Kratos Defense & Security Solutions KTOS
Kratos is an overhyped drone play run by executives tied to the Titan FCPA scandal; with the weakest margins in defense and a recent Director fraud indictment, we see 40%-70% downside.
Thesis
Kratos Defense & Security Solutions (NASDAQ: KTOS) has reinvented itself repeatedly — from the collapsed dotcom Wireless Facilities, through a reckless $1bn 2008-2012 M&A spree that destroyed value, to today's heavily-promoted unmanned aerial drone pitch. Spruce Point argues the drone story is largely hype: Kratos has spent only $63m on drone R&D and capex since 2013 versus AeroVironment's $255m, holds roughly 1% of unmanned market share, and touts experimental programs like LCASD where the Air Force pushes 82% of capital onto Kratos. CEO Eric DeMarco and CFO Deanna Lund both carry baggage from Titan Corp's $28.5m FCPA settlement, and a senior Kratos Director recently pled guilty in a $20m Army contract fraud scheme. Yet KTOS trades at 20x EBITDA and 70x P/E — the sector's richest multiples — despite below-average margins, 88% fixed-price revenue risk, and index-fund buying masking fundamental-investor outflows. Spruce Point demands the CEO and CFO resign and estimates 40%-70% downside to $3.15-$6.30 per share.
SCQA
Kratos Defense (NASDAQ: KTOS) is a mid-cap defense contractor that pivoted from a collapsed dotcom into C5ISR and now aggressively positions itself as a pure-play on unmanned aerial drones to justify peak valuation.
A 2008-2012 M&A binge destroyed $800m of value, drone R&D spend is meager versus peers, and CEO DeMarco and CFO Lund carry fraud baggage from Titan Corp, which paid $28.5m in FCPA fines.
Spruce Point urges shareholders to sell and calls for the resignation of CEO Eric DeMarco and CFO Deanna Lund, citing abysmal compliance failures and a recent criminal conviction of a senior Kratos Director.
Valuing Kratos at 10x-12x EBITDA, 1.0x-1.5x book, or 20x-25x free cash flow — in line with weaker-quality defense peers — implies 40%-70% downside to a $3.15-$6.30 per share target.
The three reasons
- 1
Management (DeMarco/Lund) tied to Titan Corp FCPA scandal; senior Kratos Director pled guilty to $20m Army contract fraud
- 2
Drone story is hype: $63m Kratos R&D/capex since 2013 vs AeroVironment's $255m — only ~1% unmanned market share
- 3
Trades at 20x/70x 2018E EBITDA/P/E — highest in defense — yet worst margins and 88% fixed-price contract risk
Primary demands
- Resignation of CEO Eric DeMarco
- Resignation of CFO Deanna Lund
- Shareholders should sell — Strong Sell recommendation with 40%-70% downside
- Address undocumented accounting of 'corporate activities' segment assets (~$127m not being depreciated)
KPIs cited
Pattern membership
Precedents cited
- Titan Corp FCPA scandal ($28.5m settlement, DeMarco/Lund alumni)
- Arthur Andersen / Enron (CFO Lund omitted Andersen from bio)
- Spruce Point short of iRobot (2017, stock -20% Feb 2018)
- Spruce Point short of AeroVironment (Nov 2017, -18%)
- Spruce Point short track record: 9 CEO departures post-report (Gentex, Sabre, Intertain, Caesarstone, Greif, AMETEK, LKQ, Boulder Brands, Bazaarvoice)
Composition what's on the 49 slides
Slide gallery ·
Notes
Spruce Point short report with a memorable 'Target Locked: Ready To Fire Management' fighter-jet HUD cover — rare creative imagery for the genre. Calls for resignation of CEO DeMarco and CFO Lund by tying them to Titan Corp's $28.5m FCPA settlement and a recent $20m guilty plea by Kratos Director Dwayne Fulton. Leads with Spruce Point's own track record: a table of 9 prior shorts that resulted in CEO departures. Classic 'What company says vs what evidence shows' contradiction slide on page 21. Shareholder-base rotation slide (page 45) showing fundamental holders replaced by index/ETF flows is an interesting structural argument. Valuation bridge on page 49 presents three independent methods (EBITDA multiple, P/B, FCF multiple) all converging on 40%-70% downside.