David Rosenthal: uncertainty

Transcript context

…Correct, our allies, because the US government basically has a role on anything and can put the kibosh on Lockheed exporting to anyone. It's not terribly profitable. Their net income margin is 8%, as we've been talking about the whole time. You can see the cost-plus pricing right there at the bottom line of the company. Lockheed Martin makes a bunch of money. At the end, they only have 8%. That's basically contractually figured out, I think. Whenever one of these contracts gets bid out, the big defense contractor says, I'm going to slap 8%, 9%, 10%, 11% on top of it, and that's going to be the cost. That is exactly why their financial statements look the way they do is because that's exactly how the government decides to fund it. Which we should probably talk a little bit about the rationale for that. I'm no expert in this, and we should probably have an economist on ACQ2 at some point in time to talk about it, but my understanding is that while Warren Buffett and Charlie Munger hate cost-plus contracts, and in general, they set up terrible incentives. They are useful in cases where you don't know what the cost is going to be, but it's an incredibly important investment to make. Traditionally, that has been defense expenditures. We need the U-2. We don't know what the cost is going to be, but we need it to happen. We need the Corona program. We don't know what the cost is going to be, but we need it to happen. I think that is the rationale of how we got here. But it doesn't make sense when the government's buying more modern things. We're buying Software as a Service. Let's say I'm making Slack, and I'm selling that to the government. If the contract to procure something that looks like Slack requires me to bid on it in a certain way, and I'm using Slack. There are lots of defense software you can think about here. Palantir, for example. How do you let the government put out a contract to bid on that's structured a certain way, when the way that you've decided to structure your company where you do R&D upfront, you're willing to take on some of the risk, and then you want to sell something and amortize your R&D across all of your customers the way that every tech company does, and the way that you get operating leverage on your company, that doesn't fit in these gigantic cost plus contracts. In fact, what it insures is you cannot get operating leverage on your company. No matter how large you scale, you will never have big fat gross margins that outrun your fixed costs. It's like the opposite of what every tech company is trying to do.…

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