Kraken Robotics: A Hypergrowth Small-Cap Stock For The Defense Spending Supercycle

Episode Overview

• This episode analyzes Kraken Robotics, a small-cap defense company, in the context of a new under-sea arms race and a global "supercycle" in defense spending.
• The hosts evaluate Kraken's business model and competitive moat, concluding its strength lies in high switching costs from long-term defense contracts rather than superior proprietary technology.
• The discussion highlights the company's impressive 50% gross margins as a key operational strength despite facing product parity with competitors.
• A significant portion of the analysis focuses on the company's future growth prospects, particularly in the subsea battery market for uncrewed underwater vehicles (UUVs).

Key Concepts

• Under-sea Arms Race: The podcast is framed by the rising geopolitical tension between China and the U.S. and its allies, which is fueling technological competition and spending in submarine and under-sea warfare.
• Defense Spending Supercycle: A primary theme is the secular trend of increased global defense spending, especially for modernizing military technology, which acts as a major tailwind for companies like Kraken Robotics.
• Strategic Importance of the Sub-sea Domain: The discussion emphasizes that control of under-sea environments is critical for global powers like the U.S. to project military power and maintain strategic advantage.
• Competitive Moat Analysis: Kraken's competitive advantage is identified not as a patent or intellectual property moat, but as the high switching costs created by being deeply embedded in long-term government and defense contracts.
• "Good, Not Great" Business Model: The company is characterized as having a solid business with high (50%) gross margins and operational efficiency, but it lacks the clear technological superiority that would define a "great" business.
• Subsea Battery Growth Opportunity: The subsea battery segment is presented as Kraken's most significant growth driver, positioned to benefit from the increasing global investment in uncrewed underwater vehicles (UUVs), particularly through a partnership with Anduril.

Quotes

• At 0:33 - "China is on the verge of becoming a world-class submarine power with new technology and a bigger, better fleet that is gaining on the U.S. and its allies, spurring a new undersea arms race in the Pacific." - Ryan Henderson reads a quote from a Wall Street Journal article to set the theme for the episode.
• At 1:13 - "Brett is going to be talking about a hyper-growth, small-cap defense stock... that is up 10x in the last three years." - Ryan Henderson introduces the company to be discussed, highlighting its impressive recent performance.
• At 2:15 - "Defense spending, for various reasons... has increased from, you know, just absolute spending and the urgency of importance of modernizing defense for the United States, Europe, its allies..." - Brett Schafer explains the macro tailwind driving the industry and Kraken Robotics' opportunity.
• At 2:56 - "The United States is somewhat of a global empire, but they do not actually control physical land. They really monitor and control, you know, the sea, underwater, aerospace, and outer space as a way to get people to get on their side..." - Brett Schafer provides context on why sub-sea capabilities are so strategically vital for the U.S. military.
• At 26:18 - "I would define this as a good business, not a great business." - The speaker explains that while the company's product is difficult to replicate, it lacks a true patent or IP moat that would elevate it to a "great" business.
• At 26:41 - "The fact that they are able to still maintain 50% gross margins at a lower cost is promising." - Despite product parity, the speaker finds the company's strong gross margins to be a positive indicator of its operational efficiency.
• At 27:51 - "The fact that you can get embedded within these contracts... that can get you locked in and that... can build that competitive advantage over the long term." - The speaker identifies the true moat as the high switching costs created by becoming an integral, long-term supplier within major defense programs.
• At 28:13 - "Maybe subsea batteries are closest of all their products to the ASML, quote unquote, technological hurdle moat." - The speaker humorously suggests that the company's subsea battery technology is its most defensible and technologically advanced product line.
• At 29:51 - "You know that the U.S. Navy is going to want 250. That's just the way it goes." - The speaker explains the follow-the-leader nature of military procurement, where a large order from an allied nation often leads to an even larger order from the U.S.
• At 31:34 - "The moat comes from... they get locked into contracts with defense programs... Contractors and militaries are not going to switch to another battery product on an existing contract if one was ever invented." - The speaker reiterates that the company's competitive advantage lies in the stickiness of its customer relationships within the defense sector, not just its technology.

Takeaways

• Invest in the "picks and shovels" of major defense trends, such as the component suppliers for uncrewed vehicles, to capture growth in the sector.
• When analyzing defense contractors, prioritize companies with high switching costs and deep integration into long-term government programs, as this often serves as a more durable moat than technology alone.
• A company can be a strong investment without a dominant technological advantage if it operates efficiently with high margins in a niche with strong secular tailwinds.
• The current geopolitical climate is creating a durable, long-term investment theme in the sub-sea and underwater defense industries.
• Pay attention to military procurement patterns, as a significant order from one U.S. ally can often signal future, larger orders from the U.S. and others.
• A company's ability to secure partnerships with emerging, high-growth defense tech firms (like Anduril) can serve as a powerful validation of its technology and a catalyst for future revenue.