5 reasons private equity is betting big on US Naval investments

Private equity’s appetite for defense investments is growing – and nowhere is that more visible than in US Navy-focused targets and related services, a subsector now drawing firms of all sizes and varying investment theses.

Some of the factors drawing PE interest in Naval-centric deals include: the need to clear a large manufacturing backlog and modernize the Navy fleet; the need to tap into AI and other tech advances; a reliable and deep-pocketed customer; and increased demand for more assets as geopolitical tensions flare.

In this feature, PE Hub heard from both PE investors and investment bankers, including retired vice-admiral William Hilarides, a partner at Ventus Industrial Partners; Ben Ramundo, a managing director at Arlington Capital Partners; Ravi Shah, a partner at McNally Capital; Peter Frankfort, a managing director at Greenwich Capital Group; as well as Ryan O’Toole and Eric Cartier, managing directors at Lincoln International. Below are some of the reasons why PE firms are leaning toward Navy-focused investments.

1. Rebuilding domestic Naval base

There is a historic buildup of Naval shipbuilding in the US right now, Hilarides of Ventus Industrial Partners said. “The tonnage under construction is as high as it was in the 1980s during the Reagan buildup, and because today’s ships are so much larger, it even rivals the tonnage produced during parts of World War II. This is caused by the fact that when the Berlin Wall fell, we cut back dramatically on our Navy ship investments. It was called the peace dividend, and that caused us to not recapitalize our ships for a long time, about 15 years.”

Because ships are cost intensive and it takes a long time to build them, once you are behind, Hilarides said, “you have to go way above to catch up.” The build-up is drawing private equity’s interest because that “dramatic increase is an opportunity. Without growth, PE would not normally be interested.”

One of the Pentagon’s highest priorities right now is rebuilding the domestic Naval industrial base, according to Frankfort. “The projection of Naval power is critical to the US interests for deterrence of aggression and protecting global trade, providing investors with long-term revenue visibility,” said the Greenwich Capital investment banker.

2. Fragmented suppliers

Shipbuilding is very intense work. For one ship class, the ship builder might have 9,000 companies in its industrial base to make one submarine or ship, according to Hilarides.

The fragmented supplier base creates opportunities for PE firms. For example, as it was becoming apparent that the US needed to double the rate at which it was building Virginia-class submarines, Arlington Capital had to act. “The problem was that, for large fabricated modules, there was no credible, scaled company to outsource to. Identifying that gap is what led to the formation of Keel,” according to Ramundo. Keel is a manufacturer of complex structures for priority programs within the US Navy, Army and Air Force.

There was also a similar need for the maintenance and repair side of the Naval market, the Arlington Capital managing director said. “Unlike with submarine construction, there was already a large vendor base supporting full-service ship repair, but that base is exceedingly fragmented – and thus, poorly coordinated. We saw a significant opportunity to assemble the best specialist skillsets across the trades under one roof, so a well-choreographed, turnkey maintenance and repair offering could be delivered to the US Navy and its prime contractors.”

Recently, Arlington Capital formed Highwater, a Washington, DC-based naval services platform focused on vessel preservation, repair and other specialist services for the US, Australian and allied fleets.

3. Deep-pocketed customer

The US Navy budget is more than $300 billion, a figure which is larger than the GDP of over 75 percent of the world’s countries and most economic sectors here in the US, according to Ramundo.

“If you deliver to the government and defense, you have certainty that they will pay and this is a very logical time to come to this business,” Hilarides added. Shipbuilders such as General Dynamics and Huntington Ingalls Industries have a backlog of over $45 billion each in ship orders, and if private equity firms are going to tap and help clear that backlog, they can make the money even faster, Hilarides added.

The deep pockets of the Navy have also drawn interest from the mid and lower-mid market players. “Demand is there, it’s budgeted for, and it’s durable,” said Shah. “This has created an opportunity in the lower mid-market to focus on maintenance, repair and overhaul, and companies that support skilled tradesmen who are building the fleets and repairing them, as well as supporting the small and medium shipyards.”

However, the customer can be a hard one. “The way they contract and the intrusiveness in the way they come to inspect cause many people to not like to work with the defense because they are a hard customer,” Hilarides explained.

4. High barriers to entry

Another factor that makes PE participation in the Navy-focused market difficult is that there are high barriers to entry. First, government requires security clearances both on the PE side and the management teams of portfolio companies, according to Shah. “The government is the customer here, and therefore, it closely considers the private equity firm that is going to own businesses that are serving as prime or subcontractor supporting the US intelligence community or armed forces.”

Secondly, suppliers to the Navy enjoy high barriers to entry, O’Toole, a managing director at Lincoln International, said. “Within the Navy procurement offices, price is not the primary decision driver. This affords acquirers the comfort of knowing that a business will typically not find themselves in a situation of having their work be ‘bid down’ during their ownership. This ‘stickiness’ is a sought-after attribute and driver of M&A value.”

5. AI applications and need for modernization

Although most ships operate for 30 or more years without any need for engine replacement, electronic systems usually get upgraded and replaced after a few years to match modern systems.

Artificial intelligence has also become a critical factor in the way navies operate, both defensively and offensively. “AI is central to the growing market for unmanned surface vessels and unmanned underwater vehicles,” explained Frankfort. “These systems use AI for navigation, obstacle avoidance, sensor fusion, target recognition and mission planning.”

Lincoln International’s Cartier said he has seen some clients developing unique applications that they can install on ships to leverage AI for collision avoidance and other sorts of capabilities that can make the ship more effective.

Arlington Capital-backed Keel, for example, is piloting Palantir’s ShipOS product, which is aimed at improving efficiency and predictability of its supply chain and manufacturing process. “With that enhanced business intelligence, the company can utilize its capacity – both labor and equipment – much more effectively, improving throughput and further accelerating deliveries for our customers,” Ramundo, a managing director at Arlington Capital, said.

Mission critical

Private equity could be an upgrading partner to help companies achieve “mission critical deliveries,” according to Cartier.

Defense officials are increasingly calling upon private markets to take a significant role in the modernization of defense assets. Officials such as Stephen Feinberg, the deputy defense secretary who co-founded New York-based Cerberus Capital Management, are seen as pushing for private markets to do more.

Many Navy-focused companies were founded during WWII or immediately after, and that generation of founders is now gone, Hilarides explained. “Most of these companies are run by grandchildren who may not be interested in running those companies. That brings a perfect storm of aggregation and equity investments in a growing enterprise.”

There is also an aging ownership dynamic within the defense market, according to Shah, and part of the role for lower-mid market private equity is to take businesses that are in this category and ensure that they continue to grow. “Many of these businesses are providing critical support to the US national security apparatus, and it is important for that work to continue. PE can invest in that business at the scale and speed that is really needed.”

For more on the Aerospace and Defense sector coverage, PE Hub recently explored themes that made 2025 a record-breaking year for private equity deals in the sector.