Defense market a safe haven for space companies during pandemic

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With the global economy in the grip of the coronavirus crisis, investments are grinding to a halt, creating deep uncertainty for a commercial space sector that has seen more than $25 billion in venture capital pour in over the last decade.

Since the pandemic hit, Pentagon contracts have been a lifeline for companies in the space industry, said Chris Quilty, president of Quilty Analytics. “The Department of Defense has gone out of its way to cultivate commercial relationships and to leverage the investment in talent that exists in the commercial domain,” he told SpaceNews. “In the current emergency, the Pentagon is supporting the industry from a financial perspective through contracting practices and accelerated payment terms.”

It is somewhat ironic, said Quilty, that many commercial space companies and investors have shown a bias against the government or the military for being too slow to make decisions and award contracts. In today’s reality, Quilty said, “many companies have discovered the government in some cases has the ability to move faster than commercial entities.”

Josh Hartman, a partner at the venture firm The Flying Object, described the current business climate as a “very shaky time.”

Right before the pandemic took hold, Hartman was working to raise funds for a small company in the space sector that had drawn interest from strategic national security investors. A deal was in the works but investors pulled back, and that is happening across the board, Hartman told SpaceNews. “When the entire economy is overshadowed by something like this, all companies become lower value. It’s much more difficult to raise money.”

Hartman, who also is a senior executive at Geost Inc., a supplier of electro-optical sensors to the U.S. military, said measures taken by DoD to soften the blow to the industry puts contractors in a stronger position to weather the crisis than companies that only rely on venture capital or commercial sales.

To keep money flowing to suppliers, the Pentagon on March 20 ordered contracting officers to increase the rate of progress payments from 80 percent to 90 percent for large companies, and to 95 percent for small businesses. The payments are for work already performed, so what DoD is doing is accelerating the cash back to companies. To date, DoD said, the boost in progress payments has injected $3 billion into the defense supply chain.

Another key move intended to avert layoffs was to allow for “equitable adjustments” so contractors are not penalized for poor performance caused by the pandemic. This means companies can request adjustments to contract schedules and costs, Hartman said.

This is going to help a lot of small businesses, he said. Inevitably schedules will slow down and that will drive up overhead costs. By offering to make adjustments, said Hartman, DoD is providing a safety net to companies that, without that kind of aid, would default on their obligations and likely go out of business.

DOD’S STAKE IN COMMERCIAL INDUSTRY

In key technology sectors including space, DoD has a huge stake in the health of commercial suppliers, said Tara Murphy Dougherty, CEO of the data and analytics firm Govini.

“The picture continues to look bleak across the board,” Murphy Dougherty told SpaceNews. The economic fallout on commercial business, she said, “could undermine progress DoD has made building bridges to the small business and startup community. Those bridges I don’t think are cemented in place yet.”

Organizations like the Defense Innovation Unit and the U.S. Space Force’s Space and Missile Systems Center have been working to bring more nontraditional suppliers into the defense sector but only the companies that have actual DoD contracts have a financial safety net right now, said Murphy Dougherty.

When DoD issued a memo March 20 identifying defense contractors as “critical infrastructure” that needed to keep working during the pandemic it sent a huge message, she said. “The biggest benefit was reducing uncertainty for industry and creating some financial security.”

Despite these government actions, the long-term outlook is still blurry, Murphy Dougherty said. “Until we have a vaccine, we’ll still have to absorb the impact on operations and on the workforce, even for mission-critical companies.”

“If you look at the airline industry as a proxy from a timeline perspective, after the 9/11 terrorist attacks it took two and a half years for air travel to reach the level that existed prior to 9/11,” she said. “It’s not a perfect analogy by any means but I think we need to start thinking of compounding delays and impact that could last years.”

RISK OF FOREIGN INVESTMENT

With many U.S. businesses facing financial distress, the influx of foreign capital to companies that develop technologies for national security is a major concern, Murphy Dougherty said.

“It is hard to identify what those vulnerable companies are without really good data,” she said. “If a company is publicly traded, there’s a lot of high quality data.” With non-publicly traded companies, it’s more difficult to identify their sources of funding but not impossible.

The Pentagon is anticipating that foreign capital will target cash-strapped U.S. technology firms during and after the coronavirus crisis, Ellen Lord, undersecretary of defense for acquisition and technology, told reporters March 25.

A member of the California Air National Guard’s 216th Space Control Squadron sorts pears at a food bank in early April. Meanwhile, the Pentagon is using its contract authorities to provide a different sort of aid to space companies hit hard by the coronavirus pandemic. Credit: U.S. Space Force

The Defense Innovation Unit is watching this issue closely, said Brig. Gen. Steven Butow, who oversees the space portfolio at DIU and works with many startups in the sector.

DIU was created in 2015 to speed up the adoption of commercial technology across DoD. In addition to space, its other key areas of focus are artificial intelligence, autonomy, cyber and human systems.

Even before the pandemic, DIU had been working to identify what commercial businesses might be targeted by foreign investors, particularly from China. “The current state of affairs caused by COVID-19 does not affect this process,” Butow said in a statement to SpaceNews. “DIU has proactively engaged with our partner companies to determine how COVID-19 is affecting them and their ability to meet deliverables under current contracts.”

It’s too soon to say what the ultimate impacts might be, Butow said. “DIU continues to actively open new solicitations and execute new agreements in support of our mission to accelerate commercial technology for national security.”

CONTRACT AWARDS HELP PRIVATE FUNDING

Quilty said DoD contract announcements can make a huge impact during distressed times. For a commercial entity that is venture funded or private-equity backed, the news of a contract award, even if it hasn’t yet been executed or funded, is a major boost, he said. “If you’re an investor or a prospective investor, the fact that the company has been awarded a government contract gives you confidence to put in place bridge financing or go out for another round of fundraising.”

U.S. Air Force and Space Force procurement officials said they plan to do what they can to support suppliers. The commander of the Space and Missile Systems Center, Lt. Gen. John Thompson, told SpaceNews March 25 that SMC is issuing contracts and accelerating awards as much as possible. “Many of our nontraditional small contractors have commercial solutions that we want to try to bring into the defense acquisition ecosystem,” said Thompson. “It’s definitely a priority for us to keep those innovative small companies in play as much as possible with the available budget we have.”

The senior acquisition executive for the Department of the Air Force, Will Roper, told reporters March 27 that he worries about small businesses that have developed important technologies for national security and are now struggling.

The Air Force in recent years stood up venture-style programs aimed at attracting small businesses that have technologies applicable to national security. “We’ll continue to award every SBIR [Small Business Innovation Research] we have available,” Roper said.

Industry consultant Jo-Anne Sears, a partner at Velocity Government Relations, said many venture-funded companies in the space sector develop cutting-edge technologies that the Pentagon needs to stay ahead of rivals like China. If these companies die, the implications would be significant because of their talented workforce, she said.

Sears credited the Air Force for stepping up “out-of-cycle” SBIR projects during the coronavirus pandemic. “This program was designed to rapidly fund meaningful national security projects focused on space, hypersonics and an assortment of technical challenges,” she said. This is one way to help prevent some of these critical companies from throwing in the towel.

Hartman, the venture fund partner, said there is a chance that the landscape in the space sector will be permanently changed.

“I’m fearful that COVID-19 on the heels of a couple of bad news stories like OneWeb and Bigelow will stop the flow of capital that has sparked the space boom we have seen of late,” Hartman said. “We’ve already seen that capital is drying up but I hope it comes back within months. Otherwise, we’ll see the end of the renaissance era.”

This article originally appeared in the April 13, 2020 issue of SpaceNews magazine.