NEW PODCAST: DEFENSIVE CAPITAL - SEARCHING IN THE DEFENSE INDUSTRY - EP. 21
I’ve wanted to record a few episodes that focus on specific themes, industries, and strategies around acquiring small companies and this episode is the first in a few to come. My guest today is an anonymous Twitter account named Defensive Capital who I’ve gotten to know over the past few months. True to the account’s name, he works in supply chain in the defense industry and our conversation focuses on opportunities for entrepreneurs and searchers in the industry. If you have any interest in the defense industry or manufacturing, you’re going to like this one. Enjoy.
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Thanks for joining. It's fun to have another anonymous account, but one focused on the defense industry, it's one I've always been fascinated by and I'm excited to hear about your experience in it. And can you talk about as much of your background as you're willing to share and how you got into defense?
So I enlisted when I was 17, right out of high school. I thought I was going to be sticking around the area that I'm from, hanging out on a boat, cruising around and doing fun stuff like that. But the Coast Guard sent me over to Seattle, right out of boot camp and I ended up doing maintenance on the Polar Rollers and things like that. So I did mostly mechanical stuff my first two years and then my second two years, I switched over to doing law enforcement. I did a lot of the maritime safety mission and things like that here in Boston, a lot of search and rescue stuff. And so mostly with a background like that, people get out of the Coast Guard and they end up either becoming diesel mechanics or they join some type of federal law enforcement branch, but I wasn't really interested in that, and I actually got really into reading finance books and reading business books and so I ended up going to college for finance.
I thought I was going to be a public equities guy, but I did my first internship in asset management, and I learned that those S&T jobs and things like that, were going by the wayside and it wasn't really a growth market and coming from a non target school, my odds were pretty slim. So I ended up graduating and working at a defense contractor here in the Northeast, doing proposals and supply chain.
So what's that work look like?
Day to day, a lot of what I do is sourcing the materials that we're putting together for a proposal. So it's non execution work. It's a lot of figuring out of suppliers, OEMs or distributors, who's going to offer the best price and making sure all the materials priced out for a proposal before we send it to the government.
Are you able to share a little bit about what kinds of projects you work on exactly?
A lot of the contracts I work on are development stage that feed into DOCA programs, first time developer contracts. I think that’s the most exciting, most cutting edge part of the business that we work on.
It doesn't sound like you're able to share too much more about the specific nature of your project, but how does this fit in with what you're looking to do longterm in defense?
Longterm, obviously I'm here to become a business owner and work for myself, at least have more autonomy over my time than I do now. So how I see it fitting in longterm, something along the lines of doing this and becoming really a subject matter expert on a wide breadth of the industry and then longterm, I'd love to be an owner, an operator for a more of a sub contractor, a contractor that we would work with as a prime.
What drew you into defense?
Like I mentioned, I realized that working in public equities or finance or whatever, wasn't necessarily the best path for me, so I started looking for something that I really could see a hard outcome being built, instead of moving around dollars on an Excel sheet, I wanted to really feel like I was part of something that I was really producing. And then that coupled with just growing up, always working for the government in some capacity, I thought it was a good opportunity for me. And I was definitely really interested in the type of work that I could be doing and where it would take me. And then, I found some inspirations for seeking out business ownership and what that would look like longterm. So I saw an opportunity there too. Is there something intriguing about supply chains and managing materials and pricing and putting together a project, that you find really engaging?
I do a lot. And it's funny because I work in this really untrendy industry doing this very untrendy thing. You don't see a lot of people aspiring to get into supply chain. Some of the biggest folks on social media don't really even have degrees in supply chain, they just end up in the industry and then finding a passion for it. But I do like it a lot. I like the idea of putting something together, start to finish, and I don't necessarily do this right now, that would be more on the execution side, but really contributing to, like I said, building something tangible, like a product like this, especially one that helps defend our nation, I think is so interesting.
Why are you anonymous?
I think I'm anonymous mostly because when I first started working in this industry, I was very nervous about any type of blow back if I was going to have opinions about industry specific stuff, if I was going to be talking about contracts or anything like that, that it's public knowledge, but also if I was going to have opinions on other companies or anything like that. A lot of that has subsided as far as the fear for me, I don't consider it's going to be ever arising and it will ever be a problem, but maybe at some point I'll turn it around. Mostly I really liked the handle. It's combining the two things that I was really interested in. It was like the asset allocation and defense, that's the merger of what I want my career to be really.
So then for someone whose, like I'm really interested in the defense industry, but I don't really know very much about it, what would you say to searchers who are really curious about the industry, just to give them a high level overview?
Yeah, it's a lot like every other manufacturing style industry out there, but it definitely has its own quirks. There's a lot of government specific requirements and they write whole entire federal legislation around how you sell things to the government and how you work with the government. So having a working knowledge of the FAR, federal acquisitions regulations and EAR restrictions and things like that. That's important and so it's almost like a working knowledge of that stuff is important and so it's almost more moat-y, if that makes sense. I know it's a really overused Buffett-y thing to say, but it's just to dive even deeper into it, it's not as simple as maybe picking up another type of distribution company if you're looking to acquire a business or something like that. And I'm sure every industry says, this one is special because X, Y, and Z, but just in my experience, working with the government, there's always extra red tape and regulation and stuff that you have to go through.
And so where does your company fit in along the supply chain of distributors and or manufacturers and distributors?
So we're a prime contractor, so we work directly with whatever the government customer is. And then down the line from that, you would have subcontractors who could be either people that are providing goods and services or a distribution company that's providing goods and services and so on.
And the defense industry as you see it, what do you see as some of the most interesting business models or niches in the industry for you to work on, or that you're just interested in learning about?
Something that I really, really enjoy seeing and this is not who I am at all, I think that's maybe what I find it so interesting, is there's a caricature of a guy who has this great nifty invention and it's like a puzzle piece, that if we shave off just a little bit of the size and shape it really nicely, it fits perfectly into a product that we're trying to sell to the government or we have maybe been selling to the government and we have this really specific problem that we need to solve and that guy is building this puzzle piece that we can fit right in. I love that stuff.
As far as scaling, when we peel back the idea and talking about what the business side, as far as scaling and stuff like that goes, that's really tough because, if he's only doing this one particular thing, you can't really go above and beyond, unless you're going to be doing other products and things like that and then you get into this whole rat's nest. But having that IP and having a strong requirement for it and building up the demand for it, that's a very solid small business that can be built.
So within those businesses, the puzzle builders, if you will, what's the key driving force behind those companies and their success? Is it continuing to get new government contracts or is it developing some sort of expertise and a certain technology or manufacturing method? What are two or three things maybe that really drive those companies?
The number one thing that that company is founded on is that IP. So whatever intellectual property that company has produced, it's usually just an engineer, maybe a friend or his wife, they're trying to build a business around doing something really specific. I've seen it with a heat exchanger or even a process to do something, foundry work or something like that. And these stories are printed, you can find these online, there's tons of case studies about this, but just in my own experience, I sometimes come across this company and I make a phone call and it's the guy's wife that picks up and she's the front end of the business and then he's the back end, with maybe two or three more people. And I'm like, this is a perfect example of a fly under the radar, strong revenue creation, just with a couple more ad-ons, this could be a really great business.
Just thinking about it on my own right now, my concern would be, if I was to buy one of these companies would be, customer concentration and if that contract goes away, or if the IP becomes redundant, something new comes around that replaces it. Are those valid concerns or how do you see them perhaps differently or is that fairly accurate?
I mean, and again, like I said, I'm not an engineer by trade at all and I don't have the background where I speak intelligently about IP stuff, but I got to imagine that if you come across someone or if that prime something like we do, if they come across someone that does something a little bit better, sells it for a little bit less, checks a couple more boxes, and that contract dries up, you don't have a business anymore. And same thing with if you're trying to acquire a business, this is exactly what you are a little afraid of because the whole entire company is built around maybe one guy's own brain. It's tough to take over that kind of thing, unless you have that background or a consultant in other ways.
Are these businesses that generally should be either acquired by competitors or other engineer types, and that are perhaps more on the risky side of acquisitions then?
Yeah. I would say there's a lot of risk in acquisition in this example, because if you don't have that engineering mindset, you might run into problems where you can't develop something else and you can't build on this kind of idea.
So then are these companies that you're interested in buying, or is there a different type of company within your industry that you find more interesting as a perspective searcher?
If I was going to be doing a search fund right now, I don't think that that would be the ideal model that I'd be looking for, for a business. I think I'd be probably looking for more of a distribution style business, still catering in defense industries, a very specific commodity within the defense industry that is less competitive than say, semiconductors or something, some type of chip manufacturer that you can get anywhere. Those distribution companies are everywhere and they're very large. So if you maybe could be the distribution point of contact for a group of companies that do one specific commodity, and there was not a lot of competition around, I think that would be more of my speed, where it's just getting these widgets from point B to A. Is there an anonymized example company that you know of that fits that profile for you? I'm not really sure about a small scale one, obviously there's the classic big distributors that would compete against each other a lot. But I don't know if there is a really good example of a distributor that focuses on maybe a difficult to move commodity, or it's more expensive or something like that, it's difficult to warehouse. If you can crack those problems, I feel like you could really create a market.
Yeah. So in that sense, where do you see opportunity for a prospective searcher to come in the defense industry and make a good deal for themselves?
Well, I think outside of just the usual benefits for someone from the outside, maybe acquiring a business from business, or you could just find the obvious efficiencies, if you can bring to the table the specific knowledge that you need for the industry and then also build a couple systems and maybe streamline the sales process, sweep up the back office stuff, and then also build a really solid distribution channel or nail the logistics stuff. That would be, I think, where a major opportunity would be.
So when you say sales stuff, does that mean bidding more often on contracts or making better bids or what does that work look like?
So that's the piece of this business that I always see, and I see some of them flounder for that reason, because maybe they can't work our quoting system well and so they miss out on bidding on things, we're sending requests to them and they can't get it together for whatever reason to bid on it. Or it could be as simple as checking the email that all this stuff gets dumped into. Really, really basic stuff, or even just reaching out, I am always impressed, but I never really respond to companies that respond after they have submitted RFQs and want to check in on what the status of the bid is, when was the award date, are you looking to get this shipped by this date or how is this going to look with the followup? Doing those simple things and it might even just be a matter of hiring someone to handle it outside of just the engineer and then whoever is maybe running customer care, maybe not, that would be a game changer for these kinds of companies.
Yeah. So is that along the lines of what you might do in one of those companies or how would you step function the sales function upwards?
I guess my own sales pitch for what I could be doing is maybe even automating those kinds of processes or just setting up a flag that goes off every time you get some type of requests like that. Because if you own any type of business at all, I'm sure you're inundated with emails every single day, but those kinds of ones that are for proposals that we're building, or even if it's trying to get in touch with purchasers and things like that, those have to be at the top of your list somehow, right?
So is this an industry that really only experts should play in? What are the main dangers, if someone comes in without that defense experience or knowing how government contracts work and some of the regulations you mentioned earlier?
No, I don't think you should be deterred if you search or find a great opportunity here or something like that. There's whole subreddits on this industry, government contracting and things like that. And being on them, you see sometimes they preface their questions with like, "Hey, I know is simple and I'm sorry, but how do you do this one thing? I have this one problem, how can I make sure I'm nipping this in the bud?" So like that. I definitely think that there's walls that are built around it, but I definitely think that there's still potential there and you shouldn't be deterred by it at all. If anything, I think that it's probably one of the best industries as far as resilience goes, sales cycle is long, so you don't see the impact of recessions like you do in other industries. It's tough to compete in and so if you're established, those kinds of companies do very well for usually a long period of time.
So you mentioned that the owners or founders of the supply chain companies are generally engineers, is that true across most supply chain companies? And then what's the typical profile of the founder of a distribution business or at least the owner of one?
I believe it’s of the business minded person, less of the engineering type, that sees an opportunity to add to this value chain. And it’s feeding companies that want to outsource that sales and distribution component that I think is a huge opportunity in defense for entrepreneurial minded people or people looking to acquire businesses.
I think there's two kinds, you see the OEMs, the equipment manufacturers, they're the ones that are usually the founder, this current CEO or something like that, is an engineering type who maybe they founded the company on a type of product that they make, that they can sell. Or what I've seen too is they were working for an engineering company, they had this idea or whatever, and they spun it off into a different business and built it around this IP.
How do you find these distribution businesses to acquire? If you're a searcher now looking to find one, are there brokers that specialize in defense type companies or is this a primarily owner outreach strategy?
Yeah, that's a great question, I wish I knew the answer. I haven't done enough research into how to really seek out companies, that would be a potential, check all the boxes for what I would be looking for if I was searching now. I got to imagine that if it's anything like finding profiles on ... you're going to think like B2B businesses in general, they don't usually broadcast as much as B2C companies do. So to reach out and find them is going to be difficult, but also what is the brokerage market for these companies, I don't really know. That's a good question.
Yeah, that'd be interesting to see what you come up with. Is there another type of business outside of distributors that you find interesting within defense, that is primed for a more entrepreneurial owner to come in and turn things around or at least step function them upwards?
I think that there is an opportunity, if you were able to keep the current founder or CEO on board and maybe work hand in hand with him. Because this is also another train of thought that I have as far as ownership goes, is if I can be brought into, if you're a searcher, you could be brought in with an equity position and maybe a COO role or something like that, or biz dev manager or something along those lines, learn the company inside out. If you have the mind for it, learn some of the engineering aspects and are you able to keep up with that sort of thing, I think that would be definitely a big opportunity. So you'd be looking at an OEM or something along those lines too.
Is that something where eventually the searcher who becomes the COO, eventually flip flops with the owner and becomes the CEO and then the owner steps down to the director of engineering type role within the company?
Yeah. So I would imagine that in that case it would be along the lines of, I will come in, build an equity position over the next five years, gradually take over the role of CEO as you step down into something like an engineering director or something like that, and then gradually step away from the company completely.
Do you think that's fairly common among these OEM manufacturers, where the owner, who's just maybe more engineering minded and doesn't really enjoy the business side of it and he just wants to build things all day, maybe he's looking for someone to take over because he's tired of doing the CEO job and just wants to go back to his engineering department and just work there. Is that something that's common or is that more random?
I couldn't tell you if it was very common or not. I would imagine a lot of these kinds of OEM companies are founded on this builder seller principle, where one person is the product guy, then the other person is running, maybe all the business functions. Looking at it from that sense, I would imagine that there's an opportunity. I couldn't really tell you if it is common or not.
Do you know if there's a opportunity to roll up a few OEM manufacturers together or are there some government regulations that could come into play where if you control too many suppliers or OEM manufacturers, that there's perhaps more limitations or there's stronger regulation for you above a certain size perhaps? Is there something like that that you might have to watch out for?
I think you might run into some problems if you are in direct competition with each other, meaning building the same exact product. So if you had two OEMs that competed on one widget, that could definitely be a problem, but as far as rolling up multiple that do different things, maybe work in the same quantity field, but sell different products, I think that's a great opportunity. Definitely could see synergies there if you could consolidate four or five different manufacturing shops into one larger space and that even if they're doing pretty different varied tasks, you could probably get all of that back office stuff into one house and save on a lease a little bit. There's definitely a huge opportunity there.
If you take over a company like this, how do you grow sales effectively? So how do you find new ... Is it just a matter of bidding on new contracts and depending on R&D to develop new products? Where's the point where you can just pour in effort and hopefully something good comes from it?
I have to imagine that the R&D aspect and building out differentiating products, that's probably where you would find the most revenue driver. You can't really go out to different customers, there's only the one. Even international sales for the most part, are FMS contracts, which go through the government. So it's tough to go out and find someone else that's going to increase the demand for your stuff. So it would definitely be a matter of product innovation, adding things to your app sheet, stuff like that.
And then is there anything on the macro scale that an owner or a searcher in the defense industry needs to be aware of? Like they should be tracking news of government, military budgets and projects. What's the important leading indicator for an owner to pay attention to?
Probably international news. I mean, at the rate 2020 is going, things are looking great for the defense industry, but I would also say that if you're following the government fiscal agenda every year, that's important, but it also depends on what branch you're feeding or what stuff you're feeding. People were really optimistic at the beginning of the year because we had this grand master plan to add a significant amount of ships to the fleet for the Navy, that has since subsided a little bit. So what was once an opportunity, a really optimistic thing to be looking at, if you were feeding some type of DDG or something like that and you're a supplier on those types of contracts, now that that has subsided, you're maybe not as optimistic.
And is that driven primarily by just COVID and effects of COVID or is there some other political factor that's going on?
Yeah, it would mostly be political, like what the fiscal agenda is of the administration usually. As the example that I was giving, adding a ton of ships to the fleet is obviously a surefire sign of increased sales for primes and then subcontractors, if you're feeding those types of programs or even shipboard renovation, stuff like that, I think I want to say it was like 70% of prime contractors revenue comes from repairs and services, things along those lines. So if you were one of those kinds of contractors, then that's really where you're baking your bread from.
What do you see on your horizon as the next political event to trigger a sea change in military spending and whatnot?
I think that this is maybe played out by now, but I think the cyber and AI routes are going to be really lucrative down the road. There was a couple of big awards this year, but I think that trend will continue. There's a VC by the name of Josh Wolf, that's really interested in this space. I track a lot of the stuff that he does, he's always a great follow on Twitter, but I really think he's got the head on the nail for that kind of thing. I really think that that's going to be lucrative as far as government spending goes. And we're talking about such an easier, I shouldn't say easier, but such a lower overhead once it's built kind of thing to keep up, rather than these big mechanical, industrial type parts. I mean, you talk to any SaaS business owner, they're going to tell you that they've got the greatest business in the world. So looking at that kind of thing going forward, I think that's really where the best market would be.
Is that a part of defense that you're interested in, the AI and cyber security type businesses or has that been crowded out?
Yeah, it's definitely really crowded, it's also an area that I'm not very well versed in. So it would probably take a lot of nudging for me to get there, but I don't want to take anything off the table.
What makes you nervous being in defense? I actually just did a quick Twitter thread on this very recently because a great article was written on the defense supply chain and the risks that you see with relying so heavily on a peer adversary for so much of our manufacturing and our defense supply chain. China's obviously one of the biggest producers of semiconductors and the chips and stuff that we produce. And I couldn't tell you how much of that is linchpin things that cannot be sourced anywhere else, but I think a very big business opportunity for ambitious people are going to be to bring that to either the United States, bring that manufacturing to the United States or allies that we have.
So on the flip side then, what makes you excited?
Stability of the business, I mean, I don't think you can really beat what was offered here, but also the possibility for growth within well established companies, I think that that's what really gears me towards ownership in the long run within the defense industry. Not that I'm not open to other industries, but I think that there's so much opportunity here because it's not the trendiest, it's not the sexiest, not a lot of kids are graduating from Harvard and saying they want to go work at, well, maybe the engineers are, but on the business side, you don't see a lot of folks wanting to go work at the big industrial defense companies like this.
Beyond just buying a business, is there a longterm plan or a vision you have?
Not so much. A friend of mine have always talked about opening up a boys and girls home. So like building the assets to do something like that, I think has always been fascinating to me. And it's just such an awesome way to give back, but I mean, obviously that's not the reason I want to get into owning a business. Probably something to do with having autonomy over my own time, being able to make those kinds of decisions where it's like, are we going to do path X or path Y? I think it's just a fascinating thing. I know it's not a very good way to get educated on the business, but I read tons of business bios because I always think that those paths to growth and building real serious companies is so interesting.
Is there a particular founder or business that you admire most?
Sam Zemurray, he took over United Fruit, but he started his own fruit company that was basically moving bananas from South America to the United States. But in the timeframe he was doing, it was really difficult. It was labor intensive and also you're against the clock, the minute you cut a banana off the vine. So that's a fantastic story about distribution and really how to build a company and it's a bootstrap story. Another business owner, founder, I would definitely say reading Shoe Dog was really good for me too. I think that was the linchpin where I was like, "This is a route I'd love to go." And seeing how he overcame a lot of stuff within building the business, I thought was so interesting.
Yeah. And that's The Fish That Ate The Whale, right? The first one you recommended.
Yep. Yes. That's The Fish That Ate The Whale.
We can make a link to both of those. If you could teach a class in college about anything you wanted, what would you teach and why?
I think I would probably teach a class about getting uncomfortable, understanding how you can conquer getting uncomfortable and facing your fears and things like that. Not that I'm an expert at it by any means, but I think it's so important that if you can even teach someone that's never done 10 pushups before, how to do 10 pushups, your mind immediately goes to this place where it's like, what else can I accomplish? Where else can I move forward from this? So it'd probably be a combination of physical education and then a long reading list. I think that that would be a really cool class to teach in, I think that's the strongest form of personal development.
What's a belief you used to hold strongly earlier in life, that you've since changed your mind on?
I think I've always been at least decently ambitious and I used to look at people that maybe got comfortable in their role, or I thought that they were undershooting what their value was, I used to think they were idiots. I was so critical of people that maybe what I saw as stuck in a role or doing something that was below them, I was so critical of them. But then I grew to learn that everyone values different things and maybe that person is a young parent and they're happy with making the salary that they're making and working 40 hours and going home and having dinner with their kids. I guess I took for granted what other people value and I wasn't empathetic to that enough. And that's something I've been realizing very recently, maybe in the past two years, I've been changing my mind a lot on that lately.
Was there a pivotal moment or interaction you had that really pushed you over the edge there?
I don't know if there was a particular moment, but there was definitely an exact vision of a person that I worked with that was in the military and never went up for promotions or anything like that, just stuck around. He always wanted to look for a unit in New England, which is easy to do in the Coast Guard, but it's easy to make that next jump in a career like that, if you just went to unit X and took your service exam, things like that, but he was unwilling to do it because it was just really happy with where he was. I didn't appreciate that until I came to value other stuff, other than just career, success or doing the best you can and overachieving and stuff like that.
That's a great answer. What's the best business you've ever seen?
I can't point to a specific one, but I would say if you can be a prime government contractor for some type of good or service, it doesn't have to be in the defense industry at all and fly under the radar, never be a talking point in budgetary hearings or anything like that, I think that's the perfect route and it's just always a cash cow. If I could find one of those, that would be what I would be searching for.
Is there a place outside of defense, where those OEMs can really thrive in that role?
Well an OEM, maybe not, but even if you were providing services, like the company that cleans the floors and I'm just spit balling, maybe that's not even a good one, but if you were just providing some type of simple service department or some type of headquarters that it's just always a rubber stamp, like, "Yeah, they're doing a great job. We're not going to bother with changing them out. This isn't where we're going to cut costs or anything like that." Something like that, I'd love to find a good example for you though. Well another type of B2B business that I've heard about, this is a flower leasing company. This is a woman that owned a flower shop or something like that and then the flower shop folded up, but she kept all the plants and would loan them to coffee shops or libraries or whatever like that. That might be second hand, I don't remember where I heard that, but I thought that was just genius because it's just this fly under the radar thing that you never think of.
But the plants eventually die, don't they?
Yeah. So she was in charge of going into the place, watering the plants, changing them out or pruning them or whatever she's got to do and stuff like that. And I'm assuming they pay her a flat monthly fee to just come in on a weekly basis, change them out if she needs to or water them or do whatever she's got to do.
There's got to be someone who does that for the Pentagon who would be an amazing business.
Yeah, exactly. Someone has office plants that they need taken care of, that's like a four star. Yeah, that's genius.
Yeah. They need their office all looking nice and green. This has been awesome. Thank you very much for sharing your time. I love chatting about this stuff, so thank you very much for coming on. Yeah, of course. I wish I had prefaced this whole conversation with, I'm a rookie in this industry, so if any of your listeners are cracker jack's at the defense industry, I hope they don't criticize me too much.
Hopefully it leads to some fun conversations at some point.