets on a new generation of defense contractors.
“These small firms have been working with DARPA, our top-secret weapons maker, hunting for a way to obliterate the ‘carrier killer’ missile.
“And one of these defense contractors has cracked the code.Are you getting our free Daily Update
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“It’s developed something that looks like it comes straight from the pages of a science fiction novel.
“And I’ve been cleared to show you simulated footage of it in action that has never been seen before.”
That “simulated footage that has never been seen before” is, of course, on YouTube for all to see, and it’s from a few years ago. It’s also not from the “secret little company” Moors is pitching, so we’ll have to see what the connection might be.
Here’s the video courtesy of YouTube, in case you missed it:
And here’s a story about it in more detail, it’s one of the latest versions of an electromagnetic railgun… which does indeed send a projectile out of the muzzle at Mach 7 and reach targets at 200+ miles. The one that was written about here, with sea testing planned for 2016, was from BAE Systems, and General Atomics was working on delivering similar projects at least as long ago as 2011 (R&D on these weapons goes back much further than that, though interest has been rekindled in the past decade or so) — it could be that the two companies are working together, I don’t know. General Atomics describes their program here (GA is a private company, just FYI), and BAE Systems here.
The original prototype was getting people excited a decade ago, and phase II of the program from the Office of Naval Research started in 2012, with the goal of demonstrating a reasonable firing rate and improving the practical application of the technology. There seem to be some physical and electrical constraints that prevent it from being a deployable weapon just yet, though I am certainly not an expert on that — you can check out a piece from Popular Mechanics from last Summer here for a better explanation than I can provide (in addition to BAE Systems and General Atomics, that article throws Raytheon into the mix as yet another mega-contractor working on some aspect of these pulsed power systems), and it has also been covered in the past year by the Wall Street Journal, and there has even been speculation from the Motley Fool that speeding up the deployment of railguns would maybe lead to a windfall for General Dynamics, particularly if it increases the number of orders for their new Zumwalt destroyer.
But Kent Moors is not, of course, pitching General Dynamics — that’s a $50 billion defense contractor, and he’s talking up a company that he says has a market cap of $380 million. So we can conclude, quite obviously, that Moors’ claims that this tiny company has some sort of monopoly on this railgun technology fall under the category of “poppycock,” since certainly the company would have had something to do with the testing to date, or been mentioned as a key contractor by someone along the way, if it were the one contractor with a hold on this program.
But perhaps there’s something real under the copywriter’s hype. So what is the actual company being teased?
“Today, the Pentagon Is Fast-Tracking Billions into a Series of Top-Secret Weapons Programs to Defeat the Chinese
“They’re being run through the Strategic Capabilities Office, or SCO.
“This new unit is the action arm of DARPA, the Defense Advanced Research Projects Agency.
“It’s been secretly funneling billions of dollars to the next generation of defense contractors.
“Together they are part of a modern-day Manhattan Project to prevent World War III.”
And some chatter about this superweapon:
“Off the coast of Florida, on board the U.S.S. Trenton, the Navy is field-testing an astonishing new ‘supergun.’
“It’s called the Mach 7 Cannon.
“And along with the highly advanced rounds it fires…
“This new superweapon is unlike anything you’ve ever seen before.
“Frankly, the physics involved is mind-boggling.
“Instead of gun powder, the Mach 7 Cannon works using ELECTRICTY.
“On the order of 25 megawatts.
“All discharged in 10 milliseconds.”
Which is why they can’t test it on older ships — only the most advanced new ships have anywhere near enough electrical capacity to fire these guns, and the first test was indeed scheduled to be on the USS Trenton, which is a transport ship, in 2016. I didn’t see any confirmation or official note that this test has actually started, there’s been some chatter, as in that Motley Fool piece, about skipping those tests on non-combat ships and moving the testing to a real destroyer, but I don’t know what the status is.
More on our one small company:
“This Mach 7 Cannon and the ‘smart bullets’ it fires are the future of the Navy, folks. Right here. Right now.
“And one American company less than 1/100th the size of Lockheed Martin is at the forefront of both.
“Right now its market cap is $382 million.
“And shares are trading for around $6 apiece.
“To give that even more context, General Dynamics’ market cap is $50.6 BILLION.
“And its shares are trading for north of $150.”
“At the forefront” is a nice, non-specific descriptor, no? It gives the impression of leadership, without actually stating that the company has real control of the market or owns the patents or whatever else… though Moors does go on to say that this company that “developed the Mach 7 Cannon and these ‘smart bullets’ is not even a blip on the radar,” which does go a bit further in giving this little firm credit (erroneously, as far as I can tell) for the whole railgun program.
More from the pitch:
“Over the last two years, this defense contractor initially received multiple contracts totaling $29 million.
“One was labeled as a ‘mystery contract,’ obviously due to the sensitive nature of the technology.
“It was awarded for the specific purpose of servicing a gun that uses electricity to propel projectiles at high rates of speed.
“In other words, the Mach 7 Cannon.
“They also received funding to design, engineer, and manufacture the guidance system, as well as the prototype for ‘smart bullets.’
“So it’s not hard to follow the breadcrumbs here.
“That small starter funding was just to prove this superweapon system was viable – this cash was just a drop in the bucket.
“Now, after successful tests, the size of these contracts is set to explode…
“DARPA’s ‘Strategic Capabilities Office’ is planning to spend another $800 million on this technology.”
Moors then goes through several examples that seem to argue that this one small company will somehow be assigned the contract for building all of the “smart bullets”, at $25,000 a pop, and that means that there will be a $2-6 billion opportunity even if the smart bullets aren’t used by other services, like the Army in their Paladin howitzers… and he concludes that “I believe this $382 Million Defense Contractor is in Position to Control a $45 Billion Opportunity.”
Which sounds like absolute malarkey to me — a firm that has so far gotten a couple contracts in the tens of millions of dollars, suddenly being contracted for $45 billion in munitions sales? That’s connecting a lot of dots that haven’t even been drawn on paper yet.
But, as Moors notes in the ad, there are plenty of examples of smallish defense contractors going absolutely bonkers in the stock market when there’s a hot new rush project that sends a lot of cash their way — the one that rings a bell for me was the MRAP program for mine resistant trucks in Iraq, which sent Force Protection (FRPT) shares soaring back in 2006 and 2007 (it later collapsed dramatically, partly because of competition and partly because they couldn’t produce fast or effectively enough in the early days and saw dramatic cuts in orders as the war downshifted an defense budgets started to decline, and was bought by General Dynamics on the cheap in 2011)… but there are plenty of others.
One common denominator, it seems to me, is that the little guys rarely soar for long, they either get overwhelmed by the major competitors and dwindle back to something small, or get bought by Lockheed or General Dynamics or whoever — a little $300 million R&D-focused company is not going to suddenly become a company that can handle billion-dollar contracts when it comes to logistics, headcount, or manufacturing.
Moors also notes that this company has other programs:
“a new direct energy weapon capable of shooting down drones and disabling small attack boats…
“All for about 59 cents per shot.
“This new superweapon is armed and fully operational on the U.S.S. Ponce.”
And he runs through the fact that the board of directors for this tiny firm includes several defense experts and experienced military folks… which would make them just like exactly every other defense contractor, but also that the insiders have been buying stock over the past year or two — which is generally encouraging.
So who is it? Well, the Thinkolator can at last take you out of your misery and confirm that yes, this is Kratos Defense and Security Systems (KTOS).
Which will sound familiar to longtime Gumshoe readers — Dr. Moors’ colleague at Money Map Press, Michael Robinson, was pitching this one back in 2009 as a cyber-security pick and then again in 2012 as a politics-proof defense play with a next-generation drone program, and then Bill Patalon, also at Money Map, pitched it in 2013 as a cybersecurity stock.
Kratos has been a pretty volatile little stock, and does have some contracts that seem remotely connected to the railgun program, but certainly drones (mostly target drones, though now they have some other contracts for more advanced drones) are a large part of their business, as is cybersecurity consulting… as a small player they’ve tried to focus on small niche programs, which probably makes sense, but they have not been a great play on defense in general — over the past five years, the aerospace and defense sector in general (using the ITA ETF) is up 140% while KTOS, even after a very good surge last year, is up 23% (and KTOS is down 30% since Michael Robinson was teasing it in 2009, while the ITA ETF has returned 220%… you get the idea).
Kratos hasn’t earned a profit from continuing operations in at least five years, though they have reported positive EPS a few times since 2009. In 2015 they were profitable because of a big chunk of income from discontinued operations, which seems to be from the sale of their electronic products division that provides stuff like power amplifiers, microwave assemblies and other components for defense customers, and that seems to have also allowed them to clean up their balance sheet a little bit and pay off some debt — but they do still have a substantial debt burden, roughly $445 million on which they’re paying 7% (matures in 2019). That doesn’t seem like it should be a huge issue, but it is a lot of cash flow going to debt service — Kratos has to pay a little over $30 million a year to service that debt (and they have to pay it off with new debt by 2019, at what cost we won’t know for a while), and that’s twice as much as they spend on R&D. They do have enough cash to handle the payments for a couple quarters if they continue to be unprofitable, but they’ll have to raise money by sometime in the Summer, at the latest, if they don’t suddenly start turning a significant profit.
The bond market is not worried about Kratos, for whatever that’ worth — the bonds last traded just under par for a yield of 7.9%, which is a bit steep for a 2 year bond but not high enough that you’d read between the lines and see default worries.
There are only a couple sell-side analysts covering Kratos, but they do forecast that the company will be profitable this year and next year, so that would help — they expect 10 cents in earnings per share in 2017 and 32 cents in 2018, so at 25X 2018 earnings estimates there’s perhaps some justification for the stock in those forecasts if you can take them seriously (I haven’t looked at the analyst reports in any detail, nor do I know what KTOS is guiding for revenue or earnings, if anything)… but there’s clearly something of a leap of faith in this stock.
All I can really tell you is that no, Kratos is not going to have a $45 billion business in electromagnetic rail guns over the next couple years — though they are “supporting” that program with some contract work (both “directed energy weapons” and “electromagnetic railgun” are in the list of “additional strategic programs supported” in Kratos’ current investor presentations). For the near future, the bulk of Kratos’ revenue will come from their “Government Solutions” division, which includes lots of different contracts in training, ballistic missile defense support, satellite communications and other areas (and, presumably, the small contracts that are in support of these pulsed energy weapons), and the small profit generated by that division is more than sucked up by the investment Kratos has been making in drones, which remains a money-losing (but revenue growing) division.
So… no magic, no $382 million company turning into a billion-dollar colossus before our eyes… but certainly there is room for some optimism in defense stocks with a fully Republican government and a President who has vowed to pour more money into defense… and, naturally, Wall Street has been paying attention and has already driven all the defense stocks up pretty sharply, so it’s not like this is a trend that has yet to emerge. Specific companies like Kratos will depend, of course, on specific contracts and performance and the choice of one weapons system priority over another, but probably the pie will be getting larger.
(And that $382 million number is a bit old, as is the $6 share price — despite the fact that the ad has a January 2017 signature from Dr. Moors, the actual share price has been above $7 and the market cap above $500 million for the past month or so, those numbers in the ad are from November.)
And with that, I’ll leave you to ponder — is Kratos interesting to you, either for their drone business or their communications security business or whatever this small piece of the possible railgun business might be? Think they’ll hit profitability soon enough to handle their debt maturity and start growing revenues? Let us know with a comment below.