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We are short AeroVironment (NASDAQ: AVAV) because the CEO, Wahid Nawabi, has orchestrated a cover-up of illegal activity and dangerous conduct, according to allegations in an undisclosed new whistleblower suit. The suit was filed by AVAV’s former chief of top-secret government programs, Mark Anderson, who had worked at the company for a decade. Some of the allegations in the suit include:
- AVAV staffers allegedly transported live bombs on a commercial Delta Airlines flight in 2015. According to Anderson’s suit, this risked “the lives of approximately 230 passengers and innumerable civilians”.
- Nawabi pressured employees to mislead the government about ongoing security violations and mishandling of top-secret information, according to the suit. Anderson says company lawyers “made an effort to threaten him” and that he was fired in retaliation for his whistleblowing activities.
- Nawabi purged those who “would not ‘play ball’ by participating in a cover-up” and forced out most of AVAV’s compliance leadership, according to the suit. Our research shows that at least 56 senior employees and executives have left the company since the inception of the alleged cover-up.
- Nawabi touted AVAV’s purportedly robust safety systems and processes to investors the exact same month that Anderson alleges the company initiated an undisclosed internal investigation into security failures. While investors have been kept in the dark, the Chairman has dumped over $17 million worth of stock.
AVAV shares currently trade at over 3.3x EV/Sales and 21x EV/EBITDA, a lofty valuation that anticipates significant future sales growth. But it is our opinion that Anderson’s whistleblower allegations introduce material risks to the company’s growth story that simply are not discounted at current prices. We therefore see substantial downside potential.
AeroVironment is a defense contractor that sells small weaponized drones to the military. The stock has been promoted to growth investors as a thematic “pure play” on the secular trend towards unmanned aircraft. But history demonstrates that whistleblowers are often the first to alert investors and regulators to fraud or graft lurking beneath the surface of growth companies (Insys Pharmaceuticals and MiMedx are two of the latest examples). A whistleblower, Mark Anderson, has now emerged at AeroVironment to allege that CEO Wahid Nawabi has led a cover up of extensive illegal activity in a newly filed lawsuit (available here). Anderson worked at AeroVironment for a decade and managed security for all the company’s top-secret government programs. He says he was threatened and then fired last year in retaliation for joining his superior in reporting the company’s misconduct to the government.
The whistleblower suit depicts a corporation with a corrupt culture that regularly violated the law. For example, AeroVironment staffers allegedly transported at least one drone with live bombs on a commercial Delta Airlines flight from Utah to California in April 2015, “risking the lives of approximately 230 passengers and innumerable civilians”.
Source: Case No. BC 702904 Superior Court of California, County of Los Angeles. Note: You should assume that the company denies all allegations discussed in the complaint.
According to the whistleblower, AVAV was able to conceal this incident from the government until he told the United States Defense Security Services and the FBI roughly seven months afterwards in a November 2015 meeting. When authorities subsequently demanded more information, the whistleblower states that the company submitted a false report that “massaged key facts” and attempted to downplay the incident. Anderson says that he and his superior jointly engaged in whistleblowing to report additional illegal activity to the government and “refused to participate in or turn a blind eye to ongoing violations of state and federal law relating to security and information handling”. These other alleged violations include mishandling of classified and top-secret information and other unspecified security issues.
Anderson states that he was repeatedly called into meetings with Wahid Nawabi, who made “statements to indicate that Anderson should stop reporting potential security violations to government staff and should stop preventing AeroVironment staff and senior management from commingling Secret and Top-Secret information in violation of federal law”. Anderson states that AeroVironment attorneys also made “an effort to threaten him and dissuade his ongoing reporting and enforcement of security protocols“.
In August 2016 AVAV apparently initiated an undisclosed internal investigation that resulted in a purge of senior compliance executives. The whistleblower states that Nawabi’s true “motivation was to rid the company of anyone who would not ‘play ball’ by participating in a cover up”. The terminated compliance executives were offered generous severance in exchange for non-disclosure agreements as “part of an effort to conceal and avoid the consequences” of the company’s illegal activities, according to the complaint. Anderson says that he continued to engage in whistleblowing but was removed from every top-secret program he had previously run and ultimately fired last year in retaliation.
We discovered that at least 56 senior employees and executives have left AVAV since the inception of the alleged cover-up, a significant amount of turnover considering the company reports having only 661 employees in total. Multiple senior employees have left each of the company’s key departments and include the former CFO, Accounting Director, Internal Audit Manager, Director of Product Safety, Chief Legal Officer, and numerous Program Managers, Engineering Managers, and Sales Directors. The extensive managerial turnover at AVAV, in our view, adds credibility to the whistleblower’s assertion of an internal purge and calls into question the culture established by Wahid Nawabi.
Source: Internal analysis of Linkedin profiles.
These whistleblower allegations, if proven, may directly threaten AVAV’s growth story. Management promotes itself as having the opportunity to grow its government sales exponentially over the coming years to over $1 Billion from just $155 million today (sales to the US government account for 55% of the company’s total revenues). But if Nawabi has covered up extensive illegal activity it seems self-evident that AVAV’s relationship with government agencies could be disrupted. The political dynamics alone of the government contracting with a company that allegedly attempted to conceal putting the American public at risk by transporting live bombs on a Delta flight are extremely problematic, in our view. Especially since AVAV also allegedly mishandled top-secret information, a violation that we understand would be treated very seriously by authorities. AVAV is also facing increasingly fierce competition from companies that would likely be eager to seize on any missteps to displace AVAV. The company’s own SEC filings specifically warn that:
“If an audit or investigation of our business were to uncover improper or illegal activities, then we could be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, suspension of payments, fines and suspension or debarment from doing business with the U.S. government”.
The alleged incidents create risks that are clearly material and the company’s failure to disclose them is a serious issue, in our opinion. Incredibly, Nawabi even touted the purported “sophisticated differentiations that we offer with our defense business, safety management systems, processes, an all that” to investors at the August 2016 Jeffries Conference (transcript here). This statement strikes us as highly misleading because it was made the exact same month that the company allegedly initiated an internal investigation into incidents caused by the failures of these systems and processes. At minimum, if AVAV found its problems severe enough to investigate and then terminate leaders of its compliance team, why weren’t investors informed? With such limited information, it’s difficult for us to gauge the precise impact of these allegations and also impossible for us to know what interaction the company has had with government agencies or investigators. This is precisely why the company should immediately offer complete transparency to investors.
We find it troubling that AVAV’s Chairman, Timothy Conver, has dumped over $17 million worth of stock held by himself and his family trust since the inception of the alleged cover-up (list of trades here). The fundamental problem is that Conver has sold his shares to investors who likely are completely unaware of the risks that appear to have been concealed from them. We note that Conver retired as AVAV’s CEO in May 2016 to become Chairman, just five months after the whistleblower allegedly told the government about the Delta incident and several months prior to the beginning of the alleged internal investigation. Conver was succeeded by Wahid Nawabi, who was previously the company’s COO.
Source: Bloomberg, each red tag represents a specific stock sale.
It’s hard to for us to give AVAV the benefit of the doubt because the company displays a variety of other red flags:
- AVAV was subject to a Department of Justice investigation into government billing practices that it settled in 2013.
- In 2014, a former executive turned whistleblower filed a Qui Tam suit against AVAV (here) alleging the existence of a fraudulent government billing scheme (the suit was dropped without explanation in 2016).
- The company’s most recent 10-K states that AVAV has voluntarily disclosed export violations to the U.S. Department of State and warns of potential “significant fines, penalties, and sanctions”.
- Last November, short-selling research firm Spruce Point released a detailed report (here) that highlighted issues including the company’s lackluster financial performance, poor capital allocation record, bad disclosure practices, and threats from increased competition.
- An activist investor, Engaged Capital, sent a series of letters taking issue with bad governance practices that “eschew the interests of shareholders in favor of the Board’s misguided self-interests” (here, here, here).
We believe the equity is significantly riskier than promoted. It is our opinion that Anderson’s new whistleblower allegations introduce material risks to the company’s growth story that simply are not discounted at current prices. We therefore see substantial downside potential in AVAV shares.