Government Services & Technology Sector Thesis¹

Overview

Investors are closely monitoring key risk factors including elevated interest rates, high inflation, geopolitical conflicts, and the 2024 U.S. election cycle. In search of targeted growth opportunities, our investment team has gained conviction in the government services technology niche based on a thesis that:

1. Government spending has been countercyclical, creating structural resilience to systemic risk; and

2. Long-term government spending trends will drive rapid, sustainable growth for private businesses that can repeatably identify, comprehend, and alleviate critical administrative pain points.

The U.S. government, the largest customer in the world, is anticipated to spend ~$10.5 trillion between its local, state, and federal arms in 2024.1 The evolving priorities that shape this enormous expenditure will create both winners and losers of for-profit organizations and their financial backers. As explained below, we believe that focused exposure is worthy of an addition to our private markets’ portfolio.

Part One: The Macro – Significant Countercyclical Spending:

Over the past 50 years, an increase to federal net spending as a percent of GDP occurred during all six recessions:

Federal Net Outlays as a Percent of Gross Domestic Product (1975-2022)

Source: Federal Reserve Economic Data, Federal Net Outlays as a Percent of Gross Domestic Product, Dec. 2023

Part Two: The Micro – An Examination of Key Long-Term Challenges Facing the U.S. Government:

Investors that achieve financial success in this segment while hedging against macro risk can do so through attachment to durable, investible spending trends:

Migration to Cloud Computing

• Despite allocating over $74 billion annually to civilian IT expenditures, the federal government lags chronically behind the private sector in adopting cloud computing.

• Agencies are routinely pigeonholed into allocating 80% of their IT budgets to maintaining existing, antiquated IT infrastructure – crumbling legacy systems that carry a higher probability of maintenance costs overruns, cyberattacks, and project failures.

US Annual Federal Civilian IT Budget ($ in Billions), (2017-2024)

Source: Statista, “Federal government information technology (IT) budget in the United States from FY 2015 to FY 2024, by department,” July 2023

Workforce Aging

• The U.S. federal government is facing a growing skill gap in IT and cybersecurity; as experienced workers retire, the government is struggling to replace the lost human capital with younger talent. Retirement-age workers now outnumber employees under 30 by more than two-to-one.

• Compensation packages have been insufficient to attract digitally native professionals, with pay up to 60% below private sector wages for IT/cybersecurity.

Federal Employee Age Distribution (2007-2021)

Source: Office of Management and Budget, “Strengthening the Federal Workforce,” Mar. 2022

Ongoing Cyber Security Threats

• Despite a doubling in unclassified federal cyber security spend from $13 billion to $26 billion between 2017 and 2024, the government’s antiquated systems are still vulnerable to cyberattack.

• In 2022, the federal government logged over 30k costly cybersecurity incidents; on average, each incident caused $2.1 million in damages (~$64 billion total cost).

Reported Federal Cyber Security Incidents (2016-2022)

Source: FISMA Annual Reports 2016-2022, Aggregated by Statista

Case Study

We invite you to watch or listen to our case study of Altumint, an exciting company we researched in this space.

Altumint, a portfolio company of Capitol Meridian Partners, is a provider of traffic enforcement solutions and analytical services to U.S. state and local government customers.

The conversation features Louis Mayer, Senior Vice President at 10 East, Altumint CEO Holly Cooper, and Brooke Coburn, one of the most prominent investors in the sector, a 25-year Carlyle veteran, and Founding Partner of Capitol Meridian.