Vale the New World Order
War is apparently loose in the world again. According to the Peace Research Institute of Oslo (PRIO), there were 59 armed conflicts in the world in 2023, the most since the end of World War 2. Many were local conflicts or internecine fights. But it is the scale of the conflict in Ukraine and the military support it has received from so many Western countries that serves as a reminder of a world we hoped we had left behind after the collapse of the Soviet Union in 1991 and the end of the Cold War.
Vladimir Putin’s dramatic escalation of the war in Ukraine in February 2022 (following his invasion of Crimea in 2014) represents one of the few occasions since the end of the Cold War when one country blatantly tried to annex another.
A very different type of war - the October 2023 attack on Israel by Hamas, followed by Israel’s invasion of Gaza - reinforces the idea that the last 30 years of relative peace was the exception, not the norm.
The new arms race
National governments are re-equipping their militaries in anticipation that the present tensions may well escalate.
According to the Stockholm International Peace Research Institute (SIPRI), world military expenditures rose for the ninth consecutive year to an all-time high of $2443 billion. For the first time since 2009, military spending went up in all five of the SIPRI's geographical regions, with substantial increases recorded in Europe, Asia, Oceania, and the Middle East.
It is little wonder that defence industries and national security technology firms are experiencing a surge in interest and investment. The Australian Financial Review couldn’t have put its 5 July 2024 headline any better: “The next global investing megatrend: war stocks”.
On a similar vein, the UK’s Financial Times recently reported on booming employment growth among traditional defence suppliers such as Lockheed Martin, Northrop Grumman, and General Dynamics.
According to the FT, “Global defence companies are recruiting workers at the fastest rate since the end of the Cold War.”
Its report noted the impact of the Ukraine War on the thinking of governments, “The sudden jump in orders after decades of low volumes, combined with competition for digital skills from technology groups and a labour market still dealing with Covid-era staff shortages, are some of the factors driving the industry-wide hiring spree.”
Ukraine also revealed how quickly the nature of warfare can evolve. The use of drones on the battlefield is a case in point, as is the fact that Russia has effectively lost more than a third of its Black Sea Fleet to a country that does not even have a navy.
Is the Pacific becoming an oxymoron?
The Asia Pacific, more recently spared the horrors of transnational conflicts, is nonetheless a region characterised by complex geopolitical dynamics. These include territorial disputes, the rise of China's military power, and North Korea's nuclear ambitions.
India, meanwhile, has been engaged in serious border skirmishes already this decade with both Pakistan and China. All three countries are nuclear-armed.
These factors have prompted countries in the region to modernise their defence capabilities.
The cyber threat
In our June edition of Tech Round-Up we discussed the ever-present threat posed by cyber incursions. What is not widely understood is the extent of vulnerability in national infrastructure to cyber-attacks from foreign states. Governments everywhere are deeply concerned about the dormant malware that is quite possibly sitting within key infrastructure such as air traffic control, roads, ports and the financial system. Want to cripple a country? No need to attack the old-fashioned way. Just cripple their economies.
Against this backdrop, Government spending on cyber defences and intelligence generally is on a tear.
Witness the announcement only last week that the Australian Government is spending around A$2bn building secure data centres with Amazon - the so-called Top-Secret Cloud - so that its military and spy networks can communicate with its allies without touching the open Internet.
And guess what’s at the centre of the new arms race? Advanced technologies and innovative defence solutions.
Enter the VCs
Sniffing the opportunity, VC firms have proven keen to invest in startups and scale-ups that can use cutting-edge technologies to address the new and emerging security challenges.
Some bigger-name generalist VCs are getting in on the action in the USA. We are seeing a broadening of focus from the ‘softer side’ of national security technology – software, to increasing investment in hardware and offensive systems. Even VCs more synonymous with Silicon Valley and internet investments have been placing major bets this decade.
For instance, Anduril Industries raised its $US1.5 billion Series E funding round led by Valor Equity Partners, which included (among others) mainstay venture capital firms A16z and General Catalyst. Anduril develops advanced autonomous defence systems to enhance military capabilities, including drones, sensor networks, and AI-powered platforms.
A bet each way
VCs also invest in firms with dual-purpose technologies, where the products provide both civilian and defence capabilities. Varda Space Industries is an example of re-entry capsules that manufacture pharmaceuticals in space and also serve as hypersonic flight test platforms for the U.S. Air Force. Their US$90m Series B funding round included participation from Khosla Ventures, Founders Fund and Lux Capital, all of which are actively investing in dual-use technologies.
In Japan, according to a Nikkei Asia report - “Japan's defence and aerospace startups are seeing growing interest from U.S. venture capital as the government here pushes to bolster the country's defences while receiving less attention from investors at home, where there is a less-developed funding mechanism for the industry.” We are already seeing this change with increasing interest from Japanese powerhouses Sumitomo and Mitsubishi, and venture capital firms like Global Brain.
Here come the Diggers
In April 2024, Sydney-based Periscope Capital Partners announced that it would invest a billion dollars over the next ten years, adding to the firepower of Australian firms Beaten Zone Ventures, 1941 (Bondi Partners / Ellerston) and Salus Ventures.
The scale of investment is significant, and governments via various organisations such as the US DIU and NSSIF are also tipping funds into defence startups.
The flow of dollars is producing solid commercial outcomes for innovators.
Take North Ridge Partners’ client, Hypersonix Launch Systems. In June 2022, the Australian government awarded A$8 million for manufacturing and launching the 3D-printed DART AE hypersonic test drone.
Then in 2023, it announced that it had been selected by the US Defence Innovation Unit (DIU) to provide hypersonic vehicles for landmark testing. To win, it had to beat a field of major international aerospace companies competing for the DIU contract under the Hypersonic and High-Cadence Airborne Testing Capabilities (HyCAT1) program.
The deal with the DIU highlighted Australia's growing importance as a hub for defence innovation.
That aged well
In 1992 Francis Fukuyama famously declared the ‘end of history’ in an eponymously named book. The central tenet of his work was that liberal democracies had won the war of ideas.
Would that it were so.
Perhaps Putin - a former KGB officer and by then a middling local government functionary of little import living in Leningrad - read the book and decided to edit the conclusion.
With increasing venture capital investments, supportive government policies, and a focus on addressing regional security challenges, defence startups are operating in something of a purple patch. If geopolitical tensions escalate, expect the money funnel to flow even faster.
National Security Technology Vertical
New defence technologies are going to be front and centre in the new world order. North Ridge Partners’ National Security Technology vertical provides tailored strategic advice, fundraising, and M&A support for companies operating in the aero/space, cyber and defence sectors.