Six months in the making, DARPA's Gremlins program is finally getting off the ground -- and that statement probably requires a bit of explaining.
"DARPA" is the Defense Advanced Research Projects Agency, the "mad scientists" division of the Pentagon, responsible for funding and developing leading-edge technologies that can be employed in warfare. Respectively, "Gremlins" is one such technology.
As previously revealed by DARPA, Gremlins aims to develop fleets of "low-cost, reusable unmanned air systems" (aka drones) that can be launched from other aircraft, perform their missions, and then return to land back aboard their motherships -- an acrobatic feat to be performed entirely midair. While Gremlins will be too small to engage in combat operations, the drones will be equipped with sensors and electronic equipment capable of performing surveillance and reconnaissance missions, and also electronic warfare -- jamming, spoofing, and otherwise frustrating opposing radar systems.
DARPA invited companies interested in working on Gremlins to a "Proposers Day" last September, and has been considering their proposals ever since. Last week, the agency revealed four winners chosen to begin "Phase 1" work on Gremlins. These include:
- Lockheed Martin (NYSE:LMT)
- Composite Engineering, which, according to S&P Global Financial Intelligence, is a subsidiary of Kratos Defense & Security (NASDAQ:KTOS)
- Two privately held firms -- Dynetics of Huntsville, Alabama, and General Atomics Aeronautical Systems of San Diego, California
Why these four companies, in particular, and no others? DARPA does not say, but here's one clue: When we last looked into the Gremlins program, I pointed out how several companies already build "disposable" electronic warfare drones -- such as Boeing's (NYSE:BA) CHAMP or Raytheon's (NYSE:RTN) MALD-J -- that could fit the bill for Gremlins. Both those drones are "disposable," however, designed to be launched once, perform its mission, and then crash.
In contrast, DARPA has specified that its new fleet of Gremlins must be only semi-disposable -- designed to launch and land roughly 20 times before being used up. This suggests that DARPA placed great emphasis on contractors bidding reusable drones for Gremlins, and perhaps more emphasis than Boeing and Raytheon had bargained for. Whatever the reason for their not being awarded Phase 1 contracts, though, this represents a big missed opportunity for Boeing and Raytheon.
How big, exactly?
At first glance, it may not look like Boeing and Raytheon have missed out on much by not participating in Gremlins, because, as we've come to expect from DARPA contracts, the initial R&D phase of Gremlins will be done on a shoestring budget. MilitaryAerospace.com estimates that the total value of all four contracts awarded for Phase 1 will not exceed $15.8 million -- or roughly $3.9 million per contractor. (Indeed, MA confirms that at least one contractor -- Kratos -- has been awarded a contract for precisely that amount.)
Those funds just cover Phase 1 (proof of concept) for Gremlins, however. Following completion of Phase 1, some number of companies will be tapped to work on Phase 2 (preliminary design) and Phase 3 (build and test fly a prototype). Each of these phases will be worth additional millions. And if one or more companies should then win a contract to put Gremlins into production, that could involve the building of scores, or even hundreds, of Gremlin drones for the U.S. Air Force, Navy, and Marine Corps.
Which company will cross the finish line?
Which company is most likely to stay the course from start to finish, and end up with a Gremlins production contract? Honestly, at this stage, it's far too early to tell. What I can tell you is who would benefit most from such a Gremlins contract win: Kratos Defense & Security.
Consider this (and consider, too, that we'll pay no further attention to Dynetics or General Atomics, neither of which is publicly traded): Defense giant Lockheed Martin did more than $69 billion in business last year. While Lockheed Martin would certainly like to win Gremlins outright, it can easily survive without it.
On the other hand, even DARPA's initial $3.9 million Phase 1 R&D contract amounts to more than a half-percent of the revenues that Kratos books in a year. Additional contract wins in Phase 2, Phase 3, and beyond could "move the needle" on Kratos' business quite significantly. What's more, given the tens of millions of dollars that Kratos has already sunk into drone development through its UTAP-22 program, success in landing a Gremlins contract would be a great way to monetize that investment.
From an investor's perspective, therefore, there's one stock in particular that could profit particularly well from its Gremlins contract win, and that's Kratos Defense & Security.
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