When the Government Becomes Your Co-investor

0:01Tyler Crowe:The government as an investing partner? Motley Fool Hidden Gems Investing starts now.

0:09Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors Matt Frankel and Lou Whiteman. We are going to do our best to talk about investing with the government, getting involved more in companies recently without touching too many political rails here. We're trying to do this as much as an apolitical. We are investors. We are trying to invest. And the reality is the government is getting more involved in companies. We're also going to hit the mailbag. But first, we're going to start with some off-calendar earnings, I guess you could say.

0:47Tyler Crowe:Forgent Power Solutions. They're actually a frequent recommendation in several hidden gem services here at The Motley Fool. Shares are up about 10 % after they reported their fiscal fourth quarter and full 2026 results. The company exceeded both Wall Street and its own expectations, actually, and swung into profitability and frankly put up numbers that aren't really commensurate with what most people would say is an electrical equipment manufacturer, making things like switch gears and circuit breakers and stuff like that. I mean, there were a lot of numbers that stood out to me and we can get into those.

1:21Tyler Crowe:But guys, what stood out to you the most?

1:24Lou Whiteman:Well, let's take it and take it just a simple one. It's the top and bottom line beat with a guidance boost. And that's what's been missing in a lot of earnings reports this season. You're right. We're kind of done this season. But the kind of theme for now was things are fine, but we don't know about the future. Fortune seems really, really confident about the future. The guidance part stands out because, you know, for all these picks and shovel companies, capacity, how much you grow from here is a real issue. Well, they can grow from here. They're forecasting 75 percent year over year growth in fiscal 27, which has started.

1:57Lou Whiteman:That's just at the midpoint. Tyler, I also like to see that the EPS guidance was boosted because they did a secondary back in June. Some of it was just selling existing shares that private equity owners, but some of it was new shares they were adding to the denominator. So if they can earn more per share than expected at a time when they are growing the number of shares. That's a real good sign that the company is really, dare I say it, firing on all cylinders. Yeah, I mean, the beaten race was definitely the headline, but to me, that isn't the biggest story. To me, it is the$1.5 billion in bookings Forge and added in the second quarter.

2:33That is up 375 % year over year. I feel like with some of these AI trades, those numbers just get kind of so big that, you know, how do you put them in context? But it represents a book to bill ratio of 3.3, meaning that Forgent's bookings are 3.3 times its revenue that it's reporting. The company's backlog is now over$3 billion. That's up 53 % sequentially. The margin improvement was impressive. Most switchgear and transformer companies that are comparable to Forgent report adjusted EBITDA margins in the upper teens. Forgent reported a little over 24%. And they're spending money to add capacity and it seems like it's for good reason.

3:12Tyler Crowe:Yeah. One of the things that stuck out to me is we have a company that was relatively unprofitable. It's been growing at rather impressive rates. And based on their forecast for the upcoming fiscal year, which will be basically from now until mid-September next year, they're expecting like$1.25 to$1.40, excuse me, in earnings per share for fiscal 2027, which just doing a quick back of the math, in my head, it's somewhere around like 25, 26 times forward earnings. A company growing this fast, that seems relatively reasonable in a kind of gets almost to me is almost like a little bit of a, huh, that's relatively cheap.

3:52Tyler Crowe:If it's, you know, might be some sort of cyclical aspect to it. I think there's a lot of questions that come from these sort of earnings presentations too, especially when it comes to these picks and shovels play, because we try to dig into what What does it mean? And is this, you know, how far has the the A.I. trade gone? I guess, if you will, the picks and shovels trade. So, guys, what were some of the unanswered questions that you had kind of coming out of this? Because or what are you going to be looking for more specifically?

4:18Lou Whiteman:Well, they still need to execute. OK. You know, the good news is, is that they do see room for growth. But can that capacity expand fast enough to convert that massive backlog into revenue? They still have the same supply chain risks as everyone else. They have a lot of subcontractors that they need to make sure stay in shape. Look, the backlog is great, but delivering on that backlog is not a given. So I think that's the biggest thing for investors to watch. Most of the unanswered questions to me have to do with the backlog. In addition to what Lou just said, where did that$1.5 billion in added backlog come from?

4:54We don't know. If it's just one or two hyperscalers, it's a completely different risk factor than if it was spread amongst a dozen different customers. So that's a big unanswered question to me is how much of this backlog, how much of it is really creating a customer concentration risk?

5:10Tyler Crowe:Customer concentration has obviously been something we've been talking a lot about with a lot of these companies. Because, I mean, there are, when it comes to building out AI infrastructure, and I don't know, maybe we need a gong or some sort of sound effect every single time we say that these days. There's this, just kind of this assumption. It's like, well, yeah, you've got the four or five hyperscalers and there's some private developers as well. But it's all going to come down to just a small handful of customers here. So like you said, if there's any change in those plans, that could be a big thing.

5:38Tyler Crowe:For me here, it was something I found a little bit perplexing. And it's kind of like taking a step back and looking not just Forgent specifically, but kind of the talk we've been having about AI. It's guidance for the year suggesting growth that's accelerating at a time when we're hearing all these calls at the same time for slower AI development and political resistance to data center development. And we're starting to see, I wouldn't say moratoriums, but certainly projects are getting delayed as a result. So how do we square that circle of a business that seems to be saying like, nope, all good, all full steam ahead, I guess, if you will, versus what we're kind of seeing play out in the media or in the news cycle when it comes to these sort of developments?

6:28Lou Whiteman:Well, for one, I haven't seen anyone suggest that they don't want to continue building. So I think the orders are still coming in. We'll see maybe that affects fulfillment. But the other side here, too, is that we had a massive need for grid modernization even before everyone was talking about data centers all the time. Yes, data centers need a lot of transformers, a lot of switch gears, but utilities, builders, they need this stuff too. There was a real lack of supply coming out of the pandemic. That was kind of the reason Fortune was created, not because of data centers, but because all of this demand was out there.

7:01Lou Whiteman:So this is a company that's definitely benefited from the AI push, but I don't think they're reliant on it. I think the big investor takeaway here is this company is more than just a data center pick and shovel play. They are fulfilling a need that is out there in the broader economy as well. And let's unpack what's going on with their AI business just a little bit. So the orders that they added to their backlog in the second quarter were likely projects that were greenlit or like had capital allocated to six to 18 months ago for the most part. These were CapEx decisions that were made for the most part in 2025.

7:38Even Forgen's guidance is based on its current backlog for the most part. It's not really a live indicator of sentiment among the industry. And again, I'm just talking AI, not the, Lou's absolutely right that grid modernization is a big need. Forgent is, it's in a very strong position in the AI trade is that the parts that it supplies are currently the big constraint in the industry. So when you are the constraint, not the demand, you're getting your customers ordering earlier and kind of more often than they would just to hold slots. Plus, as Lou said, fortune sells to utilities, other industrials.

8:21It's not just an AI trade. I will be watching that book-to-bill ratio I mentioned over the coming corners. It can't stay at 3.3 forever. That's just not practical. That exponential growth of a backlog will get out of control real quick. but as long as it's well above one the the growth story is still in really good shape here

8:38Tyler Crowe:yeah to to lose point i think i remember it was like an odd lots episode maybe like three three and a half years ago maybe further back than that now where they they interviewed i think it was actually a developer and an electrician talking about like we can't get switch gears and they were just building i think like chipotle's and other like fast casual restaurants so It is a story of just a raw shortage of these things overall and not necessarily just an AI data center story. Coming up after the break, we're going to delve into the theme that is the government being an investor alongside you.

9:21Lou Whiteman:As a podcaster, my voice is heard by thousands of people. And now with Vanguard Investor Choice, I can be heard by the companies I invest in too. Vanguard Investor Choice makes it easy for eligible Vanguard fund investors to have a say in how their funds vote at company shareholder meetings. With just a few clicks, you can set your proxy voting preference and make your voice heard on topics like executive pay, board director elections, and more. Investor participation is the heartbeat of a healthy corporate governance ecosystem. You have a voice. Let it be heard. Visit vanguard.com slash investor choice to learn more.

10:00Lou Whiteman:Vanguard investors own shares of Vanguard index funds and those funds own shares of the companies they invest in. Available for Vanguard index funds that participate in investor choice. Vanguard Marketing Corporation Distributor.

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10:51Tyler Crowe:The stock rose 32 % yesterday after the company announced it planned to deploy a$450 million investment from the U.S. Department of War to build, in the company's words, a more secure, vertically integrated supply chain. Now, even after this move, this is a company with like a$650 million market cap. So, this is a monumental amount of money. this is a recurring theme we're seeing here is investing becoming more and more involved with the government and before we we'll get into the broader topics here but lou you wanted to bring this one up because you are actually an investor in lmet group we have some recommendations in the motley fool related to this company so before we kind of step back here like when you look at lmet group does this is this like a thesis changer or is this kind of what was expected yeah this is

11:46Lou Whiteman:It's funny to me because we'd normally talk about, you know, you buy the rumor, sell the news, and it feels like it worked the other way this time. The reason that Motley Fool members are benefiting from that 32 % jump, the reason we were sort of kind of interested in this company was, is that this is exactly what we thought Elmet was going to do. Elmet went public earlier this year with sort of this in mind, maybe not this exact deal, but this is a company that's been around for decades, pretty well run, that kind of read the geopolitical tea leaves and said, well, we want a currency to take advantage of opportunities, so let's go public.

12:18Lou Whiteman:So yes, it's a needle mover. Yes, this is very important for this company, but I'm surprised that the market is surprised. To me, again, the whole reason they went public, the whole reason that this was an interesting investment was that that was the start of a journey that was going to end up at some sort of growing relationship with the DoD. So we kind of just finally saw what that looks like yesterday and the market reacted.

12:42Tyler Crowe:I feel like this is one of those topics where if we come back at the end and everyone's angry at us, I think we've probably done our job because we're trying to stay as apolitical as possible, but this is kind of a little bit of a third rail one where we have seen government participation in companies and in companies' investment plans too in ways I can't remember seeing in recent history. I think it would be a little disingenuous to say that this is just purely a Trump administration phenomenon, though. The Biden administration used some several major funding mechanisms. We had like the CHIPS Act, the Inflation Reduction Act.

13:20Tyler Crowe:These were all things that were deliberate in like giving money to corporations to push certain government interests, whether it be in the Biden administration's case, we could say green energy and domestic manufacturing. In this case, we've seen a emphasis on, we'll call it like defense supply chains and critical minerals, critical materials, critical manufacturing that from a national security sort of perspective has been a little bit more of the flavor of the month here with the Trump administration. And there's been like a difference in the way that it's financed too, where Biden administration It was mostly like former grants or favorable financing rates in the form of debt, where this time around, we've seen companies, the Trump administration taking an active stake in equity as well.

14:15Tyler Crowe:And we haven't really seen this specific type of involvement before in the government. So my question to you two is whether this is just likely to go away. Is this just, like I said, a Trump administration phenomenon specifically on taking equity in this specific way they're doing it? Or have we perhaps crossed some sort of Rubicon here and that we can expect this type of co-investment from future administrations on both sides of the aisles? Like, how might a permanent change in the investment thesis for companies be with, we could almost call it permanent government involvement? Yeah. And I mean, to put some numbers behind it, I mean, the Intel deal is the one that got the big headlines, but we've seen about 30 different equity or what I would call equity-like transactions, you know, like preferred stock or something like that, since the middle of last year.

15:05So there's Intel, MP Materials, and a bunch of other rare earth companies, and several others. There's a whole long list. And you're right that the differences are mostly in the structure of the deals rather than the government participating at all. But there are reasons to believe that this is a permanent shift, and there are some reasons to believe that this might slow down or at least narrow. So on one hand, there's the national security angle. that's the Trump administration's reason for getting into the rare earth business, for getting an Intel stake. China's getting ahead in the AI race is a threat.

15:38China and other countries controlling parts of the chip-making supply chain, for example. Those are legitimate national security concerns. And there's a solid argument to be made that equity deals like the ones we're seeing are more fair to taxpayers than providing grants to companies and things to that effect. And it's also worth noting that we're not the first to do this. Other countries, including several of our European allies, have taken equity stakes in businesses in their countries for decades. There's some political opposition, mainly when it comes to potential conflicts of interest. It's not necessarily that the government's taking a stake.

16:17It's that the government is negotiating contracts with companies that it owns a part of. So there are some legitimate concerns there as well. So like you said, we're not trying to be political here. We're telling both sides. Long term, my feeling is that this will narrow into a very specific national security and defense focus, but not really spread any further. For the investment, it depends on the specific deal and the terms of those deals. But it's important not to assume that a business will be a winner just because the government took a stake. Like in other countries, that hasn't always been the case, and it's not likely to always be the case here.

16:53Lou Whiteman:You see, I don't think this is political third rail at all, because I think there's actually a lot more consensus and a lot more, you know, willingness on both sides of the aisle to do this. I think there always has been. What has changed, if anything has changed, is the appetite of companies. And some of that is kind of the new ways we're designing these. But look, you go back to 1970s, early 1970s, maybe it was late 60s. The government, I think, took a stake in Lockheed or provided funding to Lockheed. You go through Conrail, you go through kind of the 2008 GM bankruptcies. This has always been something that the government only did in times of distress.

17:30Lou Whiteman:And it mostly because that was the only time the companies wanted to play ball. It wasn't the government. So if that was kind of tepid about it. Yes, we have this new dynamic with national securities and SKUs, and we have more openness from the government to be more creative with equity and preferred and all of this. I think it continues. I don't think it goes as far, you know, I think there are natural limits to it. But I don't think, I definitely don't think this is a one administration thing. I think that there is more of a willingness from both government and corporations to find ways to work together to advance common goods.

18:08Lou Whiteman:And so I do think there's been a shift here, but I don't think it's a dramatic political shift. I think it's just a shift in the way I think companies view government assistance or government partnerships.

18:20Tyler Crowe:I want to leave it at this, and you guys are more than welcome to respond to this. If not, we can move. But to Matt's point, like European countries have been doing this. And I lived in France for a while, so I'm just going to use France as an example, the ques de pagne, which is basically like the investment vehicle that you're talking about where they take stakes in companies. This is similar to the Social Security Administration that we have, where instead of just owning treasuries, they are able to take out stakes in corporations. And some of them are publicly traded. And one of the things I do find fascinating about this, though, is that companies that tend to be owned, have significant ownership stake from the pension systems and these national interests, is from us thinking about investments.

19:09Tyler Crowe:There aren't necessarily what we consider killer investments. They tend to pay high dividends. There's not a heck of a lot of growth because if your largest stakeholder is a pension, they're looking for reliable income and maybe a little bit more upside than just bonds. And so it would be something I think worth watching is that when government entities take significant stakes in businesses, they aren't necessarily looking to maximize the return on this investment. They're doing it for slightly different reasons. They may be, in a lot of these cases, they're looking to build out supply chains for critical minerals or critical manufacturing.

19:54Tyler Crowe:And the government may not necessarily be as adamant that those investments, you know, meet certain investing hurdles. They'll be like, well, we need it anyways. And if it's not a high rate of return, you know, we're going to vote that you do it anyways. And so there is part of me that says, yeah, this is a thing. But if I'm an investor, I may be excited about it now because it's like, yeah, great injection of cash. You know, government's a good partner. They pay a lot of money. But if they start having a stake and a say in what the businesses do in terms of like capital allocation, it could change the investing profile of these businesses.

20:35Lou Whiteman:Yes, it could. I mean, there's all sorts of dangers. The other danger, too, is and if you look at Airbus in the 70s where they couldn't streamline because streamline, they were owned by four different governments. And if you close a plant in any one of them, unless you're going to close a plant in all four, it just doesn't work. But here's the thing. Again, I not all deals are the same. And I do think there is a more. this is why I like companies actually being proactive and getting involved. Let's look at one real quick, the L3 Harris deal with the government. Basically, what was going on there is L3 Harris is involved in a lot of things.

21:11Lou Whiteman:One of them is making the engines that go into munitions. The government needs them to ramp up munitions. L3 Harris was looking at that like, that's great, but that's also the lowest margin part of my business. So why do I want to invest my capital in adding capacity there. So the deal was, well, spin that out. We'll provide capital. We, the government, will provide capital to build that, to build the capacity, and that frees up your capital to invest elsewhere. So that was kind of a win-win way to go about it. I think you do need to judge these on an individual basis, but I don't think it's as simple as to say it's a one size all approach like the 70s.

21:50Lou Whiteman:I think that I'm glad to see it happening in one off ways where companies are negotiating and trying to figure out what the government needs and how they can make it work for them. I'm being a little Pollyannish here, Tyler, but I do think there's a way to make this work, at least, you know, on paper. Well, in the case of Intel, and correct me if I'm wrong on this, the government didn't take voting rights. The real concern is, you know, negotiating contracts and things like that. But Tyler brought up an interesting point when he mentioned Social Security because there's been, it's common knowledge Social Security is gonna run out of money within 10 years if nothing's done.

22:26And there are like 50 different things that could be done. But one of them that, especially in the current political environment they're pushing for, is investing the Social Security's reserves a little bit more efficiently than just buying treasuries, which is essentially what it's in right now, and generating, you know, three, three and a half percent returns. instead, invest in the entire S &P, give up voting rights, things like that. But put money in the S &P 500. You'd really need a big investment vehicle. There's about$2 trillion in reserves in Social Security. So taking a$10 billion stake in Intel wouldn't even move the needle.