Briefly Revisiting Applied Energetics (AERG)
Thoughts about Risk
In my previous analysis of Applied Energetics (AERG), I did not adequately address the speculative nature of the investment. Readers of the initial piece might perceive AERG as a typical early-stage venture, promising substantial upside dependent on the successful commercialization of its unproven technology amidst ongoing cash burn. These types of investments inherently carry significant risks, with the expectation that a few successes will offset numerous failures. Given my lower tolerance for loss, the obvious question arises: How did I come to terms with investing in what appears to be a typical VC candidate?
Risk Analysis and Mitigation Criteria
Risk #1 - Technology Failure
Concern: The primary risk with any innovative technology company is that the technology may not perform as expected.
Mitigation: My confidence is reinforced by my discussions with a potential partner and industry experts who have direct knowledge of AE’s technology. These discussions have provided critical insights that support management's claims about the technology's capabilities and market readiness. Furthermore, AE's decision to build a Battle Lab to test the technology in real-world scenarios strongly indicates their conviction in its efficacy—it would be illogical to invest in such testing if the technology were not nearing operational readiness.
Risk #2 - Emerging Competition in USPL within Defense
Concern: The defense sector might see new entrants aiming to capitalize on the strategic importance of Ultra-Short Pulse Laser (USPL) technologies.
Mitigation: AE's market position is protected by formidable barriers such as the need for specialized sector knowledge, security clearances, and established DOD relationships. AE’s existing contracts and ongoing dialogue with the DOD not only validate the technology but also strengthen its competitive advantage, deterring potential new entrants in the foreseeable future.
Risk #3 - Financial Distress
Concern: There is a significant risk associated with the delay in securing expected contracts, which could lead to financial distress.
Mitigation: While I have advised proactive fundraising, management’s decision to delay reflects their informed strategic patience based on anticipated contract finalizations. They possess detailed insights about the likelihood of these contracts that I am not privy to. If I had the same information, perhaps I would share their level of confidence. This strategic decision is supported by a committed long-standing investor base ready to provide additional support.
Risk #4 - Dependency on DOD Funding
Concern: Any reduction in DOD funding could severely impact AE, given its reliance on defense contracts.
Mitigation: The escalating threat from drones and the widespread need for advanced battlefield sensors suggest a continuing, if not increasing, demand for defense spending in these areas. While budget cuts are a risk to any defense technology company, the essential nature of AE’s offerings is likely to safeguard it against significant funding reductions.
Conclusion
The potential rewards from AE's pioneering technology and strategic positioning make a compelling case for the calculated risks involved. This investment, though speculative, is backed by rigorous analysis and strategic foresight. It carries a speculative label, but the risk-reward balance is considerably more favorable than typical VC investments, making this a compelling risk-adjusted opportunity.