Why Redwire Stock Looks Red Hot Today, and RTX and AeroVironment Are Rising

A funny thing happened on the way to today's stock market rally. Amidst all the enthusiasm over President Trump's inaugural address and the prospects it raises for stock market growth, one tiny space stock in particular blasted higher than just about any other stock on the market: Redwire (NYSE: RDW).

Redwire's announcement today that it will purchase artificial intelligence (AI) company and drone-tech specialist Edge Autonomy sent the former's stock flying. As the trading day winds down, Redwire shares are up an astounding 44.5% as of 3:25 p.m. ET.

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Redwire's good news is having an effect on rivals in the defense industry that it's now entering, too. RTX Corporation (NYSE: RTX), for example, a defense industry giant that makes, among other things, the Coyote unmanned aerial vehicle (UAV), is up a modest 3.4%. AeroVironment (NASDAQ: AVAV), a pure play on drones technology, is up 4.5%.

What is Edge Autonomy and why is Redwire buying it?

Long-time readers of this column may recall that Redwire is one of my favorite stocks to invest in. Albeit historically, I've been most interested in the stock as a space company, not a defense company.

That changed today with Redwire's decision to spend $925 million, paid in cash and stock, to acquire Edge Autonomy and break into the defense industry. Upon closing the transaction, Redwire intends to pay Edge's existing shareholders $775 million worth of Redwire shares, plus $150 million cash, to obtain full ownership of the company.

(Note: Redwire only had about $43 million in cash at last report and $138 million in debt. It will need to borrow money and increase its debt load even more if it is to conclude this acquisition.)

So why would Redwire want to do this? "The acquisition is expected to transform Redwire into a global leader in multi-domain autonomous technology, broadening its portfolio of mission-critical space platforms to include combat-proven autonomous airborne platforms," which is to say drones, says the company. On the one hand, autonomy technology will almost certainly be useful for the company's operations as a provider of space infrastructure both in Earth orbit and, over the long term, outside it. At the same time, acquiring Edge provides a more immediate entry point into the lucrative defense market here on Earth.

What will Redwire get for its money (and stock)?

How "lucrative" are we talking, exactly? Redwire estimates that bringing Edge Autonomy in-house will immediately grow both its revenues and its free cash flow. Redwire thinks the two companies combined could generate $535 million to $605 million in sales this year, potentially doubling the $298 million in revenue that Redwire itself produced over the last 12 months.

At the same time, Redwire (which burned $14.9 million in negative free cash flow over the last year) believes that adding Edge to its business will turn the combined company free-cash-flow positive this year.

Redwire did not say precisely how much free cash flow (FCF) it expects to generate, however. Furthermore, it's worth pointing out that analysts polled by S&P Global Market Intelligence were predicting Redwire would become FCF positive this year even before Redwire announced the acquisition of Edge.

Image source: Getty Images.

Is this a good deal for Redwire?

Paying $925 million for a company that might add anywhere from $235 million to $300 million to Redwire's annual revenue stream implies Redwire is paying a price-to-sales (P/S) ratio of somewhere between 3.1 times and 3.9 times to acquire Edge. Compared to Redwire's own 3.2 times sales valuation, this implies Redwire is paying at most a small premium to acquire a business that could potentially double its size, double its scale of production, and push it closer to profitability.

I consider this a good deal but not necessarily a great deal -- and probably not a deal good or great enough to justify the 44.5% run-up in Redwire's share price today. Suffice it to say, I will not be buying into this rally and would more likely sell than buy if I owned it.

And what about RTX and AeroVironment?

As for the two other defense stocks moving on today's news, I consider Redwire's interest in Edge a modest positive for AeroVironment. But at a P/S ratio of 6.2 times, I wouldn't buy that one, either.

And RTX? At 2.1 times sales today, RTX is arguably the cheapest of the three defense stocks moving on Redwire's news. RTX isn't a huge force in drones, however, and certainly not a pure play, which probably explains the relatively small size of its stock price move.

As for what I think about RTX and other large defense stocks more generally, well, you can read all about that here.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends AeroVironment. The Motley Fool recommends RTX. The Motley Fool has a disclosure policy.