Could Ukraine's Homegrown Drones Industry Put American Defense Contractors Out of Business?

Key Points

• Secretary of Defense Pete Hegseth wants to equip all U.S. Army units with cheap, first-person view (FPV) military drones.

• Ukraine has become a leader in the production of cheap, FPV drones.

• Now, a "mega deal" could be in the works, worth up to $30 billion for Ukraine to sell drones to America in exchange for missiles.

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On July 10, Secretary of Defense Pete Hegseth announced a sea change in U.S. defense policy. More than a decade ago, America pioneered the wide-scale use of military drones, flying Predator drones first on surveillance, then strike missions in Iraq and Afghanistan. In the decades since, U.S. dominance of this groundbreaking defense technology eroded, to the extent that "global military drone production skyrocketed over the last three years," while the U.S. all but stood still.

Now, said the SecDef, it's finally time to "support our industrial base, reform acquisition, and field new technology" to equip the U.S. military "with the lethal small drones the modern battlefield requires."

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All of which sound like fine ideas. But over the past few days, a new question has emerged: Will our defense base actually get to build these drones -- or might they end up getting built by someone other than American defense contractors?

Image source: Getty Images.

Uncle Sam is looking for a few good drones

As a first step to upping America's drone game, Hegseth directed that the Pentagon open a competition to buy 10,000 Purpose-Built, Attritable Systems (also known as kamikaze, one-way attack, first-person view, or FPV drones) for under $2,000 apiece, and to get the purchase done within 12 months.

One week later, the Pentagon hosted a demonstration of 18 American-made drone prototypes that might fit the bill. (Or might not. Most American drones manufactured by AeroVironment (NASDAQ: AVAV) and Kratos Defense and Technology (NASDAQ: KTOS), or even Palantir (NASDAQ: PLTR) or still-private defense contractor Anduril, after all, are reported to cost "tens of thousands of dollars" each.)

This might complicate Pentagon plans. On the one hand, the Defense Department wants to support American defense contractors. But on the other hand, it wants to buy drones cheap. So what's the solution?

While American companies figure out a way to build the number of drones the Pentagon needs, for a price the Pentagon will be willing to pay, another country with hard-won experience manufacturing affordable, expendable FPV drones may be able to step in and fill the gap.

I'm talking about Ukraine.

"I'll trade you drones for missiles"

The past three years have given Ukraine a lot of experience in the development and use of FPV drones in real-world conditions -- and given Ukrainian defense companies a lot of experience building drones on a budget. The country's expertise in drone warfare became especially evident in June, when a Ukrainian operation dubbed Operation Spiderweb saw 117 FPV drones deployed within Russia to damage or destroy dozens of high-value Russian military aircraft on the ground.

It was both a military and a PR coup for Ukraine, and probably instrumental in the latest development in this drone saga, reported just last week: According to the Kyiv Independent newspaper, President Donald Trump and Ukrainian President Volodymyr Zelensky are currently discussing a "mega deal" that would see Ukraine trade FPV drones (which it's good at producing) for long-range missiles (which it struggles to produce). And the price should certainly be right. Reliable sources have Ukraine building basic FPV drones for as little as $400 -- and much more advanced "fixed-wing interceptor" drones for air defense for just a fraction of the cost of even the cheapest American military drones: $5,000.

Details of the mega deal remain in flux. It might be a straight trade of Ukrainian drones for American missiles. Or the deal could take the form of offsetting purchases, with Ukraine spending money to buy U.S. missiles, and the U.S. turning around and using some of that money to buy Ukrainian drones.

An even more intriguing option, suggests The Independent, would be for Ukraine to "share its drone expertise [and technology] with the U.S.," helping teach American defense companies to produce effective FPV drones on the cheap, and perhaps taking a license fee in exchange. This might take the form of joint ventures with American defense giants as well. As an example, Zelensky announced Thursday last week that Ukraine has inked a "50/50 partnership" with the Danish government to produce Ukrainian drones in Denmark.

And here's the real kicker: Zelensky says a similar agreement with the U.S. is already "in place," and could be worth anywhere from $10 billion to $30 billion in total value.

What this means for investors

Thirty billion dollars sounds like a big deal, albeit it's not clear how the math would work. Are we talking $30 billion in missile sales to Ukraine, and another $30 billion in drone sales to the U.S.? Or $10 billion in missile sales, offset by $20 billion in drone sales? Vice versa? Or something entirely different?

The one thing that is clear, is that if this deal is "in place," it's a deal a lot of big U.S. defense contractors will be interested in, and in all sorts of ways. Beyond drone-focused contractors like AeroVironment and Kratos, many of the larger defense contractors, which have struggled to break into the drones business in a big way, might welcome finding a side door into the business through licensing technology from Ukraine. And even those that don't could benefit financially on the other side of the exchange, building U.S. missiles for sale to Ukraine in exchange for Ukrainian drones.

With potentially tens of billions of dollars up for grabs, this is a "mega deal" worth watching closely.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends AeroVironment and Palantir Technologies. The Motley Fool has a disclosure policy.