Aerial Ascension

Welcome Shareholders,

Every Sunday, We'll highlight one company to do an in-depth breakdown of their business, financial situation, and whether or not it's a worthy investment opportunity - large or small. In today's edition, we'll look at how a startup became the most valuable drone maker in the United States.

Last month, US drone maker Skydio made headlines when it announced a massive $230 million Series E funding round, effectively doubling its previous valuation to an impressive $2.2 billion. This fundraising success comes on the heels of the company's staggering 30x growth over the last three years, solidifying its position as the largest drone manufacturer in the United States. With its drones now employed by every branch of the United States Department of Defense, over half of all US State Departments of Transportation, and more than 200 public safety agencies across 47 states, Skydio has undoubtedly made a significant impact in a short span of time.

In a world where drones are no longer just flying selfie cameras, the demand for advanced, reliable, and versatile unmanned aerial systems has grown exponentially. As geopolitical tensions rise, drone manufacturers are witnessing increased interest and investment in their technology, particularly in defense and public safety applications.

But how did Skydio, a relatively unknown company founded less than a decade ago, rise to prominence and become the most valuable US drone maker?

Today We'll explore Skydio's rise to prominence, examining the key factors that have contributed to its success and how it has managed to challenge the dominance of established drone manufacturers like DJI. From navigating a rapidly changing regulatory landscape to seizing unique opportunities presented by geopolitical dynamics, here's the story of how Skydio became the drone maker to beat in the United States.

The Story Behind Skydio

In the hallowed halls of the Massachusetts Institute of Technology (MIT), two friends embarked on a venture that would change the landscape of the drone industry forever. Adam Bry and Abe Bachrach were united by their passion for robotics and a shared vision for the future of autonomous aircraft.

As students, Bry and Bachrach were part of MIT's robust robotics program, where they focused on developing aircraft that could fly without relying on GPS. Their research led to the creation of a fixed-wing drone equipped with a laser range finder, which could autonomously navigate its way around a parking lot. In 2012, the duo helped develop advanced autonomous-control algorithms capable of calculating a plane's trajectory, determining its "state," and accounting for factors like location, physical orientation, velocity, and acceleration.

With graduation behind them, Bry and Bachrach joined Google's ambitious Project Wing in 2012, contributing their expertise to the development of autonomous drones. But their desire for independence and the urge to make a greater impact in the drone industry nudged the duo, along with fellow MIT graduate Donahoe to forge their own path.

In 2014, the trio founded Skydio, envisioning a world where drones would revolutionize industries and applications across the board and securing an early investment from Andreessen Horowitz.

Product Evolution

Skydio's foray into the drone market began in 2018 with the introduction of the R1. As their first consumer product, the R1 showcased Skydio's commitment to autonomous drones but was limited by its high price, retailing at $2,499, and bulky form factor.

A year later, the company launched the Skydio 2, addressing some of the R1's limitations. This new drone was not only more affordable, starting at a retail price of $999, but was also smaller and more versatile, coming in at 10.7 by 8.7 by 3 inches. Boasting onboard software powered by Nvidia processors, the drone utilized six 4K navigation cameras—three on top and three underneath—to build a 3D model of its surroundings and prevent crashes. The Skydio 2 also had an increased top speed of 36 mph, up from the R1's 25 mph. The technological upgrades in the Skydio 2 enabled it to boast improved autonomy and obstacle avoidance, as well as the ability to follow people and cars. In essence, the more affordable pricing, and improved form factor, coupled with the technological upgrades, made the Skydio 2 a more accessible and appealing option for a wider range of consumers.

Building on top of its success, Skydio unveiled the Skydio 2 Plus in 2022. Priced at $1,099 and up, the Skydio 2 Plus offered a more robust and longer-range connection due to a high-power 5GHz Wi-Fi radio and pop-up antennas. The drone's range increased to 3 kilometers when using the optional Skydio 2 Plus Beacon controller, doubling the range of the original Skydio 2. Additionally, the Skydio 2 Plus boasted a nearly 20% increase in battery life, thanks to a higher-density battery pack with a stronger magnet. This allowed for a maximum flight time of 27 minutes, up from 24 minutes with the Skydio 2.

Throughout the years, Skydio's product lineup has demonstrated a clear evolution in terms of autonomy, portability, and accessibility. Each new release has built upon the foundation laid by its predecessors, solidifying Skydio's position in the industry.

David vs. Goliath

Despite Skydio's innovation with each new generation of its drone, the company has largely lagged behind market leader DJI, which continues to dominate the drone market.

Hong Kong-based drone manufacturer DJI has long been the leading force in the consumer drone industry. With a market share of approximately 75%, DJI's resources and scale have largely kept competitors at bay. The industry is forecasted to grow into a $43 billion market by 2025, and DJI's consistent innovation and strategic moves have made it the drone maker to beat to claim supremacy.

DJI has long been described as the Apple of the drone world due to its sleek design, user-friendly products, and popularity among both recreational and commercial users. The company's value is estimated at $10 billion, and its sales have tripled or quadrupled every year since 2009. In recent years, DJI has released a plethora of new and innovative drones, such as the DJI Mavic 3 Classic, DJI Mini 3 Pro, DJI Mini 3, and DJI Avata. This prolific output highlights the vast gap between DJI and other players in the market, including Skydio. While DJI consistently churns out high-quality products, many companies struggle to release just one.

DJI's technological edge and manufacturing scale have largely enabled it to edge out and, in most cases, put to rest the hundreds of aspiring drone makers looking to take a slice of its market share.

Grow Fast or Die Trying

Many US challengers have attempted to break into the drone market, only to face insurmountable difficulties. Numerous drone manufacturers have emerged and subsequently vanished, despite raising hundreds of millions of dollars in their quest to secure a share of the lucrative drone market. Two notable examples are drone operating system startup Airware and Lily Robotics.

Airware abruptly informed employees that it would cease operations, despite having raised $118 million from top investors like Andreessen Horowitz, Google's GV, and Kleiner Perkins. The startup ran out of money after attempting to manufacture its own hardware, which was unable to compete with giants like China's DJI. At its peak, the company employed around 140 people, all of whom were suddenly out of work.

Another cautionary tale is that of Lily Robotics, founded in 2013 by two University of California, Berkeley students. The company developed a camera drone and made it available for preorder in 2015. Expecting 5,000 preorders, they were instead overwhelmed with 61,450 due to massive interest. The pressure mounted as Lily struggled to iron out the kinks in its prototype camera, resulting in multiple delays and unfulfilled promises to customers. Layoffs followed, with the company's workforce dwindling from 69 employees in June 2016 to 41 in August of that year. Around that time, Lily's management realized the company might run out of money before launching the cameras. Unfortunately, the fundraising market had dried up, and they were unable to raise the necessary cash from investors.

These examples underscore the immense challenges faced by drone manufacturers attempting to enter the market and compete with dominant players like DJI. So, how can Skydio hope to challenge DJI when so many others have failed?

Skydio's focus on autonomy and its cutting-edge technology has the potential to distinguish it from competitors. The company's focus on R&D, as evidenced by its product line evolution, is the key to carving out a niche in the market. Furthermore, the company has also learned from the missteps of others in the industry and has gradually scaled its production, preventing any manufacturing hiccups and delays.

Adversity and Opportunity

For over a decade, DJI dominated both the commercial and consumer markets, largely due to its scale and popularity, making it almost impossible for anyone else to take market share. However, things turned on their head in 2017, as a trade war with China led to the downfall of DJI in the US commercial market and the subsequent rise of Skydio.

Under the Trump administration in 2017, the United States government began raising concerns over the possibility of "cyber vulnerabilities" with DJI drones. At the time, numerous military units were using popular DJI platforms, such as the Phantom series. These security concerns led the US Navy to release a memo on May 24, 2017, titled "Operation Risks With Regards to DJI Family of Products." By August, the US Army cited the memo when it banned DJI drone use, and by May 2018, the ban was enforced across all US military branches.

Military experts were concerned about the security of data collected by DJI drones, which could be easily hacked to steal both location and visual information from users, potentially exposing military strategies. It was also possible for hackers to take control of drones during flights, increasing the risk of compromised operations.

In December 2020, the United States Department of Commerce placed DJI on its Entity List, citing its role in "enabling wide-scale human rights abuses within China through abusive genetic collection and analysis or high-technology surveillance." As a result, businesses seeking to conduct certain types of transactions with DJI, such as exporting or re-exporting products, had to now obtain a license to do so.

The situation worsened for DJI when the US government placed the company on an investment blocklist on December 21, 2021. This move prohibited Americans and American entities from buying or selling DJI shares, ensuring that American technology would not contribute to building the military of an increasingly belligerent adversary. Former Commerce Secretary Wilbur Ross stated that these restrictions were necessary measures to prevent China from leveraging advanced US tech to support its military activities.

This series of events had a significant impact on DJI's market share. According to research firm DroneAnalyst, DJI's commercial market share dropped from 69% in 2020 to 54% in 2021. While DJI still held the majority, this drastic 15-point drop signaled potential challenges for the company's future.

The ban on DJI products created a unique opportunity for Skydio, especially in the commercial segment where DJI had previously served government customers. As a result, Skydio was able to capitalize on the situation, positioning itself as a strong contender in the drone market and filling the void left by DJI.

A Whole New Market to Conquer

The regulatory challenges faced by DJI, particularly its ban from the US government and military, opened up a significant opportunity for Skydio to step in and fill the gap. As DJI's market share in the commercial segment dropped, it created a window for Skydio to capitalize on the situation and serve government customers that DJI could no longer cater to.

In 2019, Skydio opened its Department of Defense (DoD) vertical, armed with five years of experience and a proven product in the consumer market. This stability allowed Skydio to navigate the notoriously long sales cycles and restrictive milestone requirements of the DoD.

As Skydio worked with the Defense Innovation Unit (DIU) and the US Army to compete for the small Unmanned Aircraft System (sUAS) contract, they developed the X2, a drone designed for enterprise, public safety, and defense. The development of the X2 was informed by improvements made to Skydio's original drone. The DoD's requirements aligned with potential enterprise customers, allowing Skydio to develop the X2E (enterprise) version alongside the X2D (defense) version. Skydio's success in the consumer market and ability to scale manufacturing capacity bolstered their credibility as they were selected for a $100 million contract.

The U.S. Marine Corps closely monitored the DIU solicitation. After the DIU solicitation and an additional evaluation with the U.S. Marine Corps at 29 Palms, Skydio received its first order for X2D drones.

Skydio's momentum continued with a $100 million production Other Transaction Authority (OTA) contract from the US Army as part of the Short Range Reconnaissance program of record. Out of 30 competitors, Skydio emerged as the winner. This high-value contract translates to recurring revenue for the next five years ($20.2 million annually).

Fast forward to 2023, and the company's drones are now used in every branch of the US Department of Defense, by over half of all US State Departments of Transportation, and by more than 200 public safety agencies in 47 states. Skydio's new round gives the company a $2.2 billion valuation, making it the biggest drone manufacturer in the US.

As geopolitical tensions between the US and China continue to escalate, the US military is increasingly seeking homegrown companies for manufacturing critical technologies. Skydio, with its innovative drone solutions and domestic roots, stands to benefit significantly in the coming years as the demand for secure, reliable, and locally produced drones grows.

Bottom Line

Skydio's rise as a contender in the drone market can be attributed to a confluence of factors: innovation in autonomous drone technology, regulatory changes that have hindered DJI's dominance, and the company's strategic positioning in both the consumer and defense sectors. As the drone market continues to grow, Skydio is well-placed to capture a significant market share and challenge the status quo.

One of Skydio's key strengths lies in its autonomous drone technology, which differentiates it from other competitors. By leveraging advancements in AI and computer vision, the company has developed drones capable of navigating complex environments with ease. This has resonated with both consumers and enterprise users, who appreciate the convenience and enhanced capabilities that Skydio drones offer. Additionally, regulatory pressures on DJI have created a unique opportunity for Skydio to gain market share. The US government's growing concerns over data security have led to restrictions on DJI's products, allowing Skydio to step in and fill the void. The company has been able to capitalize on these shifts and position itself as a trusted alternative for commercial and government customers.

Skydio's ability to navigate the complex landscape of selling to the Department of Defense has also played a significant role in its success. By leveraging their experience in the consumer market and patiently working through the DoD's rigorous requirements, Skydio has secured substantial contracts that not only provide revenue but also boost the company's credibility in the eyes of investors and potential customers. The company's focus on both consumer and defense markets has allowed it to develop a diverse product portfolio catering to various user needs. By working closely with the Department of Defense and the US Marine Corps, Skydio has fine-tuned its drone offerings to meet stringent military requirements. At the same time, the company has continued to invest in consumer-friendly drones, ensuring that it remains relevant in the broader market.

As geopolitical tensions between the US and China persist, the demand for homegrown technology is only expected to grow. Skydio is poised to benefit significantly in the coming years as the US military and government agencies look to support domestic companies capable of providing advanced drone technology. The company's success in securing military contracts and developing cutting-edge products is a testament to its potential in this highly competitive market.