Listened to a great economist podcast (money talks: a shot in the arm). Its subscription only, I'm afraid.

The discussion was around the changing defence industry, in particular how the "cost plus" model that has existed for the last 50 years is no longer fit for purpose. This industry has been dominated by a small number of "primes" that are perversely incentivised to spend as much as possible on developing weapon systems (the more they spend the more they earn (cost of development plus a margin). Much like the NASA development and procurement model has been shown to be no longer effective by the like of SpaceX, so the defence Primes are likely to suffer significant erosion of their market share by nimble start-ups that are predicting what customers will need and building it with their own capital to sell on for a larger margin if/when they have been proven successful.

The example they used was Anduril a US defence company specialising in electronic and drone/counter drone technologies. It takes no special knowledge to predict that warfare will increasingly be heading in this direction as evidenced by any conflict currently under way in the world (Ukraine, Gaza, Houthis etc)

Clearly, the Primes will not enjoy this erosion of their revenue, and will have two options: build in house, or acquire small, specialist companies and throw money at their projects. I think it is very likely that Droneshield will get taken over before too long; it may well attract a significant premium.

I've been watching the progress that Droneshield have been making and I think I now have the confidence that are going to be a success. There are significant challenges that a small defence contractor faces: a poor negotiating position, delayed payments, capital intensive, need to manufacture in bulk before sales so slow capital recycling, difficulty competing with bigger better resourced competitors - there are probably more.

But on balance, I think the likelihood of success is now much better than it was a year ago. They have executed well: revenue is increasing rapidly, they have now got a US military contract that could lead to much bigger things (and make them a more juicy takeover target) and the are cashed up and about to tip into profitability. This might be delayed by the increased cost of new facilities and increased headcount etc.

P/S is not cheap but on a forward looking basis is not onerous (if they continue to execute as they have indicated).

The additional thing that has attracted me is the increasing percentage of revenue that is predicted to come from the recurring SaaS stream.

The thesis is rounded out by the likelihood of a takeover, but not solely built on it. Additionally, we may see small caps become re-rated as inflation eases and the rate cycle turns.

Not held yet but will do so in the next week or so. As always would like to hear the counter argument.

Nerd fact: Anduril - "Very bright was that sword when it was made whole again; the light of the sun shone redly in it, and the light of the moon shone cold, and its edge was hard and keen. And Aragorn gave it a new name and called it Andúril, Flame of the West."

—J.R.R. Tolkien^[2]