AI's Leap From Reel to Real.
Each evening, one of my favorite ways to unwind is by watching a movie or show with my wife before we turn in for the night. Recently, we revisited a classic film that's managed to retain its relevance and impact even forty years after its initial release. The movie in question is "WarGames," a 1983 American techno-thriller that masterfully weaves a tale of suspense, technology, and Cold War drama. Matthew Broderick brings to life the character of David Lightman, a young computer prodigy whose quest for intellectual thrill leads him to inadvertently hack into a U.S. military supercomputer. This machine, programmed to simulate and execute nuclear war scenarios, is triggered into a near-catastrophic false alarm by Lightman’s intrusion, pushing the world to the precipice of a third World War.
Looking back at "WarGames" forty years later, it's striking how the film's narrative echoes our current technological landscape. In an age where the advancement of supercomputers and AI is leaps and bounds ahead, scenarios that once seemed confined to the realm of science fiction are now alarmingly within the realm of possibility.
In today's world, fraught with escalating geopolitical tensions, the thin line between calculated strategy and disastrous miscalculation becomes ever so blurred, edging us closer to the brink of global conflict. In such a climate, defense is not just a matter of national security but an integral part of our collective future. As 2023 comes to a close, we look at two defense stocks that have caught my attention, not just as financial investments but as stakes in the future of global security. In addition, we'll take a reflective journey through our portfolio's past year, assessing our triumphs and learning moments, and strategizing for the unpredictable future that lies ahead.
The Dawn of AI Warfare.
Growing up, I've always had a deep fascination with history, particularly military history and advancements in military technology. As a boy, I remember being captivated by the First Gulf War, witnessing firsthand how technological superiority, especially the use of stealth fighters, guided missiles, and night vision, gave the United States a significant edge in the conflict. Fast forward a decade, and the 9/11 attacks and the ensuing wars in Afghanistan highlighted the evolution of military tactics with the extensive use of surveillance and attack drones. These drones fundamentally changed the landscape of modern warfare. Once a field where the United States military led with its technological prowess, drone technology has now become a global phenomenon, with even adversarial forces utilizing these advanced machines.
Now, as we step into 2024, it's not difficult to imagine a scenario where the U.S. military might find itself outmatched in a conflict against an adversary equipped with far more advanced military technology. The rapid advancement and integration of Artificial Intelligence (AI) in military tech underscore the importance of this area for national security. This is precisely why I view AI and drone technology as vital areas for investment.
In this edition of Trendpost, we turn our attention to two defense companies that, in my view, are well positioned to capitalize on the escalating demand for robust defense systems. This assessment comes amidst a backdrop of increasing conflicts across the globe, highlighting the ever-growing importance of advanced military technology and defense capabilities.
BigBear.AI
BigBear.ai (BBAI:NYSE) specializes in AI and machine learning software, designed to analyze vast amounts of data and aid in critical decision-making. The company's clientele primarily spans 20 U.S. military and intelligence agencies, including the U.S. Army, Air Force, Defense Intelligence Agency, and U.S. Cyber Command. BigBear.ai's product offerings encompass supply chain and logistics, cybersecurity, and autonomous systems – each tailored to enhance operational efficiencies through innovative AI applications.
Supply Chain and Logistics: BigBear.ai’s suite of products in this segment includes ProModel, Observe, and Dominate. ProModel is a discrete event simulator that optimizes operations by simulating various scenarios. Observe, a Data-as-a-Service program, assimilates data from multiple sources to provide real-time operational insights. Dominate, meanwhile, forecasts future outcomes based on different decision-making options.
Cybersecurity: In the realm of cybersecurity, BigBear.ai's Bearclaw and SpaceCrest are pivotal. Bearclaw specializes in identifying and neutralizing threats like malware through data analysis and reverse engineering. SpaceCREST focuses on protecting space assets, such as satellites, which are crucial for GPS-dependent critical infrastructure.
Autonomous Systems: BigBear.ai is also advancing in autonomous system software, facilitating autonomous operations for military equipment. The company's partnership with aerospace giant L3Harris on unmanned service vessels for the U.S. Navy is a testament to its capabilities in this domain.
US Military Contracts
BigBear.ai has made notable strides in securing contracts with the U.S. military, a testament to its growing prominence in the defense sector. In 2021, the company was awarded a contract to develop the Global Force Information Management (GFIM) system for the U.S. Army. The GFIM system aims to revolutionize the Army's force management capabilities, providing commanders with near-real-time insights to effectively manage, equip, and train their forces. After successfully completing Phase 1, BigBear.ai secured a Phase 2 contract worth $14.8 million, and recently, the Army further extended the contract by $8.5 million. Furthermore, on December 13th, the company announced a substantial extension for GFIM system contract, valued at $17.9 million. This extension reflects BigBear.ai's successful integration into the Army's operations, with the potential for the GFIM contract to lead to additional significant earnings for the company.
In a significant development for BigBear.ai, the company has secured a notable $900 million Indefinite Delivery/Indefinite Quantity (IDIQ) contract with the U.S. Air Force. This contract, awarded in January 2023, positions BigBear.ai, specifically its division now known as BigBear.ai Federal, to compete for various task orders as a prime contractor. The tasks are geared towards delivering innovative capabilities, systems, and synthetic environments, with the expectation of completing the awarded task orders by 2032.
Financials
For 2023, BigBear.ai projects its revenue to be in the range of $155 million to $170 million, expecting a single-digit negative adjusted EBITDA. In the previous year, the company achieved $155 million in sales, with a gross margin of 28%. Currently, BigBear.ai carries $194 million in long-term debt, alongside $32 million in cash reserves. Throughout this year, the company has expended $21 million in cash. The total shares outstanding for BigBear.ai stand at 158 million.
Recognizing its potential amidst these tumultuous times, I've taken a cautious yet optimistic step by acquiring a small position in the company's warrants back in July of this year at $0.29 USD each. These warrants, expiring in July 2026, allow me to place a small bet BigBear.ai's future growth and success in a world increasingly focused on advanced defense capabilities.
Kratos Defense
Kratos Defense & Security Solutions (KTOS:NASDAQ) stands at the forefront of military technology innovation, renowned for its pioneering drones and expertise in space, satellite communications, rockets, and hypersonic missile defense systems. The company has taken a bold leap, integrating Artificial Intelligence (AI) into its drone technology, a move that promises to redefine modern warfare. With 70% of its revenue sourced from the U.S. government and the remainder from agreements with major defense contractors, Kratos is well-entrenched in the defense sector. These large, multiyear supply contracts ensure a steady flow of business and position the company for sustained success and revenue growth.
Kratos Defense & Security Solutions' foray into the drone business began with crafting basic flying targets for military testing back in 2011. These initial drones were designed for simplicity and cost-effectiveness, meeting the military's need for affordable targets. This early focus on affordability has been a cornerstone of Kratos' approach, leading to the development of their advanced Valkyrie drone. The Valkyrie, an AI-enabled drone, offers a remarkable blend of capabilities – from operating as a loyal wingman in single or swarm operations to carrying a variety of lethal weapons. Its affordability is a standout feature, with a potential cost reduction from $6.5 million to $2 million per unit, a fraction of its competitors' prices which can range from $15 million to $40 million. This price advantage positions Kratos as a compelling option for the U.S. Air Force and Navy.
Kratos' financial prospects are bolstered by its "Unmanned Systems" and "Government Solutions" segments, contributing to a combined revenue projection of $2.1 billion. The "Unmanned Systems" segment, currently 22% of Kratos' business, is expected to see substantial growth, driven by the increasing demand for AI-integrated drones. The "Government Solutions" segment, comprising 78% of the business, is also on an upward trajectory. As the company expands, economies of scale are anticipated to improve profit margins, enhancing its financial strength. Wall Street's projection of a 10% annual growth for Kratos through 2027 may well be a conservative estimate, given the company's strategic positioning and innovative capabilities in a rapidly evolving defense landscape.
As much as I want to own shares in this company, I am placing KTOS on my watchlist for now. The company's shares have soared by 121% in the past year, making it prudent to wait for a more favorable entry point. The escalating global conflicts underscore the potential of Kratos' AI-integrated military technology, but my investment strategy favors patience and timing over chasing market trends. A pullback in the stock price would present a more opportune moment to consider adding Kratos to our portfolio.
2023 Investment Strategy
Entering 2023, I braced myself for a potential market collapse or, at the very least, a significant downturn. With this possibility looming, and my portfolio already positioned entirely in cash, the objective was clear: earn a guaranteed return of around 4.30% while keeping my capital safe. I understand that holding too much cash often means missing out on market upturns, but for me, there's always been a dream scenario, what I like to call the 'Holy Grail' of investing – being cash-rich in the midst of a major bear market. As the year unfolded, the anticipated downturn seemed to lurk around the corner, with bank failures in March, mass layoffs, and a rough start for tech stocks. Yet, despite these tremors, the expected crash didn't materialize. This meant forgoing the stellar returns of the 'Magnificent Seven' (Alphabet, Apple, Amazon, Microsoft, Meta, Nvidia, Tesla) and the broader S&P 500. It was a deliberate choice I made, all for the chance to capitalize on what I believe could be the investment opportunity of a lifetime.
In this, my approach mirrors the military strategy of "reserve deployment." In a battle, the strongest units are often kept in reserve, not immediately committed to the frontline. Instead, smaller units or less critical forces are deployed initially to engage and assess the situation. This allows for a more flexible and responsive strategy, conserving key resources and applying them at the most impactful moment. Similarly, by keeping my portfolio in cash, I am holding my most powerful 'units' back, ready to deploy them when the market conditions are most advantageous.
Throughout 2023, my strategy extended beyond merely waiting in cash. I strategically utilized parts of my cash reserves for small, well-calculated investments. These moves were designed to position my portfolio for potential economic scenarios, such as a global recession or a 'crack-up boom.' A 'crack-up boom' refers to a situation where excessive money printing and currency devaluation lead to a rapid increase in prices, creating a frenzy as people rush to buy assets and move away from devaluing cash. It's a risky and unstable situation, where things might look good economically on the surface, but this is misleading because it's all built on price increases that cannot be sustained long-term. By making these small, asymetric, calculated bets, I ensured active participation in the evolving financial landscape. These minor deployments were crucial, allowing me to remain agile and ready to capitalize on emerging opportunities, all while keeping the bulk of my capital safe for the moment when significant investment prospects arise.
Here's a detailed breakdown of how I managed my portfolio and strategically deployed some of my cash reserves throughout the year.
Portfolio Segments
Cash As we entered 2023, the portfolio was already strategically positioned 100% in cash. This decision was reinforced by the rising interest rates, offering a solid 4.30% return while keeping my capital safe. As the year progressed, and interest rates climbed further, the returns on my investments improved. My Canadian cash holdings in the RBF2010 Savings Account saw an increase to 4.55%, and the RBF2014 USD Savings account started yielding 4.90%. In a calculated move in October, I transitioned some of my cash into 1-year GICs, locking in a higher return at 5.50% annually. By year's end, my cash position remained intact. Futhermore, 100% of the interest earned throughout the year was strategically used to make the investments outlined in the paragraphs below, ensuring a balance between preserving capital and seizing growth opportunities.
Speculative bets As the interest from my portfolio began to accumulate, I strategically channeled 45% of this cash into modest investments in speculative companies with the potential for high returns. Among these investments are what I term "Trailblazers" – companies leading in significant trends. For instance, I invested in Clear Blue Technologies and Nuran Wireless, both pioneers in the expansive trend of bringing internet and cellular connectivity to rural and remote areas globally. I also acquired warrants in BigBear.Ai, marking my entry into the AI and defense sectors. Additionally, I invested in shares and warrants of Desert Mountain Energy, gaining exposure to the strategic helium and natural gas sectors. My stake in Niocorp Developments secures my position in critical minerals within the USA. In September I acquired warrants in Aris Mining at $0.17 CDN. To round off the year, on December 29th, I purchased SPXU March 2024 call options with a strike price of $10. SPXU is a 3x inverse ETF, meaning its value increases when the S&P 500 declines, and decreases when the S&P 500 rises. Opting for call options instead of direct ETF shares allows me to place a bet using a smaller amount of cash. All these investments are high-risk but represent less than half of the total interest income I earned in one year from my GICs and other cash holdings.
Defensive bets As the year came to a close, I recognized a prime opportunity for a defensive hedge in the midst of escalating geopolitical tensions. Gold, which I view as a crucial safeguard against financial instability, became my primary choice. Using 55% of the interest accumulated from my cash reserves, I purchased shares in Newmont Mining, seizing an attractive entry price of $33.91 USD per share. This price was even lower than during the COVID-19 market crash in 2020. These shares not only offered a favorable entry point but also provided a substantial annual dividend of $1.60 USD per share, yielding an decent 4.70%. On December 14th, to further boost my returns, I sold January 2024 call options on Newmont with a strike price of $43, yielding an additional income of $0.65 per share from my investment in Newmont. My strategy is to maintain my Newmont stake long-term and augment my returns by consistently selling monthly call options.
The portfolio gained4.84% this year.
PORTFOLIO
| CASH | Date added | Annual Yield | |||
|---|---|---|---|---|---|
| 30 Day Cashable GICs | 01/01/2023 | 4.30% | |||
| 1 Year Monthly GICs | 10/23/2023 | 5.40% | |||
| RBF2010 | 01/01/2023 | 4.55% | |||
| RBF2014 (USD) | 01/01/2023 | 4.90% | |||
| TRAILBLAZERS | Ticker | Date added | Initial Price | Current price | Return (%) |
| CLEAR BLUE TECHNOLOGIES | CBLU.V | Sept07/2023 | $0.045 | $0.07 | +56% |
| NIOCORP DEVELOPMENTS | NB.TO | Oct20/2023 | $5.14CDN | $4.22CDN | -18% |
| DESERT MOUNTAIN ENERGY | DME.TO | Nov10/2023 | $0.39CDN | $0.335CDN | -14% |
| DESERT MOUNTAIN ENERGY (MAR/2025 WARRANTS) | DME.WT | Nov10/2023 | $0.025CDN | $0.005CDN | -80% |
| NuRAN WIRELESS | NUR:CSE | Dec01/2023 | $0.14CDN | $0.11CDN | -21% |
| ARIS GOLD (JUL/2025 WARRANTS) | ARIS-WT | Sep20/23 | $0.17CDN | $0.25CDN | +47% |
| BIG BEAR AI (DEC/2026 WARRANTS) | BBAI-WT | Jul25/23 | $0.295USD | $0.3381USD | +15% |
| PROSHARES ULTRAPRO SHORT S&P500 (Call options) | SPXU | Dec29/23 | $0.33USD | $0.33USD | -- |
| -- | |||||
| Defensive Buys | Ticker | Date added | Initial Price | Current Price | Return(%) |
| NEWMONT MINING | NEM:NYSE | Nov08/23 | $33.91 USD | $41.39 USD | +22% |
| -- | |||||
Trendpost Takeaway
The year gone by has been a journey of cautious navigation and strategic positioning. The Trendpost 2023 Portfolio ended the year with a 4.84% gain while the benchmark S&P 500 index concluded the year with a notable 24.2% gain. Similarly, the Dow Jones Industrial Average rose over 13%, and the Nasdaq skyrocketed by 43%, primarily fueled by significant gains in large technology companies. Yet, amidst these market highs, my belief in an impending major market downturn has not wavered. This conviction has guided my decision to maintain a heavily cash-centric portfolio, securing steady returns between 4.3% and 5.5%.
This strategy might seem unorthodox to some, especially in an environment where chasing higher returns is often the norm. But here's the thing: I'm steering my own ship, managing my personal wealth. There's no external pressure to conform to conventional market strategies, no fear of being fired for choosing safety over speculation. My objective remains clear: to be in a strong position to capitalize on the opportunities a bear market could present.
Moving into 2024, I plan to stick to this path. My cash holdings, while secure and steadily accruing interest, also serve as a reservoir for strategic investments. The monthly income generated from these assets is my tool for making selective forays into sectors I believe hold strategic importance. This approach allows me to stay agile, ready to pivot and seize opportunities as they arise in what promises to be another intriguing year in the markets.
My philosophy is not about forecasting the market's next move but about being well-prepared for any turn it takes. The global landscape, as I see it, is increasingly turbulent - marked by escalating chaos, rising tensions, widespread protests, and heightened volatility. This volatile landscape presents a mixed bag of prospects where certain strategic sectors, like commodities, AI, and defense, could emerge as winners, while others, such as hospitality and consumer discretionary industries, may face challenges. As we usher in the new year, my focus will be trained on capitalizing on opportunities in these promising sectors while steering clear of the less favorable ones.
As we wrap up this year, there's another cinematic gem from four decades ago that we should all rewatch: 'The Terminator.' This 1984 sci-fi classic, directed by James Cameron, introduced us to a dystopian future where autonomous AI and robotics have spiraled out of control. The movie paints a grim picture of an AI system, Skynet, which becomes self-aware and decides humanity is its greatest threat. This leads to a world where machines and humans are locked in a relentless battle for survival...
Remember that the content of this newsletter is neither a stock recommendation nor investment advice. This is just something to consider. You can access my watchlist and portfolio through the link below. By clicking the link below you accept all responsibility for any potential losses that might result from buying any of the stocks mentioned in this newsletter.