00:00Carlyle has been in defense since 1987.
00:02You personally have been in the industry for nearly 30 years.
00:06But in mid-May, you launched a platform, a middle market platform.
00:10Why this now?
00:11Why this strategy?
00:12Yeah, we're just seeing a lot of opportunities for smaller, innovative companies.
00:17You got to remember that we've come off over 30 years of over-consolidation in the space,
00:20which resulted in just a few players at the top, a hollowing out of the middle.
00:24And you have a real deep ecosystem of small, innovative companies that lack the industrial
00:30relevance to really make a difference.
00:32And we think the time is ripe to really rebuild that middle.
00:36And so supporting and identifying the future leaders is a real opportunity for competitive.
00:40How competitive is it for these companies right now?
00:43Because obviously this is a huge theme.
00:44As I mentioned, Carlyle's been in that theme for some time.
00:46But is there a lot of interest in these types of defense companies in these smaller, middle
00:50market ones that you're seeing?
00:51There definitely is a reopening of the market.
00:53Our pipeline is probably 3x what it's ever been over my last 30 years of doing this.
00:58So we're really excited by the number of opportunities that we're seeing.
01:01Just in the last 12 months, we closed three deals in the national security space, an encryption
01:07company, a cyber company, and a hypersonics company.
01:11So these are all companies that are really, really deep in their technology.
01:15They're kind of viewed as disruptors in their space.
01:18And we're really just seeing a lot of innovation at the lower end of the market.
01:21Can you just, again, the pace that you're deploying cash, just how out of bounds with historical
01:26pace has it been?
01:27Is this the most rapid that you've ever seen, just given how much the needs of this defense
01:31sector of the US of Europe has changed?
01:33Yeah, the deal count is definitely up, but the average deal size is down.
01:36And I think that's true.
01:37If you look over the last six months, the number of deals done in the aerospace defense
01:43sector from an M&A perspective is up about 140%, but the average tech size is down about 60%.
01:49So there's definitely a lot happening at the lower end of the market.
01:52And I know that Carlisle's whole ethos when it comes to this sector is the bleeding edge
01:56of technology and innovation.
01:58And a lot of that innovation has centered around AI.
02:00We've seen that through just how much warfare has changed.
02:03There's this conversation happening right now about ethics in AI, let's say, concern about what it
02:09means for humanity. Is that same conversation happening in defense right now? And should it
02:14be happening in defense?
02:15It does. I mean, when we play in it, it's predominantly on the non-kinetic side.
02:18There's typically a human in the loop. But it is a big part of what we're doing.
02:24One of our portfolio companies, I'd say about 70% of their pipeline somehow touches AI in some way,
02:30shape or form. So it's definitely a meaningful part of the market.
02:32Are you concerned that we might get to a world, especially around defense,
02:35where there aren't humans in the loop?
02:37That's a scary world. And, you know, one for policymakers to determine.
02:41You know, we definitely advocate and support more human intervention.
02:45And I'm guessing you advocate that with DC too, given your close ties here.
02:48How often are you talking to regulators about the way defense takes form and the types of companies?
02:53There's definitely a renewed openness for partnerships. You know, the current administration
02:59is very forward leaning with encouraging public-private partnerships,
03:03direct capital infusions, engagement with commercially available technologies.
03:08So there's a freshness in the dialogue that's happening that we haven't really seen over the past number of years.
03:14One of the striking things that this administration now has to deal with is the depletion of munitions.
03:18And it's been really stark. There was one report I was looking at.
03:21The U.S. burned through 60% of its Patriot missile inventory in just the first five months of the
03:27war in Iran.
03:28Ian, how did we get to this place?
03:30Yeah, I mean, it's the consolidation theme that I mentioned before.
03:33You know, it really came to a point where we became over-reliant on exquisite systems.
03:38It depleted a lot of the industrial capacity.
03:40The Patriot problem you mentioned is going to take multiple years to remedy.
03:44It's not something we're going to be able to fix overnight.
03:47And I think there's a real attention now focused on cost and capacity.
03:51And people talk about magazine depth and affordable masks.
03:53And those are really, really important themes going forward.
03:56So how do you place within that?
03:58Is there a role for Carlyle as the U.S. looks to rebuild this stockpile,
04:02looks to make sure that we are ready for Iran and beyond?
04:06Absolutely. I mean, the refocusing on repopulating the middle of the ecosystem,
04:11building more capacity and means that our economic to scale is going to be super, super relevant.
04:18You know, we're excited.
04:20Not only do you have the capacity and the cost, but you have all these new technologies,
04:23whether it's space, cyberspace, AI, autonomy, electronic warfare.
04:29There's a lot of new capabilities that need to be introduced to the warfighter faster.
04:33And, you know, look, we're now facing great power competition.
04:36And so the need to do things better, cheaper and faster has never been more urgent.
04:40And again, one of the interesting dynamics within that, that you've been discussing,
04:43is this play between primes and neo primes in a world where things used to be consolidated.
04:48And now these smaller companies that you're backing are coming up.
04:51What do you think will be the equilibrium between them?
04:54Do you think the primes continue to kind of back off to shrink or do they remain as they are
04:59now?
05:00There's a role for both to play. There's definitely an imbalance.
05:03We've historically been overly reliant on the primes.
05:05You know, there is a pivot away from that.
05:08You know, they do have great capability and they do have the industrial scale.
05:13You know, the neo prime side, you have a lot of innovation, a lot of cost advantages happening.
05:18I do see a world where those two business models start to converge and marry.
05:23But yeah, we're not there yet.
05:24How often is it that they're looking at your companies, that you're looking at an exit through
05:28strategics versus the other way around, that they're carving out parts of their business and
05:32you're looking at that?
05:33No, it's an interesting look.
05:35There's huge valuation disparities between where the primes trade and where these defense
05:39tech companies trade. I think it makes a lot of sense that all of the primes are looking at
05:44their portfolio and reexamining, you know, what's the proper balance. You know, they are a little
05:49more limited in how they deploy their capital, returning it to shareholders and the like.
05:53And so that's causing a deeper look at their portfolio construction.
05:57It's reversing a trend of over consolidation for the last 30 years.
06:01And this deconsolination theme is something that's super interesting.
06:05You know, that said, particularly for the mid-market opportunities,
06:08we do see the majority of our exits to strategics.
06:12What about the IPO market? There has been a fair amount of defense-related IPOs.
06:17Does that remain wide open and do you expect it to remain wide open if it is?
06:21It's been an interesting time. I mean, there's definitely a lot of
06:23investor excitement around the defense tech and the promise that it offers.
06:30You know, look, it's hard to speculate on how open the IPO market is going to be for any
06:35narrow part of the ecosystem. You know, that said, I think the themes that get people excited,
06:41whether it's the venture community, the IPO community, are themes that are benefiting private
06:45equity as well. You know, creating themes in the market for innovation and new entrants to prosper.
06:51You know, I would love to know, you know, I started this with saying that you have
06:53nearly three decades or about three decades of experience in defense. You've seen other defense
06:58cycles. What do you think makes this one different that we're currently living in in the past?
07:02Yeah, I mean, people are very excited about, you know, rising budgets globally,
07:05right, in Europe, in the U.S., even in Asia. I think what's different this time is competition.
07:12And, you know, I keep saying that, look, this is an environment where not all boats are going to
07:17rise. There will be winners and losers. You know, we talk about the drone ecosystem a fair bit,
07:21where there's over a thousand manufacturers of drones globally. And we know things, two things
07:27are true. The U.S. will buy more drones, but they will not be buying them from a thousand different
07:31companies. So, you know, the valley of death is real, and we're going to have to see others.
07:36How hard is it to pick from those winners and losers?
07:38Yeah, I mean, we try not to make those types of bets. With the private equity model, we tend to
07:44look
07:44for more mature businesses, ones that have backlog, ones that are proven winners from a technological
07:49standpoint, and ones that have defensible modes. We do see a lot of opportunity on the defense tech
07:54side of the equation. There's a lot of these venture-backed companies that would love to have
07:59Carlisle's within their cap table before going public. We recently made one investment in a hypersonics
08:06business that we're very, very excited about, but we think that's a very much more defensible model than
08:10what you typically see.
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