Since Star Wars day just passed (May the Fourth Be With You!), I guess it’s time for a “Death Star” story — this one comes from an ad for The Wealth Warrior ($99/yr), which is Jason Simpkins’ security and defense-focused intro-level newsletter from the Outsider Club.
And the headline, of course, sounds terrifying:
“Beijing’s Death Star
“Top General: ‘Our Entire Integrated Defense Can Be Dismantled’
“One Company Can Save Us
“Its Shareholders Will Retire Early”
We know, of course, that any such “one company will save us” teaser pitch is going to be an exaggeration… whether a wild or a mild one depends on the situation. But that’s the nature of these teaser “story” pitches — they start with a huge threat or opportunity, then craft a narrative around it that points directly at one beneficiary, shrugging off the complexity of the world. It’s both comforting and intoxicating.
So who’s the “one company” that can save us this time out? First let’s figure out what he means by this “Death Star” business… apparently it’s some kind of laser weapon, and while of course we’re not talking about something that can destroy a distant planet, apparently it’s got the potential to destroy satellites, ground targets or even submarines. Here’s more from the ad:
“China fully intends to push the United States out of the Pacific and retake Taiwan.
“That’s the plan. Period.Are you getting our free Daily Update
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“And to do that, it’ll have to overcome the world’s most powerful military machine — the last remaining superpower….
“China is going to need every single technological edge it can get.
“One such edge is a new material uncovered by Chinese scientists…
“It’s called caesium bismuth germanate (CBGO). CBGOs are non-linear crystals — a chemical compound that converts low-energy beams into high-energy beams with ‘unparalleled efficiency.'”
I know, when we get into the science-y bits a lot of us tend to nod off… but apparently these CBGOs are “magic crystals” that “increase the power, intensity, and frequency of lasers,” and China has weaponized them…
“Beijing immediately put these magic crystals to work in a secret military program called “Project Guanlan” — a codename that translates to “Watching the Big Wave.”
“With this high-power laser, China can already shoot down into more than 500 meters (1,640 feet) of water.
“This gives it the capability to detect and potentially sink our submarines…
“Beijing’s Death Star can reach 22,236 miles into space to shoot down our satellites….
“Here’s a direct quote from the head of the Air Force Special Operations Command (AFSOC), Brigadier General William Whittenberger: ‘Radar [can be] overloaded, computers and terminals overheated, rendering command and control centers ineffective, guidance capability on missiles blinded or burned, satellites overloaded, cell phone towers destroyed, all by directed-energy systems.'”
So that’s the basic “threat” pitch — and this is not brand new stuff, though perhaps things have changed more recently, that quote from General Whittenberger is from a talk he gave at the Directed Energy Summit two years ago.
Then it’s back to that “one company”…
“Luckily for us…
“One company can stop it.
“It won’t be easy. There’s a lot at stake and a very small window to act.
“But the small, virtually-unknown company I’ve found makes a crucial component for laser weapons…
The Crystal Diode.”
OK, so I guess we’re talking about an arms race here, where China is already far along with its “Death Star” laser, and the US is trying to develop competing weapons for deterrence or defense. Arms races are good for defense companies, for sure, but what else do we learn about this secret one?
“ONE company makes the kind of crystal diodes strong enough to power laser weapons like the one China is building.
“This one, small supplier of crystal diodes is the go-to vendor for our country’s top defense contractors — companies like Lockheed Martin and Northrop Grumman, to name a few.
“That’s why this company and its shareholders are about to be handsomely rewarded.”
We also hear that there’s a ton of money flowing into this fight:
“America’s top generals have asked for an unprecedented amount of money to meet this threat head on.
“And the money is on the way.
“We’re Talking About $317 Million, and That’s Just for Starters…”
That was in the original 2019 appropriations bill, though the “directed energy” categories of defense spending are not necessarily discrete or consistently described — when you include stuff like microwaves and space laser research run through all the different agencies and armed forces it’s well over a billion dollars and rising. Interestingly enough, some of the talk from government officials indicates that the advantage China or other actors might have is not in any technology edge, but in a willingness to quickly deploy technologies that the US wouldn’t consider viable. Here’s a quote from Kelly Hammett, who hears the Directed Energy Directorate at the Air Force Research Laboratory, in an Air Force Magazine article from last October that I found interesting:
“‘One of the reasons [for the] significant increase in funding … is that our near-peer adversaries are acting,’ he said. ‘They are moving forward in a whole bunch of technology areas, [including] directed energy, that are alarming.’
“It wasn’t that the US was being overtaken on the technology front, he said, but rather that America’s adversaries were more willing to deploy emerging technology before it was mature.
“‘We still preserve in many areas a research and development advantage [over them],’ he concluded. ‘What we don’t have is the risk-accepting culture that will take a minimum viable product and field it.'”
I’m sure there are plenty of other perspectives on that, but it points to the complexity of the situation.
So, then, let’s get back to identifying the stock teased. Some hints, please?
“… this emergency defense initiative is creating one of the most important investment opportunities of our lifetime.
“And I’ve found the one stock that’s going to benefit the most.
“Tens of millions of dollars are being sent to one laser defense firm.
“It’s already locked in deals with Northrop Grumman and Lockheed Martin — two of the Top 5 largest defense contractors in the United States.
“These two companies already have a giant purchase order from the government for new lasers.
“But there’s a big problem — neither of these companies have the crystal diodes they need to build them.
“My laser defense pick is the only firm in the world (outside of China) that can build the crystal diodes these companies need.”
OK, what else do we learn about them?
“… the firm I’ve found just secured $5 million in funding.
“Immediately, $3.5 million of that capital is being poured into equipment for the express purpose of increasing ‘manufacturing capacity for low size, weight and power (SWaP) laser diode pump modules in support of high-volume directed-energy programs.'”
And Simpkins says these are the specific goals for this company and its work with those big defense contractors:
“1. Come up with a stable crystal structure for the diodes. This will include developing a non-linear green crystal diode (Magic Crystals) of our own.
“2. Design and build the diode layout.
“3. Amp up the power supply; Power generation and transfer are literally the name of the game when it comes to high-powered lasers.
“This laser defense firm is leading the way.
“Most of its engineers came from Northrop Grumman and Lockheed Martin — not the other way around.”
And some other clues for us to feed to the Thinkolator…
“This company has pulled in steady growth of more than 100% a year on laser innovations.
“… it has contracts to add components to everything from helicopters to submarines.
“It’s building new LIDAR for self-driving cars and self-driving tanks….
“It has a new line of jet-mounted and helicopter-mounted lasers that scan the terrain below. The exact details are top secret, but it’s safe to say that this firm is bringing one of the biggest advances to U.S. reconnaissance since the invention of the spy plane.
“It’s even developing next-generation handheld laser guns that will give our soldiers infinite ammunition on the battlefield.”
And one more specific clue…
“In November of 2017 this laser defense firm was awarded a major contract from DARPA — the highly top-secret defense research division of the Pentagon.”
We’re shown a chart of this “Laser Defense Firm” that shows a share price around $12… in 2015, after it had gone from about $3 in 2012, which they call a 385% gain (it’s more like 300%, but more on that in a minute). I suppose there’s probably some reason why they’re using an old chart, most likely that gain has not been replicated over the more recent five years, but we’ll see, that chart does let us at least confirm the Thinkolator’s results.
So yes, dear friends, we’ve got an answer — this is the European defense conglomerate Leonardo (LDO in Milan, FINMF OTC in the US, or FINMY for the 1/2 share ADR), known long ago as Finmeccanica, which has been struggling of late because of weakness in their aerospace business but which does, yes, have a laser business.
This is not a huge company, at least not by defense standards, but it is substantial, with a market cap near $4 billion and about $16 billion in trailing revenues. And the good news is that the stock is a lot cheaper now, but the bad news is that the laser business is a very, very small part of the conglomerate, so even if it grows dramatically it will have a limited impact on the income statement over at least the next few years.
In case you want to compare their chart to the one that Simpkins shares in his teaser pitch for confirmation, here’s a ycharts version of that 2012-2015 chart which matches the ad’s version precisely:
The return numbers don’t match precisely, but the prices do — so presumably the Outsider Club copywriter is making the common mistake of calling a 285% gain a 385% gain, but the chart is otherwise identical give or take a day or two. And, of course, the stock has given up most of those gains in the past five years, it’s back down below $7 now.
The division that Simpkins is talking up here is a fairly small one, Leonardo Electronics US, which was itself formed by the merger of Selex Galileo, mostly an avionics and radar company, and Lasertel, which is the US division that actually makes those laser diodes and other laser-related components — but as with all conglomerates, you can’t just buy the division that you’re excited about, you have to buy the whole company or none of it. Here’s how Leonardo Electronics US describes itself, including the Lasertel laser diodes business:
Leonardo Electronics US Inc. is a subsidiary of Leonardo. We enable next-gen technologies in defense, security, medical and industrial segments. Our US-based R&D and service provides nimble product development, program support and vertically integrated production of laser and electronics components and systems.
And this page provides some interesting background, including their brief assessment of the market for directed energy lasers and the size of the market (US military spending on these projects has doubled since 2017, we’re told, and spending on directed energy is expected to grow at a 20%+ rate for at least the next five years).
If you’d like further matches, Lasertel did win a small contract from DARPA in November of 2017.
And while that’s still a very small part of parent Leonardo’s business (vanishingly small, in fact — Directed-Energy projects are mentioned in the research priorities and plans in Leonardo’s 2019 annual report), the recent price drop makes the company look fairly compelling, at least on the surface — it appears pretty undervalued relative to other large defense companies, and I assume that’s largely because of the weakness in the aerospace sector in general, led by Boeing and the collapse of civilian air travel…. So let’s dig in a bit.
Leonardo’s biggest business focus is helicopters and aerospace — their large helicopter division (both civilian and military, roughly 2/3 military or government orders at this point), and their participation in several big military jet projects, including the Eurofighter. The next biggest driver is defense electronics, which includes the laser business along with lots of other projects that are currently substantially more important to Leondardo’s bottom line (the annual results presentation is a pretty good overview of their divisions and their areas of focus, lasers and directed-energy weapons aren’t specifically mentioned but certainly lasers play into some of the other areas).
The weakness Leonardo has seen this year is shared across lots of other stocks in the sector, including key European firms like BAE Systems (BAESF) and Safran (SAFRF), but to find one more beaten up than Leonardo you really have to go to those who are most focused on commercial aviation, which, broadly speaking is about 70% of the global aerospace business — firms like Airbus (AEADSF) and Rolls Royce (RYCEF) in Europe or, of course, Boeing (BA)… it looks like the more defense-dependent you are, the better these days, though Leonardo has probably also taken a larger hit because the majority of its operations are in virus-clobbered Italy. Here’s a chart of a few US and European aerospace/defense suppliers year to date, just to illustrate — that’s Leonardo in red if you can’t read the tiny print, down about 45% like Safran (blue) while the airliner firms are down 60% and the straight warfighters like Lockheed Martin (LMT, brown) are almost flat:
They do pay a small dividend, and it hasn’t been growing, so that’s not of huge interest — the yield right now is about 2%, and they pay only once a year (the ex dividend date is June 22 this year, so you’ve got time to think it over on that front).
And if you want more information about Leonardo, well, you’re in luck — they report their first quarter results in just a few moments (at 12:30 EDT in the US, 6:30pm local time for them), so you can jump on that conference call and check out the presentation here if you like. It seems unlikely that we’re going to put the genie back in the bottle and start to cut defense budgets during these times of rising nationalism and global competition, so that bodes well for the defense industry in general, so looking into some of the more beaten-down names in the space like Leonardo might be worth our time… but these lasers and “directed energy” weapons aren’t going to immediately make a big impact for Leonardo shareholders.
So I’ll just leave you with one thought, in case you got really excited about the laser stuff: Even if all of the billion dollars that the US might be spending on its variety of laser weapon research projects this year went straight to Lasertel (which it won’t, of course, they may be a critical supplier of some components but they’re not the only company working on laser weapons and research), that would be roughly 6% of Leonardo’s revenue in a given year. Leonardo might bounce back strongly if the helicopter and avionics businesses are more resilient than investors fear right now, but get comfortable with that before you go chasing your money after the small laser business.
Back to you, then, dear reader — have any thoughts about Leonardo, helicopters, laser weapons and diodes? Think the sector is appealing or frightening? Let us know with a comment below.