00:00On this week it's all about defense investing and we take you into the boardroom debates in real time. Today's
00:05investment committee it is Ian Fujiyama head of aerospace defense and government at Carlisle. Mark Marengo global co-head of
00:12diversified industries investment banking at J.P. Morgan and Aaron Price right general partner at Andreessen Horowitz who over also
00:19looks at the sector.
00:20You know I want to start with you because Carlisle is the only firm of its size that actually has
00:25a dedicated aerospace and defense business and you've been doing it for decades. So what would your pitch to the
00:30ICB. What is the most attractive area to invest among defense companies. Thanks. And I want to say thank you
00:37for allowing me to be here today. It's a pleasure. It's definitely a dynamic time for our industry in our
00:42thirty five years of doing this. We haven't seen more opportunities. As you think about defense spending here in the
00:49U.S. you know it's roughly a trillion
00:50dollars but that still represents roughly only three and a half percent of GDP which is near a 70 year
00:57historic low. And so now as we're pivoting from counterterrorism to great power competition the need to do things better
01:03cheaper and faster has never been more urgent. You know the problem with the industry is that we've gone through
01:08a period of immense consolidation. So you have a hyper barbelled industry led by and dominated by the large primes
01:15and then a very hollowed out middle and then there's innovation happening but at a much smaller scale.
01:20So you're looking mostly at the innovation then. Is that where the most. We think the opportunity would be to
01:24help rebuild the mid-market because you need the capability but you also need the scale and the ability to
01:30grow to make it relevant.
01:33Aaron let me take this to you because of course at Andreessen Horowitz you're going to be looking at maybe
01:37more of the more younger innovators that Ian maybe would sort of pick up along the way. So what would
01:43be your pitch. What do you think is the most attractive area of defense right now.
01:48Well you know if we want to be prepared to protect and defend our country we have to be producing
01:52at scale for cost that is reciprocal to the cost of the weapons our enemy is using. So we can't
01:57be shooting down 40k drones with a three million dollar single use missile and we shouldn't be putting the warfighter
02:03into harm's way when autonomous systems exist to help get the job done.
02:07Where we're really excited though is the supply chains up and down the stack. So you don't have a defense
02:12industrial base without an industrial base and the current state of the defense base is making us realize how much
02:18work there is to do to build out these supply chains up and down.
02:22You know if you look at the situation in Iran we're desperate for low cost systems with embedded intelligence but
02:28when you're shipping drones interceptors missiles at high volume with all these autonomous features and you're iterating on designs from
02:34one week to the next you know we're starting to ask the question of where are we getting motors for
02:38those drones because we don't manufacture those motors in the U.S. today.
02:41Even the materials that comprise those motors copper steel magnets right now the majority of these these supply chains run
02:48through China and if you think about even all the electronic systems on board you're iterating quickly on these components
02:55we don't have a massive supply of electronics and electrical engineers to be able to do that work so how
03:01are you even iterating at that design speed.
03:03So where we're really excited is just seeing this huge explosion of opportunities and incredible founders who have grown up
03:09in real manufacturing companies like SpaceX and Earl and even Palantir and are starting to move down to the stack
03:15to some of these more industrial problems.
03:17Mark let me bring you in because of course you're overseeing the aerospace and defense portfolio for the one and
03:22a half trillion dollars of JP Morgan security and resilience initiative.
03:26Where do you fall in what is the most attractive area to be investing in.
03:31Yeah and look I think Aaron touched on this supply chain and critical rare earth minerals is a is a
03:39very important part of where we're seeing a lot of the opportunity when you consider that 89 80 to 90
03:45percent of the rare earth that we use in our defense products today are sourced overseas you know there's a
03:51big gap in our supply chains.
03:55And so we've been spending and so we've been spending a lot of time in many cases in partnership public
03:59private partnership with the government looking to develop solutions to solve for and bring a lot of the rare earth
04:07processing capability back to the United States right.
04:10We saw that in the MP materials deal we saw that in the Korea zinc deal and both of these
04:14are examples of deals that I don't think would have happened without the government industry and the financial community locking
04:23arms to develop a bespoke solution to bring those capabilities back.
04:27The other area when you look at the platforms and you really dig deep into the supply chain which you'll
04:32find is as you get below the tier twos and the tier threes it starts to get very very fragmented
04:37and you have many smaller companies who may not have the capital or the resources to expand capacity modernize in
04:45order to hit the increasing production rates that are expected of them.
04:49And so we're spending a lot of time focused at that level of the supply chain making sure they have
04:54the resources in order to deliver on on the mission.
04:57So we're running we're running up against a little bit of hard time and I want to get get some
05:00more in here because Ian Mark there was talking about the importance of public and private partnership and you're you're
05:06based in the heart of this you are in Washington D.C.
05:09How does that look when you're thinking about investing is that more risk or is that more opportunity with working
05:15with the government.
05:16Yeah so we've been navigating the regulatory framework for 35 plus years it's definitely something to be cognizant of it
05:22does benefit us in some ways that a lot of our peers just don't focus on this area because it
05:27is too complicated.
05:28And so and those that we do compete against tend to be more mid market firms which as a global
05:34private equity firm with a global footprint with the resources we have it's easier for us to differentiate when we're
05:40looking at court a founder of a business that he should partner with us.
05:44And so you know there are some opportunities as well as risks with regard to regulatory I'd say one of
05:50the big changes and Mark alluded to it is the real change in the administration.
05:53You know some of the deals that they're putting forward are truly innovative and things that we would not have
05:57even imagined.
05:58Aaron Aaron how are you thinking about the regulatory risk in the sector.
06:05There's risk and there's also opportunity.
06:07I mean a lot of our companies are building physical things they need to build factories they need a they
06:13need power to do that they need land they need permission to do that.
06:16And a lot of building physical things is really an alignment problem and it involves working with the federal state
06:23and local governments and local communities to basically get the permits and approvals needed to actually build something and the
06:29capital required in order to do it.
06:31So one thing we're really seeing is in our portfolio companies we're working with governments state and local governments as
06:38well as the federal government to be able to build real projects.
06:40Our new centers of excellence popping up kind of outside the traditional tech hubs which is pretty exciting and what
06:47we see is that once a region makes itself known that it's open for business and that it wants to
06:51work with federal government that it wants to work with military and it wants to work with these startups it
06:56starts to create an ecosystem a talent pool process knowledge that attracts the next businesses to the area.
07:01So we're starting to see that play out in regions like Texas Ohio Arizona that are really becoming the next
07:07generation of defense industrial base right in partnership with both private companies and the federal government.
07:13Mark I just wonder look this conversation itself highlights the fact that there is demand for these types of deals
07:20and for these types of companies what evaluations look like right now.
07:25It's interesting I used to say having covered this space for a long time it all defense is treated equal.
07:31Meaning that historically you've seen defense valuations trade in a relatively tight range.
07:38Now what you've seen is a pretty in the current environment there's a pretty wide disparity in terms of valuations.
07:45You have the large caps that typically trade in the mid-teens on a forward EBITDA basis.
07:50You've got the platform agnostic mid-cap defense suppliers that are trading in the you know call it high 20s
07:58low 30s
07:59and that are projected to grow high single digits on the top line for the next couple years.
08:04And then you have this emerging group of defense tech and space tech companies that are trading at 40, 50
08:10plus times EBITDA and are projected to grow it at 20 to 30 percent.
08:15And so the valuation paradigm has changed dramatically which has really created an opportunity for public market opportunities.
08:25So IPOs for example we saw three defense IPOs last year that raised a little over $2 billion in North
08:33America.
08:33This year we've already seen one in North America.
08:36We've seen two in Europe.
08:38Our pipeline of IPOs for defense and defense tech companies has never been as high as it is today.
08:46Sorry for jumping in Mark but I only got 30 seconds here.
08:48Ian I would love to get your view on this of is our IPOs a good exit opportunity for these
08:53deals you're looking at?
08:54And apologies just just just only about 30 seconds here.
08:57At the size we plan IPOs are definitely an option.
08:59We look at things across our portfolio and there are a number of candidates.
09:02We recently took one company public just a year and a half ago.
09:06So strategic buyers are generally our preferred route and we try to tailor make our businesses to be more desirable
09:12by strategic buyers.
09:13But if we can hit an IPO window for the right opportunity we're absolutely happy to do that.
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