DroneShield shares have halved in two weeks – Where to from here?

DroneShield (ASX: DRO) is a stock that can do both – creating millionaires after a meteoric 600% run in just seven months, then leaving investors reeling as it almost halved in the past two weeks.

Wednesday's trading halt only added to shareholder woes. And it wasn't halted to announce a major contract deal. It was for yet another capital raise.

DroneShield was seeking to raise $120 million at $1.15 a piece, representing a 17.2% discount to its last close.

What doesn't make sense is that the company had $146 million cash at the end of June and raised $100 million just three months ago.

Capital Raise Highlights

• Bell Potter, Shaw and Partners, and Macquarie are acting as joint managers on the placement to sophisticated and professional investors. It's worth noting that Bell Potter and Shaw have been very active with their ratings and target prices for DRO.

• DroneShield says $90 million will be used for R&D, $20 million for strategic bolt-on acquisitions and $10 million for working capital.

• R&D investment includes the development of next-generation counter-drone systems and the acceleration towards a software-as-service revenue model.

• The stock resumed trading on Thursday, down around 14% to $1.20

The Tumble

DroneShield shares started to unravel on 16 June, when the stock finished the session down 22.3%. The sell-off coincided with an article from Capital Brief, titled "Short sellers circle DroneShield as it nears 'wild' $2b market cap."

The article's key insight came from Rodney Forrest, Director of Sublime Funds Management, who stated: "Its valuation is wild ... Cumulative losses sit at around $40 million. There's been a three times increase in the share count, no change in the profit pool and the insiders sold stock at 70 cents."

Forrest also disclosed his "small short position against DroneShield."

About a week later, DroneShield held its 2Q24 results call, when management addressed the sell-off, attributing it to the article and dismissing it by claiming "there was no real substance in that report."

Objectively speaking, I agree with DroneShield management. The article merely quoted a fund manager and lacked the depth of short reports we've seen on stocks like Wisetech Global and Nearmap in previous years.

However, there are some substantive points to consider:

• DroneShield's meteoric rise occurred mostly between 23 May and 16 July, with the stock rallying around 200% from $1.21 to $2.71.

• During this period, the company announced just one market-sensitive announcement: A $4.7 million contract with a "high-profile Government agency."

• The company's 2Q24 earnings update noted the doubling of its sales pipeline to $1.1 billion (as of 15 July 2024) from $519 million in the previous quarter.

But a closer look reveals a lot of work to be done in translating leads into sales:

• The order book increased by $1 million quarter-on-quarter, from $27m to $28m.

• Purchase orders processing on the customer end fell 15% quarter-on-quarter, from $39m to $33m

Pipeline as at 31 March 2024 (Source: DroneShield)

Pipeline as at 15 July 2024 (Source: DroneShield)

But to be fair, DroneShield is in its early days and its leads have grown substantially in just three months.

Where Are We Now

DroneShield has emerged as one of the year's hottest stocks, seemingly in the right place at the right time. The company description states:

"DroneShield provides Artificial Intelligence based platforms for protection against advanced threats such as drones and autonomous systems. We offer customers bespoke counter-drone (or counter-UAS) and electronic warfare solutions and off-the-shelf products designed to suit a variety of terrestrial, maritime or airborne platforms."

This combination – AI and warfare solutions, coupled with lucrative US government and NATO contracts – has created a perfect recipe for a multi-bagger stock, especially against the backdrop of ongoing conflicts in Ukraine and the Middle East.

From a technical perspective, it became a "20-day moving average hugger," displaying a strong short-term trend with shallow, short-lived pullbacks.

But as the saying goes, the "trend is your friend" ... until it isn't.

The recent unwinding has likely left many new holders with sizeable losses. This creates a lot of excess supply – in other words, if the share price begins to tick higher, these holders might seek to get out at breakeven.

DroneShield price chart with 20-day moving average (red line) and 50-day moving average (green line) | (Source: TradingView)

When everyone is rushing to get on board the next big thing, valuation often takes a backseat. Remember Zip's (ASX: ZIP) meteoric rise during the buy-now-pay-later craze of 2021?

Its valuation peaked at $6.5 billion (Feb-21). In the same month, the company reported half-year revenues of $155.5 million. This is comparable to DroneShield's recent peak market cap of $2 billion and $24.1 million in half-year FY24 revenue.

Zip is still down around 85% from all-time highs but the stock has managed to rally more than 200% year-to-date amid a shift towards profitability.

Similarly, Brainchip (ASX: BRN) managed to tag a $3 billion market cap in early 2022. It's now down around 90% from all-time highs, with its latest quarterly report showing just $48,000 in customer receipts.

DroneShield is arguably in far better shape than both these companies. However, its recent sell-off has drawn criticism, left many shareholders underwater and set high expectations for future performance.