Redwire: The Roll-Up To Success

I have been on a bit of a space kick lately. I started down a vein and I guess I am still running down it. The space industry is going through a boom right now and I don’t think that will slow down. The industry continues to advance and importantly more money is being spent on space. I started looking into a few companies in the space (pun intended) and some ancillary markets as well. I have written about a few of them, including Rocket Labs USA, Inc. (RKLB), Viasat Inc. (VSAT), Markforged Holding (MKFG), and 3D Systems Corp. (DDD). The 3D printer market is very connected with the aerospace industry if you were wondering how that fits together.

This research led me to another interesting company operating in the space market, Redwire Corporation (NYSE:RDW). This is an intriguing company that is very active. The company piqued my interest. I will share my thoughts on the company and whether or not you should buy the stock.

Redwire - The Roll Up

Redwire “is a global leader in mission critical space solutions and high reliability components for the next generation space economy, with valuable intellectual property for solar power generation, in-space 3D printing and manufacturing, avionics, critical components, sensors, digital engineering and space-based biotechnology. We combine decades of flight heritage with an agile and innovative culture. Our “Heritage plus Innovation” strategy enables us to combine proven performance with new, innovative capabilities to provide our customers with the building blocks for the present and future of space infrastructure.”

Redwire really came to be through acquisitions. The company is a roll up of a bunch of smaller, more niche companies. The companies are not new companies but older companies that had experience and expertise in their specific area. These were consolidated into one entity that has a much wider range of capabilities. The company integrated “several acquisitions from a fragmented landscape of space-focused technology companies with innovative capabilities”. The company expects to continue to grow organically as well as through strategic acquisitions going forward. The company has completed 9 acquisitions since March 2020.

March 2020 - Adcole Space, LLC

June 2020 - Deep Space Systems, Inc.

June 2020 - Space Group, Inc.

October 2020 - Roccor, LLC

December 2020 - LoadPath, LLC

January 2021 - Oakman Aerospace, Inc.

February 2021 - Deployable Space Systems, Inc.

November 2021 - Techshot, Inc.

October 2022 - Redwire Space NV

This has allowed the company to expand what it can offer to customers. It also has allowed it to build on top of the other companies technology to have a more complete offering. Their tech ranges from solar panels, antennas, berthing and docking equipment, software, to biotechnology for medical research. They have a much larger breadth of knowledge and abilities to win contracts as a larger combined entity. I actually really like the strategy and how the company came to be. They saw a lot of small space companies that were good in their niche. The market was fragmented and they brought them all together to form a larger and more competitive company.

While I am a fan of what they have done, consolidation can be great. This growth strategy is not without its risks. It is not always easy to integrate new companies into your system. Also it is hard to get the valuation right on a lot of these companies. With that many acquisitions you are bound to end up paying more for some technology than you probably should have. One of the companies might also not fit as well with your other products as you thought. The acquisition might also not perform financially as expected. There are plenty of risks through the growth by acquisition strategy.

The other concern here to me is that the roll up was performed by a private equity group. Obviously they are out to make money on their investment. I am not over here saying that the big bad private equity company is the boogeyman that is out to burn the small guy. This is definitely something to consider when investing. PE groups do not typically hold long term investments. They need an exit strategy. What is their exit strategy and how does that affect the investment? What are the intentions of the private equity group, how do they plan to get paid? Do they hope to build a profitable company and then sell it to a high bidder? Typically I would want to see ownership invested in the long term on their investment. I think decision making becomes much better when management has the long term benefit of the business in mind. There is a risk that does not happen due to the ownership structure.

Company Growth

The company has seen strong growth in revenues. If you look back on the past 3 years the company has had high growth. Revenues grew from $44.5 million in 2020 to $160.5 million in 2022. That is growth of over 260% in two years. They also made 9 acquisitions over that time period. It is pretty hard to strip out the organic growth versus the acquired growth over those years. While growth through acquisitions is fine, as long as they are paying a fair price for that acquisition, it cannot realistically go on forever. I want to see those acquisitions being incorporated and adding organic growth benefits to the company.

This can be more clearly seen in the latest quarter. They only have 1 acquisition in the last year so the company is able to break out the organic growth versus acquired growth rather easily. Revenues for the latest quarter grew by 63.6%. This is mostly due to the latest acquisition, but even without the acquisition the company saw organic growth of 25%. Still a good number. So the company is seeing some success in incorporating the acquisitions and growing organically. They also expect year-end revenue to be in the range from $220-250 million. The midpoint of this estimate at $235 million would be growth of approximately 46%.

The growth each year is lumpy depending on acquisitions. They acquired Space NV later in 2022 so they did not see as much growth. Those acquired revenues will be included all year for 2023 so you will see a good growth year. The question is what kind of growth is going to be seen in 2024? Also it does appear that the growth is slowing a bit as well. The company saw sequential growth from Q1 to Q2 of 4.3% without the acquisition this growth was 1.1%. The sequential growth would eliminate the effects of the latest acquisition. The company is showing much slower growth when stripping out the jump from the acquisition. Analysts also expect growth to slow in the coming year, with an expected revenue growth of 18%. This is still a respectable number but a big drop off from the close to 50% expected this year.

This is the main concern for me on their revenue growth, will they be able to integrate these companies and grow organically. I am getting mixed signals from their results. On one hand it appears they have had some success at that, demonstrating 25% organic growth in the latest quarter, but then their organic growth was only 1.1% from Q1 in a non-seasonal business (an important note). This is something I would want to keep an eye on and see how it continues to play out.

Scale and Efficiency to Profitability

There is a red flag on the company for me. Redwire came to exist by a roll up of smaller companies. These were not start-up companies but rather legacy players that have been in operations for years. If they are not start-ups then why is the combination of a bunch of legacy players still a loss making entity? Shouldn’t these older companies be profitable? If they were startups that were in high growth stages then that is acceptable. You don’t want a bunch of slow growing old companies losing money. Combining a bunch of older loss making entities into one loss making entity doesn't sound great.

The way I see it is that the combination of the different companies provides growth opportunities, as discussed in the section above. Consolidation can be a driver for growth. The other factor to consider with their acquisition strategy is if they are able to utilize their larger scale and operate efficiently. The main items I would be looking at are the gross margin, SG&A spend to revenue, and then R&D spend to revenue.

The gross margin should in theory see an increase as the company is able to win more contracts that are larger. It can leverage its additional assets to produce more. Utilization rates of employees can increase and operations run more efficiently. Also with more scale it should have stronger buying power on raw goods. There are a lot of moving parts. They have to incorporate new products into their portfolio. They would need time to see many of these benefits. Despite this overall the company has seen its gross margin stay fairly steady at 18%, 21.4% and 19.8% in the last three years. The latest year had the lowest GM which is not good but also they did have a large acquisition that year. The first and second quarter of 2023 saw a GM of 24.7% and 26.5%, respectively. This is definitely trending in the right direction.

One of the largest expenses for a smaller company can always be SG&A. The company needs to grow revenues to better leverage its costs. This is where the biggest gain for Redwire has come. In Q2 of 2022 SG&A made up 48% of revenues in Q2 2023 SG&A made up 29% of revenues. The company has seen its SG&A hold fairly steady over the past 2 years. The difference is that revenue has increased in that time period. The company has been able to be prudent with their expenses while still growing. They also said in the conference call that they would expect SG&A expenses to run fairly steady going forward. This provides even better operating leverage and profitability for the company.

The last item was R&D expenses. This expense line item is smaller than I initially thought it would be. The arena in which the company operates is highly competitive and highly technical. I thought R&D would make up a higher percentage of revenues. R&D is investing for the future of the company. When you consider the way the company has grown and come to be then it makes more sense. Instead of spending large amounts on internal R&D they have instead acquired new technology. They spend their R&D dollars on acquisitions. This is all part of the acquisition strategy. I am a little more leary on this side of the acquisition strategy. I feel that the company needs to have strong internal R&D to be successful in the field that it competes in. Either way scale helps here as well. The company spent 4.7% or revenues on R&D in Q2 2022. They increased R&D spend by 21% from the year ago period but it only accounted for 3.2% of revenue. This is the benefit of scale and efficiency in their operations.

Overall it seems that the scale and efficiency is occurring for the company. They are starting to get more leverage within their operating structure. Revenues continue to grow at a faster rate than expenses. This is a recipe for profitability.

Profitability and Liquidity

The company has consistently operated at a loss. It recently reported two positive adjusted EBITDA quarters in a row. The company recorded cash from operations of $2.8 million. It reported its first positive free cash flow in the latest quarter, with FCF of $1.1 million. These are big steps for the company. This profitability came about thanks to the items we discussed above. The company has been able to grow revenues while keeping expenses steady. That being said, the company is still a long way off from achieving profitability as a whole.

If they are able to continue with the same GM as last quarter (26.5%) and also keep the SG&A and R&D steady as expected then the company is still going to be looking at an operating loss. The estimates are below.

The loss of approximately $17 million is still a ways from achieving profitability. Keeping the same GM, SG&A and R&D expense the company would need to generate approximately $299 million in revenue to earn an operating profit. That is growth of 27% from their year-end estimate of $235 million. Unless the company can grow faster, improve the gross margin, or cut more operating costs they will be operating at a loss in 2024.

The company ended the last quarter with $11.2 million dollars in cash. They have $75 million in debt on the books as well. Now the company has operated at a positive Adjusted EBITDA and also just had its first positive quarter of FCF. Both of these numbers were very small positives and it really does not provide much wiggle room for the company to easily fall back into negative territory. It also does not leave a lot of room to deal with the $75 million in debt on the books. The company has stated that they plan to continue to grow through acquisition. They do not have cash to do so. They would have to take on more debt, already a high level, or dilute shareholders. I think there is a good chance of further dilution ahead for shareholders. While the company has been able to generate positive cash flow it is minimal and they are walking a thin line on their cash pile. I expect a dilution to allow the company more wiggle room and to keep options open for future acquisitions or growth. The company filed a prospectus for a mixed securities offering up to $400 million in early September.

Valuation

The company has a market cap of $178.1 million and the trailing twelve month revenue figure is $208.7 million. The P/S ratio is .85. Their estimated revenue of $235 million for the year would leave them with a P/S ratio of .76. This is a low multiple for a company that is growing revenues and is EBITDA positive. A P/S under 1 is usually reserved for a company that is not seeing growth. This is well below the sector median.

An approximate 40% undervaluation on the P/S ratio. This shows there could be a chance for a run up if investors decide this company should not be discounted. The company has a fairly large debt load. This plays into the EV/Sales ratio. The company does not look as cheap when looking at this metric.

This is one of the main reasons I see the company being valued at a low P/S ratio. I think their large debt load causes other concerns as well. Investors are concerned about dilution. As discussed above I think there is a good chance that there will be dilution going forward. Also the company is seeing revenues slow. My same concern is that the company is not seeing enough organic growth. They don’t have money to acquire another company without diluting or taking on more debt. So any more bolt on acquisitions will come at a cost to shareholders.

While the company does appear to be undervalued based upon sales and growth. There are some reasons for this lower valuation. When looking at the enterprise value it is much more fairly valued. A big part of this is capital structure decisions, more debt and less equity.

Conclusion

Redwire came to be through a roll up of a bunch of different small aerospace companies. I think the consolidation strategy has merit. Although the fact that the company rolled up heritage companies and still operates at a loss is a little concerning. The company is not a new startup with new technology entering a market. The idea is that with more functions and capabilities the company will be able to better compete within the space industry. It will also allow it to leverage its operating structure to be more profitable.

The company has seen strong growth, most of this growth has come from acquisitions. While the company had good organic growth in the latest quarter it appears this is slowing. The company also continues to operate at a loss. It reported its first quarter of positive free cash flow but this does not make it a profitable company. It needs to continue to see strong growth to reach profitability.

The company is being discounted in the market. While this may make it seem like a good buy, there are some concerns. Slowing growth, high debt levels, and a small cash position. The debt and cash position make it likely that shareholders will be diluted. I do think this potential dilution is mostly built into the stock price.

I would rate the stock a hold. I think a dilution is likely and I think this is mostly baked into the stock price. Although there is no knowing what level of dilution might occur. This risk hangs over the stock. The stock has potential, especially at the current price. I want to see a couple of things before I buy the stock. I want to have more clarity around the dilution. I want to see if the company can improve its gross margin and keep its costs in line, thereby continuing to generate positive EBITDA and FCF. Also I want to see it generate more organic growth. I will watch the stock going forward and see if it is able to execute. By waiting I am likely to miss a lower buy point but also lower my risk. The stock has potential, I am just not quite sold yet.