When it comes to investing in space and defense tech, Leonid Capital Partners is doing something different.
What we do is we allow companies, especially early stage companies working in technology and research specific environments, to borrow money against their government contracts, which is actually, oddly, a weirdly unique space in the market in the sense that there's not really been a functional way for people to leverage those government contracts to bring in additional growth capital for their businesses.
Unlike venture capital firms, which typically provide funding in return for an equity stake, Leonid Capital Partners is in the private credit business.
It's kind of like asset-based lending, but instead of securing that loan using machinery or real estate, companies can borrow against their government contracts.
The firm's co-founder and president, James Parker, a former NASA flight controller, says the perceived credit quality associated with this type of lending doesn't actually match what the data show.
We just ask a very simple question, which is, recognizing the government has the right to cancel these contracts, how often do they actually do so, right?
And what we found, it was, you know, it was a four terabyte, right now we have a four terabyte proprietary data set.It's about 20 years of contracting history.What we found is when you core it down into our specific subset of the market, i.e.
overweight national security and overweight critical technology development, The cancellation rates exceedingly low and so much so that it creates a pretty compelling investment thesis, especially on a credit perspective on that.
There's just sort of a disconnect between the risk and the actual reward on the environment.
Founded five years ago, Leonid counts Canopy Aerospace, ABL Space Systems, and Phase Four among its clients.
It's one of just 20 investors in the Defense Department's trusted capital provider marketplace, which was created to help startups in emerging technology sectors critical to national security access capital.
On this episode, which was taped in September, so well before the presidential election, Leonid's Parker discusses the investing landscape. And what's enticing him right now?I'm Morgan Brennan, and this is Manifest Space.
What we do is we invest capital into national security critical technology initiatives.Specifically, we have a focus in the DOD, the intelligence community, and the space markets.We do so via pretty unique model, however.
If the predominant amount of investment comes into the space via traditional venture capital, targeting dual use technologies, or even defense only technologies, we actually come in with a credit model.So we run a private credit firm.
We focus exclusively on U.S.national security contractors.Although national security is, there's a lot of things that fall under that envelope, even if they're outside of the traditional government department identifications.
And what we do is we allow companies, especially early stage companies working in technology and research specific environments, to borrow money against their government contracts.
which is actually oddly a weirdly unique space in the market in the sense that there's not really been a functional way for people to leverage those government contracts to bring in additional growth capital to their businesses.
That's really fascinating.How does that work?How did this idea come about?
It's a long and tortured story just on a weird Venn diagram of my partner and I's background.But fundamentally, the core disconnect in the market is that Banks won't loan money against U.S.
government contracts because the government has a 30-day cancellation right on any contract they want for any reason with no penalty.
So in a lot of ways, from a business perspective, it's not really a contract the way you and I would really think about things.
And banks understandably don't want to loan five-year money against a three-year contract that could disappear effectively overnight. So there's sort of a reasonable disconnect there.
What really happened at the end of the day was my partner and I, we come from sort of a variety of backgrounds.
I was originally an engineer in the aerospace world before I went to business school and had a finance career in the restructuring side of things.My partner similarly has got a PhD in neurobiology.
He was a DARPA funded neuroscientist, ended up in business school where I met him and had a private equity career.
We had found this gap in the market, and then we just asked a very simple question, which is, recognizing the government has the right to cancel these contracts, how often do they actually do so, right?And what we found, it was, you know, it was a
Right now we have a four terabyte proprietary data set.It's about 20 years of contracting history.What we found is when you core it down into our specific subset of the market, i.e.
overweight national security and critical technology development, the cancellation rate is exceedingly low.And so much so that it creates a pretty compelling investment thesis, especially on a credit perspective on that.
There's just sort of a disconnect between the risk and the actual reward on the on the environment.
So we decided to come at it with this more unique model to kind of stand alone in the market, really give people an opportunity to take a run and what we think is a very founder friendly model in the sense that it allows our borrowers to the entrepreneurs to keep more of the business, to make more of a run at the business rather than diluting themselves through VC or, or having to run and, you know, for the run is the wrong term, but
having to turn to sort of the more traditional corporate development buyout by one of the larger primes.We just like the idea of giving people a chance to take a run of things.
This is so fascinating to me.I mean, I feel like asset-backed lending is having a moment right now and has been really, it's been growing pretty exponentially for the last couple of years.
And it's almost, it reminds me of asset-backed lending, but the asset here is the government contract.
That's correct.And it private credit is definitely taking caught a big institutional bid right now.And fortunately, we're enjoying that as well.
But what this comes down to is the very sort of like, what's your interpretation of what what's an asset like?Specifically, what's a lendable asset?Right.
So obviously, we can't go seize, you know, seize those contracts and execute on somebody's hypersonic missile research.Right.Like, but
The way we look at it is that there is a disconnect in the market between the perceived credit quality of these contracts and their actual credit quality.And so we're trying to drive a truck through it while we can.
Hmm.OK, so what's compelling to you right now?
It's so much, especially in the space market, like obviously the space market's extremely hot.It's sort of gone through its swales of funding.
You know, if you go from the hype through the SPAC, it's sort of all the SPAC problems to sort of back now where things seem to be moderating.It's such a capital intensive side of the business.
It's something I personally have a deep appreciation for and love for in the space market in general, just having grown up a space geek. My mom's moon landing newspapers are on the wall of our office here and have been for years.
But like fundamentally, like the challenges people are trying to undertake within this space can be so capital intensive.
They don't align well with very traditional venture backed expectation returns, certainly not in certain venture, you know, specific venture models.But there's also so many interesting subsets of the space market.
that I think are either underappreciated or underinvested or both.The world's not all heavy launch, right?There are digital twin architectures, there's unique propulsion systems, there's material science.
I think the best way I heard the space market, somebody was making an argument and it was like, space isn't an industry, it's a domain. It's a place where all of the regular industries you're already familiar with.
It's just a new place to try and operate it.So if you really want to invest in space, you find what you're comfortable with in a terrestrial standpoint and just find the space analogy or the space operator that's focused on that.
And you can get yourself exposure to the space market that way.You don't always have to chase the heavy launch fireworks.
But you are invested in heavy launch as well, right?ABL Space Systems?
We do.Yeah.Like in particular, what we like about ABL's market is that it's a responsive launch versus solely heavy launch.Obviously, they have a roadmap up to heavy launch, like, you know, like anybody in the launch market.
But their responsive launch, their sort of containerized tactical responsive launch scenarios, the use case is so obvious in a potential conflicted environment.
So if you really break it down, there's only three FAA licensed launch facilities in the country.There's Kennedy in Florida, there's BOLSA in Texas, and then there's the Vandenberg Space Force Base in California.
That's all fine and good when there's no problems.But if you imagine some sort of increased conflict with China or Russia or something that creates a more kinetic environment, it's pretty easy to take out the three only, we'll call it,
kitted up launch facilities in the country.In fact, Vandenberg got knocked off line for three or four months not that long ago from a wildfire that no one to this day can can actually say of whether or not it was set on purpose or not.
So what ABL's fundamental work with the Space Force is, is creating these, you know, containerized system that allows you to pull up, put up a fully usable launch facility in, say, a large parking lot of an Air Force base inside of 22 days.
And then they want to put hundreds of these in strategic depots around the country.I just think it's fascinating.I think the use case is very obvious.I love that take on it.And I love that angle on space and launch in particular.
So we know, I hate to use this moniker, but I'm going to, we know space is hard.We know these investments can take long lead times.
So whether it's AVL or whether it's some of the other names that you've invested strategically in, how do you think about that return profile, especially since you're approaching this differently than say a more traditional venture capital firm?
I mean, I know the VC folks I speak to, a lot of them say they think about this on a five to eight year, maybe 10 year, You know, turn horizon.
So this is another thing that I love our model and why I think our borrowers love it as well is that we have a very discreet view on the company, right?
Like we are focused on the company's wherewithal and their ability to get through and execute on particular government contracts.
right, which, you know, if you go all the way from the silver side of things is, you know, 12 to 18 months, if you go up to more traditional three year contracts, that's kind of our scope of exposure.
And, but critical to what we do, like one, I'm underwriting these companies on whether or not they can get through that period of time.So it allows us to open up our credit box a lot wider than a traditional lender.
I'm not trying to do a, you know, a going concern assessment.I'm not trying to make a commercialization assessment of whether or not there's a greater business beyond the government for them.
I don't even have to do technology validation, quite frankly, because the government has already ordered it.They're the ones that have decided that this is the group to do this work in this particular field.
So it allows me to move very quickly and be very reactive.Again, my horizon is a bit shorter, but I think critically for our borrowers is that we understand that things get delayed, especially as it relates to the government.
So we've set up a pretty specifically, bespoke pay when paid model, which is to say you only make P&I or your monthly, you only make your debt service payments to us when you get paid by the government.
So if you've got a delay, if you need a contract mod, if your contracting officer goes on TDY and is not not replying to your emails for two or three weeks, we're not freaking out because you're not missing your monthly payment.
We only get paid when you get paid.And so it allows people to really plan out their cash flow appropriately as it relates to these contracts with some of these weird nuances that can happen.
I mean, continuing resolutions or government shutdowns aside, which are obvious in these cases. just what happens on a day-to-day basis.Going back to, sure, space is hard.Things get delayed.The government understands that.
The government is still good for the money.You just need a financial partner that isn't going to have a disconnected expectation when it comes to the highly technical and complex work that you're doing.
You know, acquisitions reform, it's something that certainly gets talked about constantly, especially when you are talking about defense tech or space startups and dual use tech companies, but even the defense contractors.
I mean, L3Harris CEO, Chris Kubasik was talking about this with me just recently as well.And the fact that there just needs to be acquisition reform.
And I wonder what you see from your key vantage point and whether you think that's something that is in fact happening or more needs to be done.
I think it's certainly something everyone is aware of, and I think everyone has their best of intentions.
I don't think, frankly, the country can afford to wait to fix that, given some of the key technologies we need to work either behind on or need to develop more of.
Good intentions are great, but the changes are likely to take so long that it's just not something that I think in my horizon that I can really try to take into account.I love seeing some of the things.
I love the idea of TAC buys and STRAP buys out of AppWorks organizations and the idea of AppWorks and similar organizations and the likelihood of them expanding those private capital partnerships.
OSC, the Office of Strategic Capital is a great step in the right direction as far as just at least getting new capital in.But as far as baseline acquisition,
I always go back to, I think it was General Moffat that was in charge of putting the ICBM program back in the early stages of Silicon Valley, which effectively he got given an unlimited budget.
And you know, it was everything was judged against whether or not ultimately at the end of the day, he got a ICBM program that was actually working that could put a missile in Red Square. Right.And yeah, he wrote a lot of checks.
There was a lot of waste.There was a lot of failed technologies.But at the end of the day, you amortize everything over that successful capability. And I think that's fundamentally kind of what we're missing.
I know I grew up in the era of the $900 toilet seat and the $800 hammer that everyone used to be upset about in the papers.I just think that there's a certain amount of risk you've got to take when you're really pushing the envelope on technologies.
And the government has to be willing to lose that money and think about things more in the terms of capabilities and equipment and technologies that we can put in the hands of the warfighter that we give
give our soldiers and our country the best chance to succeed and survive without being so overly dogmatic about where every dollar goes and exactly how we go through this process.It's a risky world.
And I love going through technology readiness levels assessments as well.But at some point, we actually have to get the right things pointed in the right direction.
Okay, so the government needs to get over some of its risk aversion.And you're not the first person to say that to me.
But what about from an investor standpoint, as we do see more money come in from the private sector to this broader aerospace and defense sector right now?
I think what you've got is sort of a disconnect.And I saw an article somebody wrote the other day, which was like, in order to fix this, we need to change the exit multiples on our industry, which is a great thing to say out loud.
Sure, we're just going to fundamentally change the exit multiples to 10 instead of 4.But the fact of the matter is that This industry's got the lowest exit multiples on record.
Therefore, the venture, the dilution entrepreneurs take is the highest on record because you just don't have that thousand X hook that comes off of things.
The capital that comes in needs to have a different return expectation, given the timelines it takes to do business with the government, given the cap on profitability the government puts on particular contracts.
Unless you can change those things, you're not going to see a fundamental change in the economics, and then you're never going to see that super vibrant venture side of things.
Frankly, this is one of the reasons why I like our spot is that I think the industry is hampered by not having access to the full suite of capital raising tools.
The fact that nobody's really bought a brought a functional debt product to this early side of the market to the market before is, it's a little surprising, I'm happy to be in it.But
At the end of the day, if you don't give people all of the traditional tools of capitalism to build their business, you're always going to have sort of this hampered development.
And the work people are doing is too important to hamper, quite frankly.
Do you think we're entering bubble territory?
I had one longtime defense startup investor say to me that he thinks we are, and he thinks the risk is you see investors pour a lot of money into a lot of companies, get burned, and then you see an overcorrection in response to that.
Yeah, I think you're... I, I agree with that.The issue right now is if you actually look at the, you know, there's a lot of decent, eye catching numbers on defense tech investing right now.
But if you actually break down to where that money's going, it's going to like three companies.It's effectively SpaceX and drill and like shield AI, and maybe a few more.
So I and I think SpaceX probably took up 80% of that headline number that goes out there.So yes, like, people like there's money going around to a lot of different places.
I'm not sure anybody is so overinflated that like at least not I don't think anybody's going to get burned by SpaceX.I think that's probably a good investment in the long run.So I don't think you're going to quite have that.
That same call it like, you know, hand on the stove moment.I think what the real issue is, the timelines take too long, you're going to not see the proper fund level returns.
And so you don't get quite that same level, like backload of additional LP capital that you need to come in to keep supporting these companies through the development cycle.
I think fundamentally, the DOD side, I think we're in the beginning of what is crazy, a super cycle on top of the super cycle.
If you actually look at our shift, our strategic shift from discrete special forces engagements, you know, a 20, 30 year war on terror against technologically over, you know, overmatched opponents, we're moving into, you know, great power conflict, China, Russia, logistics, and a whole host of additional challenges that go along with that.
There's just like kinetic frontline aside, you've got logistics challenges, you've got supply chain challenges, you've got domestic cybersecurity. I think we are at the beginning of a huge amount of potential of certain government related investment.
And I was just at a JP Morgan kind of state of the economy presentation yesterday.And one of their primary themes is, you should try to invest alongside the US government when you can.
So I think we actually have a lot of potential and opportunity coming up just from the sheer amount of work I think that's coming off of it.We just have to either change expectations or change how we think about investing in the space.
And so if I bring this all full circle and back to space specifically, what are the technologies you're most excited about and where do you see this space economy specifically headed over the coming years?
Yeah, I love this sort of picks and shovels place more than anything in the space world.So digital twin architecture is a huge issue, right?
So if you've got an asset on orbit, it's very hard to start testing it if you want to try to get new capabilities out of it, because if you knock it offline, you may never get it back again. I love that angle.
We work with a company called Phase Four that does a very unique ion propulsion engine solution.
Whereas if traditional ion propulsion engines work on noble heavy gases, namely xenon, which happens to almost exclusively come from China and Russia, Phase Four stuff works on any gas, including all the way down to hydrogen.
And if you think about it, and I remember the last episode you did, you were talking about very low Earth orbit.
There's a potential there where with phase four, you can put what amounts to a scoop on the front of it, skip a spacecraft off the atmosphere, collect and uptrace gases that actually feeds back into the ion propulsion engine that keeps it at a particularly low orbit, sort of in perpetuity, which creates a whole host of new capabilities, which I just find fascinating.
That's one of my favorites out of the market right now. And we just did a deal with Canopy Aerospace.
They do really unique materials on the ceramic side of things, which obviously just more and more material science are just going to be, they're just new uses, new uses in space require new materials.
So that's just an obvious, like right down our fairway sort of deal.
You could say we're largely agnostic when it comes to space, especially with my background, but I do love the sort of more unique focused approaches to what I think is just going to be a game-changing sort of era when it comes to the impact that the space industry has on, you know, not just the government, but just mainline command.
Well, James Parker, Leonid Capital Partners' founding partner, thanks so much for joining me in this conversation.Appreciate it. That does it for this episode of Manifest Space.
Make sure you never miss a launch by following us wherever you get your podcasts and by watching our coverage on Closing Bell Overtime.I'm Morgan Brennan.
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