Why AeroVironment (Nasdaq: AVAV) Has 30%-50% Downside Risk
Report Entitled "Guidance Correction, Crash Imminent"
Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving AeroVironment, Inc. (Nasdaq: AVAV), a producer of unmanned aircraft systems (“drones”) for military usage and electric vehicle chargers.
Spruce Point has conducted an extensive fundamental and forensic accounting review of AeroVironment, and believe that investors are overlooking significant long-term business challenges, poor capital allocation, questionable governance issues, an undisclosed whistleblower complaint, and technical factors causing temporary overvaluation
As a result, we have a "Strong Sell" opinion and a long-term price target of approximately $24.00 - $34.00 per share, or approximately 30% to 50% downside risk.
Our detailed research report is available on our website . We also encourage all of our readers to follow us on Twitter @sprucepointcap for regular updates. Please review our disclaimer at the bottom of this article.
AVAV Nearly Identical To Our iRobot Short, Another Over-Hyped Play On A Laggard In Its Industry :
Spruce Point conducted an extensive evaluation of AVAV, and find it to be a nearly identical stock promotion to IRobot. AVAV is being hyped as a play on drones, but its products are stagnant and being out-innovated by peers. Like iRobot, we find: 1) Foolish stock promoters, including a former one tied to a notorious Ponzi-scheme, 2) Poor governance + unjust insider enrichment, 3) Continuous insider selling, 4) Poor capital allocation, 4) Frequent accounting errors + warranty revisions, and 5) Nonsensical and distorted valuation
AVAV’s Recent Outperformance Makes Little Fundamental Sense And Partially Fueled By Excessive ETF Buying:
A perennial underperformer in the market, AVAV has almost doubled in 2017 despite management’s recent reiteration of revenue and earnings guidance that call for little growth. AVAV trades at the highest valuation multiples in its history and at 2-3x the multiples of defense-industry peers – despite the fact that it has produced no sustained revenue or FCF growth over its history, has not undergone any fundamental transformation, and earnings visibility declines every year. We believe AVAV’s price surge has been fueled by billion-dollar inflows into the fastest growing ROBO, which at one point had AVAV as its #1 holding. We think ETF restrictions will limit additional share purchases, and may have to sell because AVAV’s bad governance and military applications may conflict with ROBO’s ESG policy (environmental, social and governance)
AVAV’s Drones Fail In Real-World Conditions; Its Technology And R&D Have Fallen Behind:
While hope springs eternal that AVAV will one day broaden its horizons by selling its drones to businesses and not militaries, the market has overlooked the evidence that its drones work poorly even for military uses. An internal Department of Defense document released via FOIA request shows that one of AVAV’s key products “ did not meet key performance parameters, ” calling into question its usefulness in actual combat. Problems included poor landing accuracy (with a 44% failure rate), an inability to cope with high winds (a feature that was supposed to be designed into the product), and an unexpectedly heavy and fragile carrying case. Military test operators used words like “ chintzy ,” “ cumbersome ,” and “ horrible ” to describe AVAV’s drones. Other real-world users speak of routine crashes and other shortcomings, using harsh language (“ even in training they f***g sucked ,” “ that thing really was a piece of s**t ”). When the Ukrainian military received AVAV drones as aid from the US in 2016, it quickly abandoned them, citing poor performance including susceptibility to enemy jamming. We believe complaints about AVAV’s product fundamentally stem from its stale technology. R&D staffing and capex as a percentage of sales have declined over the years, while staffing for overhead functions has grown, giving a picture of a bloated company not committed to the cutting edge and a vehicle to enrich mgmt. For a decade, AVAV has made very few changes to its product line-up, with only one significant new model in the past five years. Meanwhile, it has wandered into several major technological dead ends, including an overpriced vertical-takeoff drone and two larger, higher-altitude drones that have failed to drum up any actual contracts. These failures are quietly swept under the rug through frequent revisions to what AVAV actually says it does.
AVAV Faces Poor Industry Dynamics In Both Its Businesses: In the drone/UAS business, hype about commercial drone adoption has begun to fizzle, with competitors like 3D Robotics, Parrot, Autel, and Yuneec all going through layoffs or closing. No one has been able to make a dent in the leading position of DJI, a Chinese drone manufacturer known for high-quality and relatively inexpensive products. VC funding has also begun to dry up. Meanwhile, in the military market, FLIR and Boeing have both just acquired small competitors of AVAV’s, aiming to expand the reach of their technologies, while another small competitor has started to sell spare parts for AVAV’s own products to the US gov’t – all signs of greater competition. The notion that AVAV has a long runway of growth in int’l markets is belied by the tiny relative size of non-US military spending, and, even as new int’l customers do come on board, the growth is not sustainable since military drones are durable and don’t need to be re-purchased routinely. In the long run, the US military will work toward using cheaper commercial drones, a negative for margins
In AVAV’s electric-vehicle charging business (~10% of gross profit), there is little to distinguish its products in a crowded market with few barriers to entry. Product reviewers see no standout benefits to its offerings, and large companies like GE have already exited the market. Despite working on EV charging for years, AVAV’s business and margins have shrunk!
Undisclosed Whistleblower Complaint, Compliance Record Merit Scrutiny : If the fact that AVAV is on its fourth CFO since coming public doesn’t concern investors, then perhaps an undisclosed whistleblower lawsuit will. AVAV’s former VP of Strategic Operations – an executive important enough that his initial hire was officially announced – accused it of fraudulently obtaining gov’t reimbursement for costs connected to the non-military EV-charging business. He alleged that “ false billings ” cost the gov’t tens of millions of dollars. The case was eventually dropped. If true, such misdeeds would appear consistent with AVAV’s past issues, including a DoJ investigation of its billing practices, an unexplained recent lapse in approvals from the Defense Contract Management Agency, and unexplained violations of State Department export restrictions. AVAV’s audit fees have been suspiciously rising to new highs ever since the complaint and imposition of an equity clawback in 2013
Terrible Capital Allocation and Governance Echoed By Undisclosed Whistleblower Complaint:
If the fact that AVAV is on its fourth CFO since coming public doesn’t concern investors, then perhaps an undisclosed whistleblower lawsuit will. AVAV’s former VP of Strategic Operations – an announced executive hire – accused it of fraudulently obtaining gov’t reimbursement for costs connected to the non-military EV-charging business. He alleged that “ false billings ” cost the gov’t tens of millions of dollars. Such misdeeds would be consistent with AVAV’s past issues, including a DoJ investigation of its billing practices, an unexplained recent lapse in approvals from the Defense Contract Management Agency, and unexplained violations of State Dept export restrictions. Recent insider behavior to change bonus targets to extract incentive bonuses is even more distasteful in light of its squandered opportunity cost with excess capital (AVAV doesn’t acquire, buyback stock or pay a dividend). This behavior exists while AVAV’s audit fees have been rising to new highs ever since the complaint and adoption of an equity clawback in 2013.
Stock Promotion Runs Deep At AVAV, Valuation Can Correct 30% - 50% As Disappointment Looms Large :
Insiders have consistently sold shares (47% post IPO to 11% ownership currently), while a laundry list of rogue brokers have relentless pumped AVAV since its IPO (remember Stanford Financial or Jesup & Lamont?). Also don’t be Fooled when Mr. Motley says buy, recall they have also relentlessly pumped iRobot. True to form, AVAV has exhibited terrible FCF generation and margins, high management turnover, unwillingness to engage activist investors, and limited long-term share price upside until recent ETF buying. Even typically optimistic sell-side analysts don’t currently recommend AVAV, with zero buy ratings and an average price target of $40 (implying 17% downside). AVAV’s current peak valuation of 3x and 31x 2018E Sales and EBITDA will eventually normalize with defense industry peers and with its own historic valuation. As a result, we see 30%-50% downside or $24 - $34 per share, representing a terrible risk/reward
About Spruce Point Capital Management
Spruce Point Capital Management, LLC is a New York based investment manager founded in 2009. The firm focuses on short-selling and special situations opportunities. The firm conducts in depth forensic fundamental research and takes an activist approach to investing. Our research challenges conventional thinking with deep fundamental analysis, analytical rigor, and conclusions rooted with our unique viewpoints. For more information visit our website , and follow us on Twitter @Sprucepointcap
Disclaimer
This research presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation AeroVironment, Inc. (“AVAV” or “the Company”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.
This research presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.
To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of AVAV or other insiders of AVAV that has not been publicly disclosed by AVAV. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use.
This report’s estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor. This is not an offer to sell or a solicitation of an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.
