War Profiteering (part 1)

New Middle East War Brewing

In this stock report, I will cover one of the largest defense companies in the world. One for which every business line is likely to benefit from the return of the USA to the Middle East and its likely involvement in Israel's defense.

First, we will do a recap and see WHY the US will almost inevitably go back to a large military intervention in the Middle East.

Of course, there is some moral aspect to the question of essentially making money from war.

However, I think that for people like me, and most of my readers, we are not changing the fate of the world by moving in or out a few million. We are simply passengers on the boat of the world’s tumults, and getting closer to the lifeboats will not make the captain change direction.

Small Newsletter Update

This report might also mark a slight shift in the focus of this publication. From now on, I will try to cover somewhat mainstream companies, ideally listed in the US. This does not mean I will stop looking for interesting stocks selling at a cheap price, worldwide.

But there is a tension between:

• keeping this publication running requires me to expand my readership, which requires not too esoteric ideas. For example, coal miners in Mongolia and Indonesia might be a good investing idea, but it also caused a surge in unsubscribes like no article or report before.

  • From a purely business point of view, I would do better writing about popular mainstream ideas.

• Finding good and profitable investing ideas, hence delivering real value to my subscribers. Popular stocks are generally overvalued and will underdeliver.

So I need to find the balance between large enough appeal (so that the newsletter subscription pays my bills), and good enough ideas that my readers can make money from.

I will also still cover general topics and geopolitics, but will slow down the publish rate of this theme, as many readers have expressed the wish to see more writing about stocks that would help them retire early. So I will focus the “general” topics on what is relevant to investing thesis and risk management.

Impossible Pivot

As far back as the Obama presidency, the US has been looking at performing a “pivot to the Pacific”. This was meant to leave a smaller military presence in Europe and the Middle East, to achieve a refocus on the Asia-Pacific region.

This switch from the historical domain of the US empire was obviously done in order to “contain” China and manage the US to stay the global Hegemon.

For a while, the largest drag on this strategy was the inertia of Washington DC refusing to retreat from Iraq and Afghanistan. In theory, the botched Afghanistan departure should have finally achieved the beginning of such a pivot, even with a lingering military presence in Syria and Iraq.

At the same time, it is pretty clear by now that the US establishment is deeply divided, with the left hand not aware or agreeing with what the right hand is doing.

One part of the US state apparatus would have looked for a normalization of relations with Russia, in order to control the rise of China and make Xi Jinping lose his most reliable source of oil, gas, and food. A sentiment the Trump administration frequently expressed.

Another part wanted to crush and break apart Russia instead, perform a regime change, and remove the threat of the Russo-Chinese alliance this way.

Meanwhile, other factions are looking at a war with Iran as a solution to re-establish dominance in the Middle East, and the Pacific pivot be damned.

Getting Dragged Back Into The Middle East

Almost 2 years into the Ukraine war, we can safely say that any hope of using Russia against China is definitely gone.

What is more concerning for the USA’s position, any hope of regime change and a collapse of Russia seems equally gone, even if this is only something think tank people are now authorized to admit. Sanctions failed, and they failed badly.

With resurgent Russia building tanks and artillery shells at a higher rate than the whole of NATO combined, it would seem obvious that the priority for the West is to reduce its attrition rate, re-arm, and find a way to see how to outproduce at least Russia.

Would China start a military conflict, with 50% of the world’s steel production and 50% of shipbuilding capacity, it is hard to see how the US/NATO could win, or even maybe survive, short of using nuclear weapons.

The very last thing the US needs is another Iraq-style of engagement, draining resources from rebuilding stockpiles and adapting its weapon systems.

It is pretty clear to me that this is exactly the reasoning of the Russia-Iran-China alliance when they gave the benediction to Hamas for its attack on Israel.

For various ideological and political reasons, the US cannot and will not abandon Israel the way it abandoned other satellite states like South Vietnam (and soon Ukraine?).

So far, the US has mostly been posturing more than intervening in this new Middle East war. But can it last?

Is Israel Alone Doomed?

With only 9.3 million people, Israel is ill-equipped for a massive, long-lasting attrition war. In addition, it has no strategic depth (territory it could give up), nor natural resources that could sustain the war effort even with a mobilized population (contrary to Russia for example).

So when going to war with a not much smaller size Palestinian population (4.9 million), Israel is at risk of self-destroying would the conflict lasts too long.

Due to smaller size and economic disparity, Israel can easily deal (at a high cost) with any Palestinian military capacity. It might even manage to do so against the Lebanese Hezbollah at the same time, although this would increase the costs even more.

The problem is to determine what is the endgame here.

Returning to the pre-7th October status quo is probably impossible. Too much anger and hate on both sides. So from this perspective, the plan to displace all Palestinians in Gaza, or maybe even all Palestinians everywhere in Israel makes sense. This is the only way for Israel to secure some strategic depth and a shorter, more defendable border.

In fact, it might be the only way for Israel to survive more than a few decades.

I am not going to discuss the morality of this, nor who is right here. As I expressed before, the maximalist goals of both Palestinians and Israelis are a recipe for disaster, and my sympathy goes to non-fanatics individuals on both sides, as well as the local Christian populations who are stuck between the hammer and the anvil of this conflict.

Of course, any mass displacement of the Palestinians people will trigger a chain reaction with Israel's Muslim neighbors.

First Domino

The closing of the Red Sea by the Houthis is the first step. By the way, with 80% of Yemen’s population under Houthi control, it is de facto THE Yemen government, irrespective of diplomatic posturing.

The Houthis have clearly stated that they are essentially declaring war on Israel and its supporters as long as the war in Gaza continues.

A very revealing fact is how poorly the building of a coalition to reopen the trade sea lanes went so far. NONE of the neighboring countries joined.

Not even Egypt which has everything to lose if the Suez Canal closes.

Not even the Saudis or the UAE, which have waged war against the Houthis for almost a decade (and mostly lost).

No Arab nations (short of irrelevant Bahrain), nor any Asian ones either are willing to get involved.

Even France, the UK, and other European allies are barely sending ships, and are apparently refusing to be put under American command. Many are only sending a few officers and no ships.

Whilst named by the United States as part of the coalition, the French Defense Ministry stated that its warships, including the frigate Languedoc, would remain under French command.

Italy's Defense Ministry, which has deployed the frigate Virginio Fasan in the Red Sea, also stated that the warship was not part of Prosperity Guardian.

Spain's Defense Ministry stated that it would only take part in operations under NATO or EU coordination. Spain also vetoed any potential EU contribution to Operation Prosperity Guardian through the resources of EU-conducted Operation Atalanta.

The message is pretty clear. When it comes to Israel's war in Gaza, the US (and maybe the UK) is pretty much the only one who is going to help.

The Intervention Dilemma

While okay for the short term, just sitting by the Bad-el-Mandeb strait and shooting every incoming drone, cruise missile, ballistic missile, and suicide gunboat is not a viable long-term strategy.

To begin with, shooting every $2,000 drone with two $2,000,000 missiles will quickly cost more to the US than the entire funding of the Ukraine war does.

An x4,000 cost ratio differential is the way guerrilla warriors win against powerful empires.

The same disparity is at play in Ukraine as well:

…for the cost of producing one Leopard II tank in Germany, Russia can produce 683 Lancet drones. This raises an obvious question: is the battlefield worth of a Leopard II equivalent to nearly seven hundred Lancet drones? Probably not.

With Merkava 4M tanks costing $3.5 million per unit, we can estimate that Hamas can produce 17,500 al-Yassins for every tank the Israelis produce, or 34,155 on a PPP-adjusted basis. 

The Shrinking Cost of War Threatens Western Militaries- National Interest

As the article above mentions, this is reminiscent of how simpler longbows and then early guns made the very expensive knights in plate armor obsolete and shattered the balance of power of Medieval Europe, not only between nations but between the commoners and the nobility, between kings and local lords.

This would only get “worse” until the mass conscription armies initiated by Napoleon and then in WW1.

I have seen passing an estimate that the current operations in Yemen cost around $200M/day to the US taxpayers. Even if it grossly overestimates it, this would still be a tremendous cost. For reference, Yemen's whole GDP is barely $20B or 100 days of US spending at current rates.

In theory, bombing the Houthis enough so they lose the capacity for strikes would be ideal and almost painless for the US. In practice, 8 years of this exact method deployed by Saudi Arabia has shown it will not work. If anything, the Houthis came out of it stronger.

Contrary to the fight with the Taliban, leaving the Houthis alone is NOT an option, as they blocked very successfully, and - which is more problematic - very VISIBLY one of the world’s most important trade lanes.

A lot of the aura of invincibility of the US stems from the power of its Navy, which is rightfully considered a threat by all major powers. Would Yemeni rebels manage to keep the Red Sea closed, it could only mean 2 things:

1. Option 1: The US Navy appears completely unable to fulfill even a simple mission against Yemen.

2. Option 2: Traditional modern fleets are completely obsolete when facing modern drones and missiles.

Option 1 is something the US military apparatus and defense industry will do everything to avoid becoming a globally shared opinion.

And option 2 needs to be dismissed as well, as it would mean land powers (like Russia and China) are now in an era where they would dominate sea powers (Like the UK and the USA), at least locally.

(We must take note that the jury is still very much out regarding option 2. For now, drones and missiles seem to have a cost advantage, but point defense and electronic warfare could tip the scales back in favor of large naval platforms again, although probably not aircraft-carrier-centric fleets).

Both options would mean a complete collapse of the credibility of US protection of Taiwan and its Asian allies in general, especially South Korea, Japan, and the Philippines).

So to avoid a dramatic and devastating loss of prestige, and the spread of the idea of its Navy’s impotence, the USA is now backed into a corner and forced to crush the Houthis. And doing it very visibly and without a doubt.

What’s Next?

I suspect that at first, a campaign of bombing and escorting ships will be attempted. I also suspect this will prove rather insufficient. Maersk recently giving up on Red Sea travel for the second time is a good indication of the problem.

Air power and precision bombing are quite overrated when you are fighting an enemy able to adopt guerrilla tactics, caring little about human losses, and relying on cheap, small, easy-to-dissimulate weapons systems.

Just look at Israel's stalemate in Gaza against an under-equipped, smaller Hamas.

So a land invasion is most likely required.

The logistics of it should be relatively easy. French and US military bases in Neighboring Djibouti can provide direct support (granted it stays safe from bombing and its air defense performs better than the ones of US bases in Iraq and Syria).

Fighting in this territory will be another matter. Yemen is EXTREMELY mountainous on top of being overall an overall hostile geography (hot, dry, poor infrastructure).

If that was not enough, most of the population is located not on the coast but in the mountains themselves, which are less hot and more habitable.

And those mountains are where the power base of the Houthis is located.

This makes both the fighting terrain (urban and/or mountains) and the length of the supply chain an issue.

Source: ACLED

The Israeli Front

Meanwhile, the Israeli front is threatening to open in the north toward Lebanon at any moment. Especially since the drone assassination of a high-level Hezbollah leader in Beirut’s center.

Overall, it is increasingly obvious that the USA is facing an array of uncomfortable choices:

1. Strong-arming Israel into a lasting ceasefire, at the risk of endangering the long-term viability of the Jewish state (and possibly a massive internal political backlash).

   1. This could create de-escalation, but may equally embolden even more Hamas + Iran and its allies.

2. Attacking the Houthis to re-open the Red Sea, at the risk of getting entangled into another Afghanistan.

3. Accepting the Red Sea is not a safe trade lane anymore, incurring a massive loss of prestige and putting into question how useful all these aircraft carriers are.

Investing Takeaways

De-escalation could be achieved, but the path to it is getting narrower by the day, the worse the war in Gaza gets and the more the Houthis feel that they are winning.

If it fails, there will be a desperate demand for:

• Air defense & electronic warfare (EW), especially of the cost-efficient kind, can be mounted on a ship, but also on a vehicle convoy susceptible to ambush.

• Armored vehicles, especially of the light type and with anti-drone and anti-missile capabilities.

• Ships able to protect the trade lane while the land operations are ongoing.

• Ammunition to feed air defense, ships, and land weapons.

It just happens that among the top 5 big defense suppliers of the US military, one company in particular is somewhat specialized in building all these items. They tend to be more cost-effective, and less “fancy” than top-of-line fighter jets or missiles, but this is just what the US military will need in the hills of Yemen and Lebanon.

Mind you, I hope my prediction is wrong and that the US will manage to avoid getting entangled in this trap. Both for the sake of local civilians and US military personnel.

But political posturing and broader diplomatic concerns make it very hard to see that happening.

So I suspect the one company in particular I am covering this month will be the prime beneficiary of a Middle East quagmire that might last years if not decades like Iraq and Afghanistan did.

And it will also be in a prime position for radical change in the naval doctrine of the USA, with a refocus toward smaller and more flexible naval platforms, instead of the air power primacy of the last 60 years.