The Perfect Stock for a Dangerous World

I was in Manhattan a few days before the 10th anniversary of Sept. 11. There were reminders of the upcoming anniversary all over the city. The date inspired a lot of reflecting on how America has changed since that horrible day.

When I arrived in New York City, I didn’t intend to find an investment theme that grew directly out of the events of Sept. 11. I stumbled on it, by accident, at the Gabelli 17th Annual Aircraft Supplier Conference.

My beat is financial markets. So I don’t want to write a treatise on all the ways America has changed in the last decade. But I do want to focus on one important way it has. It directly affects our next investment idea, which is a remarkable company doing some extraordinary things. The stock ought to easily double in 2012 if management can come anywhere close to hitting the numbers it laid out.

Let me go back a few days before the conference. I happened to watch an episode of Frontline, called “Top Secret America.” It’s based on the work of Dana Priest and William Arkin. I admire Priest, who is a legendary reporter at The Washington Post. Her expertise is on matters of intelligence and the “war on terror.”

What Priest uncovered as part of a near two-year investigation was a secret America growing up in the wake of Sept. 11. After Sept. 11, America’s intelligence, surveillance and counter-terrorism agencies basically got a blank check to fund their efforts. The CIA got a billion dollars right away. So did the National Security Agency (NSA). “What we found in the years immediately after Sept. 11 was that the existing agencies grew enormously,” Priest says. “They doubled in size, many of them, and new organizations were created as well, big ones.”

There was a boom in new agencies geared to fighting this new war. Consider that in 2002, there were 34 new organizations created to work at the top-secret level. In 2003, government created 39 more; in 2004, 30 more; in 2005, another 35; and more each year since. “Every year,” Priest goes on, “more than two dozen, sometimes three dozen, entirely new federal organizations dedicated to counterterrorism [were] being created after Sept. 11.”

And each agency, after its creation, grew and grew. One example is the Office of the Director of National Intelligence. The DNI started as 11 people in the Old Executive Office Building. In short order, it grew to a couple of hundred people and moved to a bigger building. It had two floors in the massive Defense Intelligence Agency building. Still, it grew. “So they moved to some of the priciest real estate in the Washington area,” Priest says. “And now they are gigantic — 500,000 square feet, five Wal-Marts stacked on top of each other.”

At the conference, the big topic of discussion was defense spending. Everyone is expecting defense-spending cuts. They are inevitable. And this will affect many of the companies at the conference because they have large defense businesses.

But there is one aspect of defense spending that isn’t going go to go down. In fact, broader government spending on intelligence and surveillance and covert warfare is only to go up.

What’s going to be cut are the traditional battlefield programs. The big stuff: Tanks. Submarines. No one is going to let the air out of a ballooning secret America. “No one’s talking about turning them off,” Priest says. “It’s not like they’ve got mobile trailers that they’re up in, and then when the floods recede, they’re going to take them away.”

The rules also changed, greasing the skids. Government made it easier to higher contractors to skirt the slow process of hiring more federal workers. Now, when they want to grow quickly, they turn to the private sector. Priest talks about how the big defense contractors — CACI, Lockheed Martin, L-3 — and others saw this boom in intelligence, surveillance and the like.

The “war on terror” is not one that needs tanks and submarines and fighter jets. It needs to gather information. It needs to analyze that information. It needs surveillance equipment. Smart weaponry. Unmanned drones. It’s a top-secret America.

Priest talked about how she discovered that nearly a million people have top-secret clearance. That’s 2.5 times the population of Washington, D.C. There are 1,900 companies and 1,100 federal organizations that work at the top-secret level.

It also seems independent of political affiliation. President Obama has shown an affinity for the covert, as David Ignatius reports in a column titled “The Covert Commander in Chief.” Obama stepped up the pace of Predator drone attacks over Pakistan. He approved the raid on Abbottabad that killed Osama bin Laden. He has favored the covert on many other occasions. “The president appears to be ratcheting up intelligence and paramilitary operations,” Ignatius writes, “even as he withdraws uniformed troops from Iraq and Afghanistan.”

All of this costs a lot of money.

I am not going to pass judgment on what’s happening here. You can decide for yourself. I would encourage you to read Dana Priest’s and William Arkin’s work. There is a lot out there on the web, too, in addition to a book, plus the Frontline episode.

Some of their work is mind-blowing. If you were to start talking about this stuff at a dinner party, your friends would think you were a conspiracy theorist. But this is real. I mean, we’re talking about massive nondescript buildings in the Washington area that might be one or two floors up, but go 10 stories down. One of the guys on TV said they have shops and restaurants down there “just for them.” I’ll never look at the Washington suburbs in quite the same way again. What are they are all doing? No one knows for sure.

Anyway, my main focus here is how we can invest intelligently to secure our own financial futures, given the world as it is. And the above mark an unmistakable trend and a big change from the way we used to think of defense and security in a pre-Sept. 11 world. This will have an impact, positive and negative, on a slew of companies.

But I have a favorite that will benefit from the proliferation of top-secret America. It is, as far as I know, the only pure play on the theme.

Out of consideration for the subscribers of Mayer’s Special Situations, I can’t reveal the name of the company. But here’s a hint: It was one of the company’s that presented at the Gabelli conference.


Chris Mayer,
for The Daily Reckoning