The surprising sector shielded from government shutdowns

Key Concepts

• National Security Investing: A specialized investment strategy focused on companies that support national defense and security priorities.
• Esoteric Space: Refers to the complex and specialized nature of the government procurement and defense sector, requiring deep expertise.
• Geopolitical Peer: A nation that possesses comparable military, economic, and technological capabilities to another major power, leading to a multipolar world dynamic.
• Industrial Base Reinvigoration: The process of strengthening and modernizing the manufacturing and technological capabilities of a nation's defense industry.
• Autonomous Systems: Military technologies that can operate and make decisions without direct human control, encompassing drones, AI, and robotic systems.
• Force Protection: Measures and equipment designed to safeguard military personnel from harm.
• Bid and Capture: The process within government contracting of bidding on and winning new contracts.
• Strategic Buyers: Large defense corporations (e.g., Boeing, Lockheed Martin) that acquire smaller companies to integrate their technologies or capabilities.
• Peace Through Strength: A foreign policy concept advocating for maintaining military power to deter aggression and ensure peace.
• Deterrence: The act of discouraging an action or event through instilling doubt or fear of the consequences.
• Collaborative Combat Aircraft (CCA): A US program involving human-piloted fighter jets operating in conjunction with autonomous companion drones.
• Full Spectrum Cyber: A cybersecurity business offering both defensive and offensive capabilities.

Capital Meridian: Specializing in National Security Investments

This episode of Opening Bid Unfiltered features Brian Sazi, Yahoo Finance Executive Editor, in conversation with Brooke Coburn, co-founder of Capital Meridian. The discussion centers on Capital Meridian's specialized approach to investing in the national security sector.

Firm Founding and Mission

• Founding: Capital Meridian was founded in 2021 by Brooke Coburn and his partner after 25 years of experience at The Carlyle Group.
• Specialization: The firm is a specialist in national security investing, operating with one fund and one office based in Washington D.C.
• Mission: To navigate the complex and "esoteric space" of government procurement, which involves understanding the intricacies of over 400 different government agencies and procurement offices.
• Carlyle Background: Coburn highlights their experience at Carlyle, which began as a small firm with one fund and strategy, mirroring Capital Meridian's focused approach. They witnessed Carlyle's growth into a large, diversified firm, which led them to spin out and build a narrowly focused entity.
• Current Environment: Coburn notes the current geopolitical climate as "the most fraught environment... in at least a generation," creating significant investment opportunities.

Impact of Government Shutdowns

• Minimal Impact on Investments: Coburn states that government shutdowns have "very very little impact" on the companies Capital Meridian invests in.
• Reasoning: Shutdowns typically affect civilian agencies (e.g., IRS, State Department). Companies serving national security infrastructure, such as the Department of Defense, Department of Homeland Security, and intelligence agencies, are considered "essential." Their functions and the companies supporting them continue uninterrupted.

Defense Spending and Investment Thesis

• Long-Term Perspective: Capital Meridian invests for the long term, typically holding investments for five years or longer. This timeframe inherently encompasses multiple presidential election cycles and congressional investment cycles.
• Transcending Leadership: The investment thesis focuses on "big challenges facing the country" that transcend any single leader, with national security being a primary example.
• Shift from Unipolar to Multipolar World:
  • Past: The US was the sole superpower after the Cold War, with national security apparatus heavily focused on the war on terror post-9/11.
  • Present: The rise of China as a "real peer to the US" has led to a pivot back to a multipolar world. This necessitates retooling technologies and capabilities to deter new geopolitical rivals.
• New Investment Cycle: The current environment marks the "very beginning of what will be a substantial new investment cycle" focused on capabilities designed to deter geopolitical rivals.

Differences in Defense Spending: Trump vs. Obama/Biden Administrations

• Underlying Theme: The fundamental investment theme around national security has been consistent.
• Trump Administration Priorities:
  • Capabilities for Peer Competition: The Trump administration has emphasized capabilities needed for dealing with geopolitical peers, which differ significantly from those required for combating terrorists.
  • Industrial Base Reinvigoration: Investments are designed to catalyze the rejuvenation of the industrial base. An example cited is the government taking direct stakes in critical minerals companies.
  • Commercial Technology Integration: The conflict in Ukraine has highlighted how commercial technologies have surpassed military systems (e.g., the effectiveness of off-the-shelf drones). This has created a "dislocation" and a need for new investment and innovation.
• Specific Investment Areas: The Trump administration is investing heavily in autonomous systems, AI, and missile defense (e.g., the "Golden Dome" system). These are long-term investments expected to yield returns over 5-15 years or longer.

Geopolitical Tensions and Investment Implications

• Russia's Nuclear Weapon Testing: In response to Russia testing a delivery mechanism for a nuclear weapon, President Trump indicated the US would resume nuclear weapons testing.
• Investor Perspective: Coburn views this as a reflection of being "back in an environment where the US has real geopolitical peers" and a "cold war environment." This necessitates a "mindset shift" and corresponding investments.
• Hypersonic Weapons: This is a key area of investment for geopolitical peers, and a major reason for the US focus on missile defense systems like the "Golden Dome." Current missile defense systems were designed for older ICBMs and are not equipped to counter hypersonic missiles.
• Innovation Battle: The current competition with peers is an "innovation battle," most acutely seen in semiconductors and tensions around Taiwan.
• Investing in Potential Conflict: Coburn clarifies that Capital Meridian does not invest in nuclear weapons themselves.
• "Peace Through Strength" Philosophy: The firm operates under the principle of "peace through strength," believing that parity in capabilities is the primary source of deterrence and prevents major wars.
• Next-Generation Deterrence: The US and NATO are investing in a new generation of deterrence capabilities to counter threats from adversaries who have been developing new capabilities. This is not a prediction of nuclear war but a clear-eyed response to evolving threats.

Autonomous Systems and the Future of Warfare

• Significant Investment and Advancement: There have been "huge investments and advancements in so-called autonomous systems."
• Forms of Autonomous Systems: These can manifest in land, sea, and air.
• Ukraine Example: The first "fully autonomous assault" in Ukraine, relying entirely on autonomous systems without ground troops, is cited as an example of this trend.
• Potential Positives and Negatives: While autonomous systems can reduce human lives at risk, there are also significant ethical concerns.
• Collaborative Combat Aircraft (CCA): This US program involves human fighter jets flying with companion drones that operate as a system, extending sensor range, enhancing surveillance, and improving attack capabilities.
• Ethical Questions and Human-in-the-Loop: Coburn believes that "real ethical questions" arise when there is no human in the decision-making chain. Currently, all deployed systems have a human in the loop, using technology to gain insights and make faster decisions.
• Future Outlook: Coburn does not foresee a future without humans in the loop in the foreseeable future, emphasizing the use of technology to enhance information flow and speed up decision-making. The question of whether adversaries will maintain a human in the loop is presented as a separate concern.

Capital Meridian's Investment Portfolio and Thesis

• National Security Focus: National security constitutes the largest portion of their portfolio.
• Broader Technology Modernization: They also invest in companies modernizing technology infrastructure for the government, including cyber defense, ERP systems, and traffic safety enhancements for cities.
• Example Investments:
  • Clarity: A national security business providing full-spectrum cyber capabilities (defensive and offensive) to military and intelligence agencies for rapid information gathering and decision-making.
  • Bowfort (Acquisition): A company providing protective equipment for military personnel, including pilot flight systems for the F-35 and submarine escape suits. This investment is driven by the fastest-growing defense budgets in Europe, responding to the threat from Russia.
• Investment Strategy: Investments are designed to capitalize on growth cycles in critical defense areas.

Working with Portfolio Companies

• First Institutional Capital: Capital Meridian often invests as the first institutional capital in companies bootstrapped by founders.
• Growth Plan:
  • Building World-Class Operating Teams: Assisting companies in rounding out their leadership teams with experienced professionals. They leverage a "deep bench of operators" with extensive experience in the sector.
  • Alignment with High-Growth Submarkets: Guiding companies to align with emerging trends like AI, missile defense, and autonomous systems to drive higher growth and profitability.
  • Organic Growth: Focusing on "bid and capture" to help companies build new contract capabilities and win new customers.
  • M&A Support: Providing support for mergers and acquisitions where strategically beneficial.
  • Operational and Financial Improvement: Strengthening operational processes and financial systems.
• Hands-On Approach: Capital Meridian makes only 8-10 investments per fund, allowing for a very hands-on approach.
• Partnership Model: They typically do not buy 100% of companies, pitching themselves as sophisticated partners who understand the end markets, provide liquidity, and work collaboratively to build the company.
• Exit Strategy: Approximately 75% of their portfolio companies are ultimately acquired by larger strategic investors like Boeing, Lockheed Martin, and General Dynamics.

Leadership Philosophy and Mission-Driven Investing

• Financial and Missional Aspects: While driving 3x cash-on-cash returns for investors (pension funds, endowments), Capital Meridian is also motivated by a "heavy missional aspect" of serving US national security priorities and keeping Americans safe.
• Entrepreneurial Alignment: The entrepreneurs they work with are generally "heavily mission-driven" and seek help in areas like team building, market entry, and operational capabilities.
• Bespoke Approach: Their playbook is tailored to each company's specific needs, focusing on building world-class teams, aligning with high-growth submarkets, driving organic growth, improving operations, and supporting M&A.

Conclusion

Capital Meridian operates in the highly specialized and increasingly critical national security investment space. They leverage their deep experience to identify and support companies that are vital to US defense and security, focusing on long-term trends like geopolitical peer competition, technological innovation in autonomous systems and AI, and the reinvigoration of the industrial base. Their hands-on, mission-driven approach aims to build strong companies that not only deliver financial returns but also contribute to national security.