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Taking flight: Drone M&A lifts off thanks to Ukraine war and China ban

The US drone industry is finally seeing liftoff.

Mergers and acquisitions of North American drone companies rose 9% last year to USD 2.13bn from USD 1.96bn the year before.  

A confluence of three factors is driving the dramatic increase in activity, say dealmakers and executives, even as M&A overall sank in 2022.

First, since the US government took steps in December 2020 to ban Chinese drone giant DJI due to espionage fears, an opportunity for US-made technology has opened up. Until then, DJI had dominated the US hobby and government market, and while its flying cameras are still favored by many state and local agencies, that is also changing. DJI was placed on an official blacklist last October for suspected ties with China’s military.

 “It has created a vacuum for US manufacturers” that is only now being filled, says Jeff Thompson, CEO at Red Cat Holdings [NASDAQ:RCAT], a provider of military and industrial drones.

“So many startups supply a piece of the pie but not the whole solution. It makes the market ripe for consolidation and partnerships.” Red Cat’s military subsidiary Teal Drones has hatched several partnerships, including one with Tomahawk Robotics so warfighters can control up to four drones or land-based rovers simultaneously, but it continues to seek acquisitions too, says Thompson.

The Ukraine factor

A second factor driving deals is Russia’s war with Ukraine. That has underscored just how critical the use of drones has become in modern warfare, mostly to identify targets and their coordinates in preparation for an artillery strike. The US and NATO militaries are placing greater priority on replenishing their fleets, and that increase in spending is translating into M&A, says one sector advisor.

One deal highlighting that came in early January. Highlander Partners
DZYNE Technologies, a Fairfax, Virginia-based company focused on making unmanned aircraft systems for the US Department of Defense and other agencies.

As the US military continues to invest into drone technology, some military-focused companies will become attractive acquisition targets, the sector advisor says.

One that has seen a good amount of growth is drone manufacturer Skydio, according to the advisor. In March 2021, it raised USD 170m in Series D funding at a valuation exceeding USD 1bn. That financing was the first since Washington placed DJI on the Entity List, prohibiting US companies from selling it parts. 

Skydio, along with Red Cat’s Teal, is among a handful of US-based companies whose rucksack-sized drones have been approved for government use by the Department of Defense. Defense giants such as Lockheed Martin [NYSE:LMT], Northrop Grumman [NYSE:NOC], Boeing [NYSE:BA], and AeroVironment [NASDAQ:AVAV] typically wait for smaller drone companies to land DoD contracts before targeting them, says Thompson.

Less venture adventure

A final factor driving dealmaking is that venture capital for drone startups has largely dried up in the last few years, especially after DJI outmuscled domestic rivals in the 2010s on price and performance. The funding spigot has stayed shut for all but a select few startups, as part of a broader pullback in venture investing due to market uncertainty. That pushes many smaller startups to the brink, with some opting to sell. Teal, which sold to Red Cat in July 2021, was one.

The exceptions are the largest drone startups. In addition to Skydio, other American unicorns that have raised capital include counter-drone company Anduril Industries, which raised USD 1.48bn at a USD 8.48bn valuation in December, and pilot software startup Shield AI, which raised Series E funding at a USD 2.3bn valuation last June. They have added capabilities via acquisitions, filling DJI’s void. The US drone industry is fighting back. 

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