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Investment Thesis
Kraken Robotics (OTCQB:KRKNF) is an underwater vehicle hardware manufacturer with revenue growth >40% CAGR, and the current stock price implies the same level over the next 5 years. The peculiarity of their growth narrative is that it is mainly driven by strong OEM partnerships with established defense companies [e.g., Anduril and Huntington (HII)] by providing sonars and batteries to their unmanned underwater vehicles (UUVs).
The biggest lift is expected to be coming from the new factory Anduril is currently building, expected to produce up to 200 large UUVs a year which I expect has C$3M worth of equipment from Kraken for each unit (C$2.5M battery + C$0.5M sonar based on the latest investor presentation). The ceiling of this opportunity would represent 6x Kraken's total expected 2024 revenue (C$3M x 200 = C$600M). Right now, only a portion of the full capacity is currently being priced in, around 125 out of the 200 units in 2029. The trade will be that any positive news pointing towards reaching capacity earlier will help lift the stock to ~US$2 a share, representing a 25% gain.
April 2024 Investor Presentation
Additionally, lifts in UUV adoption and new OEM partners would be other primary catalysts. I think Kraken is well positioned to benefit from the macro wave of navy budgets shifting towards unmanned vehicles, and there is plenty of runway left for the growth of the whole system. The ending TAM is also attractive. If Kraken can reach US$500M in the next 5 years (similar ~5x achieved historically), they would be a 2% global market share player based on submarine budget spendings, which doesn't seem impossible in the long-run given its partners and its executive team's depth of contacts.
Submarine navy budgets give plenty of runway for the growth of the UUV market (Global budgets = US$26B by 2029 vs. US$4B UUV market)
According to McKinsey, the navy budget currently sits at US$78B (assumes EUR.USD 1:1) growing at 2.8% CAGR (excluding unmanned vehicles) with a split of 70% invested in surface ships, and 30% in submarines (US$78B x 30% = US$23B x 1.028^5 = US$26B). This puts the contestable market at $26B in 2029 in terms of what is available for switching to UUVs. Given that budget growth isn't massive, Kraken will need to rely on increasing uptake in unmanned vehicles to drive growth.
McKinsey
The split is equally reflected in the US unmanned marine programs tracked by AUVSI based on DoD filings, where underwater vehicles make up ~30%. If UUV uptake grows faster, Kraken is well positioned to benefit from the lift, having OEM positions with major defense players. It's a bit speculative at this point, but with the current unmanned vehicle market sitting close to US$4B globally, growth wouldn't be limited.
AUVSI
Are Anduril's growth ambitions realistic? (Kraken Revenue Potential = US$429M by 2029)
If we assume the proportion of Kraken components is consistent across sizes of UUVs, we can use Ghost Shark XLUUV (Australia Navy's XLUUV) as an estimation data point. Kraken has C$8M worth of goods at a total cost of C$50M per XLUUV, giving 16% of the total cost. Using Kraken's Dive LD share of C$3M, we get C$19M per Dive LD LUUV, which seems reasonable, being between C$50M for Ghost Shark (XL) and C$6M for Katfish (S).
Sanity checking this against expected production capacity and demand, Anduril expects to produce 200 hulls a year, which would put their revenue at 200 x C$19M = C$3.8B or US$2.7B. This figure is already much larger than any estimates made by AUVSI (in the chart in the earlier section), but the US Navy seems to be backing this production expansion, which gives me some additional confidence.
We should also verify what 200 hulls a year means in terms of market penetration. The US submarine budget sits at ~US$9B (US$30B North America x 30% submarine) according to McKinsey, if you assume production reaches full capacity, you would get a 30% penetration just for Anduril. This would be possible if they are the main producer for the US Navy, or would be even more sensible if you include orders to international clients. To put this figure into perspective, you have ~70 active submarines in the US right now. Adding 200 LUUVs wouldn't be outrageous annually for 30% of the budget.
Anduril execution risk is largely de-risked given the successful delivery on budget ahead of schedule of Ghost Shark, unlike other defense contractors (e.g., Boeing Blue Orca).
One last triangulation point is the production capacity added by Kraken's recent announcement. They talk about adding production in subsea batteries of up to C$200M per year, which would mean C$200M / C$2.5M per battery = 80 units, assuming the client they are referring to is Anduril. This figure is lower than the expected 200 units from Anduril, potentially explaining some lack of movement in the stock price. As Anduril builds towards its 200 units per year target, this will lead to further derisking of the growth for Kraken, translating into positive stock movement.
Can HII bring significant growth? (Kraken Revenue Potential = US$45M by 2029)
Regarding HII, Project Lionfish is a pretty important win, but it only provides a revenue potential of C$100M (200 REMUS 300 @ C$0.5M sonar revenue), which, spread over 5 years, would be C$20M/year.
Being well integrated into the other REMUS models, Kraken also benefits from their lifts, but they are limited to only providing sonars, which represents a small revenue opportunity.
Lastly, the revenue growth trajectory of HII for their UUVs isn't great, which further limits the potential growth here (under the product line of the Mission Technologies segment). If more positive news is released through their earnings reports, this should have a small positive impact on Kraken, but for now, more evidence needs to be provided to support growth. I'm currently assuming that production levels remain at a normalized level of 53 UUVs per year based on historical revenues (avg revenue US$106M / ~US$2M per REMUS 300 based on Lionfish contract). With 93 total orders (40 Lionfish + 53 normalized) a year getting Kraken sonars and growing at inflation, we land at a $45M revenue in 2029.
HII 2023 10-K
HII 2022 10-K
Management
The thesis has a strong reliance on retaining partner relationships, and you can see Peter Hunter having a vested interest in the stock and strong relationships with HII through the sale of Hydroid to them. This gives me some confidence that these OEM partnerships are not easily replaceable and that the whole board has strong contacts to maintain their position with their existing clients. Risks do exist on the downside if one major relationship is lost, so one should tread with caution.
April 2024 Investor Presentation
Valuation
Aside from Anduril and HII, multiple other revenue streams require assumptions. HII's REMUS 300 Lionfish contract win could result in 200 orders over the next five years. I've assumed all are ordered, and only sonar revenue is generated.
Seabed and sub-seabed survey revenue is based on the investor presentation's note on the status quo with the existing fleet. I'm not assuming additional capacity lifts, but this will likely happen in the next 5 years.
April 2024 Investor Presentation
XLUUV also has an expected 10+ new XL platforms coming to market, based on the investor presentation. You can sanity check this against historical sales rates. They mention that they were able to take in C$44M in orders over the last 2 years; assuming 3 batteries a year in the future, we would land at C$22.5M a year (C$7.5M x 3 batteries), which lines up with the historical track record.
April 2024 Investor Presentation
April 2024 Investor Presentation
Regarding military UUV programs, Kraken was able to get C$40M from the Canadian Navy and C$26M from other navies. If we assume one Katfish unit is C$5M, we get 13 units sold in the last 2 years.
April 2024 Investor Presentation
Lastly, HII other REMUS revenue is based on historical normalized levels described in the earlier section. Anduril is based on their production plans, hitting 80 units in 2026, aligning with Kraken's production capacity expansion. And Teledyne (TDY) has a small assumption of 3 units a year, given no color was found on them. Altogether, we get the following schedule below:
Author's analysis
Feeding these bottom-up revenue assumptions, we get the following FCFF forecast and a DCF share price of US$2, which represents a normalized scenario and conservative assumptions of Anduril's production capacity build-up.
Author's analysis
Author's analysis
Catalysts
Anduril is the most important catalyst here, given the size of its contribution. Any news of contracts won on their end or ideas about acquiring Kraken for vertical integration will be a positive.
Other positive news that would help the stock would be new OEM partners signed and increasing UUV adoption in the market. Though these are less predictable, the macro winds are blowing in the right direction, increasing our chances for a win with this stock.
Lastly, any improvements in the components of free cash flows have a positive impact on the stock price, which I currently haven't focused on in my thesis. This could be margin improvements, better working capital management, and lower capex to maintain growth. All of these will likely improve as the company grows and benefits from economies of scale.
Risks
If you look at the opportunity pool of Kraken's military pipeline, we would get an access rate of CAD$600M = US$429M in potential sales, which represents 10% of the global spending on UUVs today. This illustrates the reliance of Kraken on other larger companies (e.g., HII and Anduril) to get access to this macro lift over the next years.
Additionally, there is a big concentration risk here, with HII not providing strong growth prospects. If you look at their revenue growth since 2020, it largely stayed flat, which shifts the reliance even more to Anduril.
Lastly, the threat of tariffs on Canada from the US is valid, but Kraken's new expansion of manufacturing capability in the Northeast US mitigates this risk. Additionally, their global footprint in facilities positions them favorably to gain access to international navies.
April 2024 Investor Presentation
Conclusion
Kraken offers some upside based on the current information available, and macro tailwinds unlock unknown gains for the future. There are concentration risks in clients, but these are largely mitigated through strong executive team connections and niche specialist positions. The trade is not for the light-hearted, but it can reward quite positively and have multiple ways of yielding positive surprises for investors. At a US$2 target price today, this seems like a safe entry point into a position with lots of macro tailwinds in the future.