Drone company Red Cat Holdings sees shares tumble

One of the key developments in military technology in recent years has been the rapid rise of unmanned aerial vehicles, or drones. Their major advantage is that they allow military forces to carry out attacks and survey the battlefield without either directly risking soldiers’ lives or expensive aircraft.

While drones are not a new technology, they used to be so large and expensive that their use was limited. Over the years they have become much cheaper and smaller, a development that has made them a major part of any modern army’s equipment.

However, as with any form of technology, the rise of drones has led to the creation of a large number of companies trying to cash in on the boom in demand. Inevitably some of these lack the financial acumen or the engineering know-how to achieve their ambitions.

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A case in point is drone manufacturer Red Cat Holdings (Nasdaq: RCAT), which aims to make drones for the US military, as well as for other purposes, such as carrying out safety checks in places where it would be dangerous for people to go.

Has Red Cat jumped the gun?

At the end of last year, Red Cat’s shares more than quadrupled on the news that it had won a competition to supply one of its drones to the US Army. The hope was that this would bring in a large amount of revenue and potentially open the door to contracts with other forces. However, as Kerrisdale Capital point out, there are two problems with this optimistic scenario.

Firstly, the contract, which has yet to be agreed, is likely to be much smaller than the company projects. Demand from the Army (or other US government agencies, such as the Department of the Interior) for the type of drone that Red Cat is selling is likely to be very limited. A bigger long-term problem for Red Cat is that the market for drones is becoming extremely competitive, with a large number of firms keen to grab a share. This has caused the price of drones to start falling.

Several established companies are offering similar drones to those produced by Red Cat for a much lower price. Finally, even if Red Cat did win a large contract, it is an open question as to whether they could fulfil it. This is because the company’s attempts to ramp up production over the past few years have been bedevilled by numerous delays and missed targets, while it has also lost money every year for the last six years.

There is evidence that the hype surrounding Red Cat is already starting to fade away, as its share price has fallen by around 40% from its peak at the start of this year, and it is trading well below its 50-day moving average. As a result, I suggest shorting it at the current price of $8.92 at £150 per $1. In that case, cover your position at $14.92, which would leave you with a total downside of £900.

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