YWR: Aegis is SkyNet
We’ll get to Aegis and the significance of April 13th, but let’s appreciate how we ended up down this rabbit hole.
There is money to be made along the way.
Outline
The Return of the Zaibatsu
A Global Defence Spending Surge
What is Aegis?
From ‘I shoot what you see’ to ‘You shoot what I see’
Aegis moves Onshore
April 13, 2024. The Penny Drops.
How we make money on this.
The Return of the Zaibatsu
In the July 30 Global Factor Model we looked at Kawasaki Heavy. Kawasaki ranks highly in the YWR model. Earnings estimates are rising, the stock is trending, and the P/E is 12x.
We learned Kawasaki is involved in many interesting business lines from motor sports, to hydrogen fuel supply chains, to Japanese missile defence. And as we looked into the defence business we learned Japan’s defence budget will grow 230% over the next 5 years.
And who benefits from Japan’s defence build up? It’s the old zaibatsu from World War 2. Mitsubishi Heavy, Kawasaki Heavy, Subaru (Fuji Heavy) and IHI (Ishikawajima-Harajima Heavy Industries).
Macarthur’s administration tried to dissolve the zaibatsu, but it never really worked. Now as Japan rebuilds its defence industry it turns to what worked well in the past.
To encourage Japanese companies to bid for projects and grow their military capabilities the MOD is promising to improve margins from 7.7% to 5-10% with inflation adjustments plus allow defence exports for the first time. Defence will be a new export industry for Japan. Mitsubishi’s presentation on the changes to Japanese defence is in the YWR library.
For Kawasaki, Mitsubishi Heavy and IHI defence is a teens % of the business mix, which is a turn-off because it’s not a pure play. However, if revenues can grow 100% over 5 years with improving margins, the business mix might change substantially. These companies might be 30-40% defence in the future. And the other businesses aren’t bad either.
A Global Defence Spending Surge
While Japan’s 43.5 trillion yen defence budget seems a lot, it’s only $62 billion/year compared with $300bn/year for China and $900bn/year for the US.
The world’s annual defence spending numbers are below. Most of these budgets will triple in the next few years. Finland at $7bn/year? Doesn’t that need to go to $25bn? Or higher? Same with Norway.
World wide defence spending is $2.4 trn/year, but look at everyone below the top 5. The top 5 spend $1.5trn while the remaining countries spend $900 billion. And these are not poor countries (Switzerland, Singapore, Kuwait).
Back of the envelope the rest of the world doubles its spending (at least) from $900bn to $1.8 trillion and the top 5 grow to $1.7 trn, with the US exceeding $1 trillion/year. That gets you a $3.5 trillion industry. My guess is this happens in less than 5 years.
What is Aegis?
When you look where Japan is going to spend their money you see Stand-off Defense Capabilities along with Integrated Air and Missile Defence are a top priority, along with drones.
And you find Japan’s flagship project is to build 2 new Aegis equipped ships which will cost over $1.2bn/each.
What is an Aegis equipped ship and why do they cost over $1bn each?
Why is this such an important part of the defence budget?
The Aegis Weapon System was developed by the US Navy and Lockheed Martin in the late 60’s to defend aircraft carriers from missile attacks. In Greek mythology ‘Aegis’ is Zeus’s shield.
The modern Aegis weapon system connects multiple ship, AWACS, helicopter and fighter jet radar inputs to create an integrated missile defence system for the fleet. The Aegis weapon system tracks all inbound targets and fires intercept missiles from the Mark 4 Vertical Launch System (VLS) which accommodates 128 missiles. The flat spot on the front of the Aegis ship, which looks like nothing, is the VLS.
Over the decades the sophistication of Aegis has improved along with its missile intercept technology. Aegis evolved from missile defence for an aircraft carrier strike group, to become a more universal ballistic missile defence platform which can intercept incoming missiles high up in the atmosphere.
Which is why Japan is paying $2.5bn for 2 of these Aegis destroyers to sail around the Sea of Japan where they will protect the homeland against inbound missiles from North Korea. It’s a floating missile defence system.
From ‘I shoot what you see’ to ‘You Shoot What I See’.
One of the unique feature of the early Aegis system was that it could leverage the radar of Hawkeye surveillance aircraft to engage long-range targets over the horizon, which the ship based radar couldn’t see. The Hawkeye radar was relayed to the Aegis ship command center, which would fire an intercept missile. This early necessity to integrate with other ships and aircraft was a unique capability.
Early days Aegis was ‘I shoot what you see.’
With the development of networking technology in 2014 Aegis developed the capability to do the reverse as well. Aegis could feed multiple incoming missile data to fighter jets, helicopters, or other Aegis ships which would shoot down the missile.
Aegis became a network. A networked system which meshed multiple radar inputs and missile attack options (early SkyNet)
The Navy called this ‘cooperative engagement capability’.
Or ‘You shoot what I see’.
You see where this is going.
Aegis Moves Onshore
Aegis worked so well the US Military decided to see what else it could connect to Aegis. The next step was to connect ground based missiles as well. Like the Patriot.
Aegis was evolving from a naval system into an everything missile system with control of ships, F35’s and ground based Patriot missiles.
Aegis also developed an ‘ashore’ version for NATO countries. Same radar and VLS set-up as the ship, but onshore. Romania has one and it was just installed in Poland too.
There are lots of integrated missile defence concepts in both the US and Europe, but Aegis seems to be the platform gaining the most traction. Aegis’s advantage is that it was never built to be a standalone system. Because of its naval history Aegis is far ahead in the complexity of integrating the air, sea and ground based missile defence assets.
It’s not official, but Aegis is effectively the platform for NATO missile defence.
April 13th, 2024. The Penny Drops
The world has missed the geopolitical significance of Iran’s April 13th missile attack. Everyone thinks April 13th is a precursor to WW3, but it could be the opposite.
Think about it. A US Aegis equipped destroyer parked off the coast of Israel, integrated with the IDF’s Iron Dome, integrated with radar systems in Saudi Arabia and Jordan created a giant, multi-national missile dense shield which shot down 300 missiles in a night.
Bamm!!
Move over White Sands. April 13th was the world’s first modern technology, live fire, mass attack missile defence exercise with Israel as the target…
And the results were astounding!
We’ve been hearing about ‘Star Wars’s since the Reagan years. For decades it has been considered an epic waste of money. ‘Star Wars’ was always an enormous pork barrel project for defence companies which would never work in practice. A Reagan era pipe dream.
Then April 13th surprised the world. April 13th showed the technology is real, it’s here, and it works better than anyone expected.
The implications are unfolding.
On July 31st Isreal assassinated a Hamas leader staying at an IRGC facility in the heart of Tehran. Iran was shocked, embarrassed, and vowed massive retaliation. Yet, two weeks later we are all still waiting.
And why is that?
Because the game has changed and Iran doesn’t know what to do.
If you are Iran what are you going to do? What big revenge move are you going to make? With missile defence whatever punch Iran throws, Israel can parry and punch back harder.
So Iran does the only thing it can do. Pretend it is taking the diplomatic higher ground by not retaliating. Maybe have Hezbollah do a few useless missile attacks just to say they did something, but effectively nothing.
In the end Israel has Iron Dome/Aegis/SkyNet and Tehran does not.
And the penny is dropping about the power of this capability.
Countries around the world realise Aegis (or Iron Dome) is a game changer and in the future you will either be in the Aegis fold or you won’t.
It’s a big message for Turkey.
It’s a big message for any country playing both sides of the fence with its military allegiance. There is a new killer application and only the most trustworthy partners are going to get access.
SkyNet is emerging so decide now whether you want to be in or out.
Taiwan for example, immediately recognised the significance of April 13th and wants to be part of SkyNet (Aegis Ballistic Missile Defence).
Does SkyNet mean everyone has to rethink the future?
Does SkyNet effectively take future invasion of a Federation country off the table?
Does SkyNet mean large scale war is less likely?
Does SkyNet mean peace in the Middle East?
How we Make Money from This
These are broad brush ideas and everyone needs to do their own stock specific research.
Lockeed Martin: It’s already run so much, but is the best way to play SkyNet through LMT? Defence spending grows and everyone wants Aegis?
Japanese Zaibatsu: They aren’t pure plays, but are the defence businesses inside Kawasaki and Mitsubishi Heavy hidden gems? Are we underestimating their future size and profitability? Will defence be 50% of the business mix for these companies in the future? Will we consider them defence companies similar to how we consider Japanese Trading companies as commodity plays? And will these Japanese zaibatsu with their historic shipbuilding capability become global Aegis ship exporters? When everyone wants an Aegis ship will they have to buy it from Mitsubishi or Kawasaki?
China: Does SkyNet mean China is investable again? Nobody wants to own Chinese stocks the day China invades Taiwan. But if Taiwan becomes part of SkyNet doesn’t that change the ability to invade Taiwan? And if that’s off the table, does it make China investable again?
Turkey: Does Turkey stop flirting with Russia and realise it has to get serious about integrating with Europe and NATO? Is Turkey another SkyNet play?
Let me know if any other trends come to mind.
Have a good weekend.
Erik
Great stuff Erik. A funny story about Star Wars. I know the head guy. That entire team was from Iran. They fled with the Shah and immediately started working with the Pentagon’s Star Wars team. Pretty soon the head of that program was Iranian.
Why isn’t it being used in Ukraine. I think it has more to say about how crappy Iran is than how successful Aegis is