Space startups an investment target for big defense contractors

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Bank of America Merrill Lynch analyst: Large defense contractors need to 'be able to bring in creative forces and ideas'

WASHINGTON — For large defense and aerospace firms looking to up their innovation game, investing in commercial space companies can be a winning strategy, said Ronald Epstein, senior equity analyst at Bank of America Merrill Lynch.

Investing in or outright acquiring space industry startups “I think is an important way for a big company to remain innovative and nimble,” Epstein said Nov. 10 at a Foundation for the Future online conference on space ventures. 

Big DoD contractors need to “be able to bring in creative forces and ideas,” he said, adding that Lockheed Martin has pursued that strategy successfully so far. The company owns 50% of United Launch Alliance and in recent years has invested in a number of commercial space companies including Terran Orbital, Rocket Lab, ABL Space Systems and Orbit Fab. 

Raytheon recently acquired commercial satellite manufacturer Blue Canyon Technologies and the spacecraft engineering firm SEAKR. Boeing has made an investment in Virgin Orbit. Northrop Grumman also has invested in Orbit Fab.

Epstein noted that Lockheed’s third-quarter financial results revealed “some hiccups in some of their big defense programs. But they also took some positive gains on some of their investments.” These gains are “peanuts compared to the F-35 [fighter aircraft program] but it’s going in the right direction,” he said. Further, investments in commercial technologies are “feedstock for future innovation at the company.”

Epstein, who also is a mentor to startups at the Techstars accelerator, said large defense contractors spend very little of their own money on innovative research and development. “Any defense contractor that’s listening to this would probably take issue with this comment, but it’s true,” he said. On average about 95% of the R&D done by these larger firms is funded by the government. “So it’s not really research, it’s revenue generating research that is customer funded and is what the customer wants.”

Big defense firms can provide startups much needed funds to pursue cutting-edge technologies  but businesses need to be understand investors’ motivations, said Michael Mealling, general partner at Starbridge Venture Capital.

Seeking investments from large primes can work out well for many space firms “but you’ve got to realize that you’re playing with a Tyrannosaurus rex,” Mealling said Nov. 9 at the Foundation for the Future conference. 

“You may end up as the egg dancing with the chicken that might eat you,” he said. “And that’s the risk. And we’ve seen that happen a lot.”

An emerging sector of the space industry where small firms are likely to be acquired by conglomerates is in-space computing, Mealling said. 

“There’s a lot of conversations around in-orbit compute capability at significant scale,” he said. “And so anybody that’s working on that has to understand that the large cloud players can easily move into that market, and you have to understand their motivations for wanting to work with you … Some of those conversations are difficult. And sometimes they can get contentious.”