Fear, Inc. 
How homeland security became the biggest market opportunity since the dotcom
boom.
By Evan Ratliff

http://www.wired.com/wired/archive/13.12/homeland_pr.html

A terrorist would kill for this view. The 11th-floor office of Fortress
America, an Arlington, Virginia, company located at the heart of the
disaster economy, is surrounded by opportunities for mayhem.

To the west, the suburbs of Washington, DC, sprawl toward Dulles
International Airport, the transit point for 63,000 passengers a day. The
Pentagon lies a few miles southeast, and still higher-profile targets - the
White House, Capitol Hill - are just east, across the Potomac. At the base
of the building, a DC Metro station handles thousands of commuters every
day.

But when Tom McMillen looks out these windows, he sees different
opportunities - for baggage screening machines, biological and nuclear
sensors, data analysis software, video surveillance, and high tech gear for
emergency personnel. McMillen founded Fortress America last winter as a
corporate shell, or so-called blank check company. In July, with no product,
no revenue, and certainly no profits, he managed to raise $46.8 million in
an IPO based on a simple promise: to spend at least $30 million acquiring a
company in the business of preventing, deterring, or cleaning up after a
disaster. Now he's looking for somewhere to invest the money.

At 611, McMillen is a commanding presence with white hair and an imposing
baritone. His résumé is a fantasy combination of sports, politics, and
business: Rhodes scholar, NBA first-round draft pick, 11-year career as a
center on four teams, three-term US representative from Maryland, successful
Beltway businessman. But on a September afternoon in Fortress America's
offices, crammed into an ergonomic chair, he's basically a team of one.
"We're still staffing up in here," he says, waving a long arm toward a room
of vacant cubicles. Actually, McMillen has no plans to hire anybody. There
wouldn't be much to do anyway.

So how does someone raise millions in the public market with nothing more
than a vague pledge to buy something? The answer to that question stretches
back to 1972. "I was very young, 20 years old," he says. He was playing for
the US basketball team at the Munich Olympics when 11 Israeli athletes were
taken hostage by Palestinian terrorists. All of the hostages died, two in
their room, the rest in a bungled rescue attempt at the airport. "At the
time I said to myself, it won't be long before this comes to America,"
McMillen recalls. "It took 30 years."

During that time, he says, as Europe and Israel began fostering strategies
to defend themselves against terror, the US failed to develop the mentality
- or technology - to protect its citizens. After 9/11, McMillen decided it
was time to suit up. Fortress America is one of three ventures he founded to
capitalize on a society increasingly preoccupied with disaster. Global
Secure, which he helped start in 2003 by combining three smaller companies
that sell first-responder training, technology, and equipment, filed for a
$100 million IPO in August. (McMillen now has no official role with the
company but remains one of its largest shareholders.) The company's
prospectus says it anticipates more than $15 billion in federal spending in
the "critical incident response marketplace" in the next year. In August,
McMillen took over a company called Celerity Systems, turned it into a
Fortress America-style outfit focusing on acquiring startups for less than
$30 million, and promptly renamed it Homeland Security Capital.

To run Fortress America, McMillen, a Democrat, has assembled a team of
advisers that includes former Republican senator Don Nickles and former
Republican representative Asa Hutchinson, who also served as an
undersecretary at the Department of Homeland Security for two years. About
$40 million of the IPO money sits in an escrow account, while McMillen and
the company's CEO, a tech industry veteran named Harvey Weiss, sift through
acquisition targets. "There were probably a thousand new companies on
September 12 that didn't exist on September 10, repackaging what they knew
as an antiterrorist or homeland security initiative," says Weiss. "A lot of
those failed. But the government has spent a lot of money in research and
development, giving very bright PhDs and laboratories a lot of dollars to
develop new things quickly."

McMillen and Weiss aren't the only ones combing the homeland security
landscape. In fact, Fortress America isn't even the only blank check
corporation in the building. Richard Clarke, former counterterrorism czar
and author of Against All Enemies: Inside America's War on Terror, has a
firm called Good Harbor Partners that's headquartered eight floors down.
Clarke is taking Good Harbor public even though, like Fortress America, it's
little more than a promise to be a holding company. The firm's prospectus
says it plans to use its cash to acquire a firm that specializes in areas
like "threat management, crisis management, and risk mitigation."

Welcome to the homeland security industrial complex, a world where doomsday
scenarios double as marketing pitches, patriotism mingles with capitalism,
and the spoils go to whoever can placate a skittish society. "The best thing
that will happen is that we will never have a nuclear event in the United
States, never have a sarin gas event," Weiss says. "But do you know how much
money is going to be spent" preparing for such events? "It's only a matter
of time before someone finds something bad in a container coming through the
port of Baltimore, Charleston, or Long Beach."

A decade ago, optimism about how technology would connect the planet,
reinvent commerce, and revolutionize society gave rise to the dotcom boom.
When optimism turned into fevered speculation, the economy crashed. Now
another mania is taking hold. It's predicated on fear and funded by a drive
to defend against, prepare for, and recover from perils both man-made and
natural, real and imagined. For every nightmare scenario - a nuclear weapon
in a shipping container, a suicide bomber in the subway, an avian flu
pandemic, another killer hurricane - there are entrepreneurs and venture
capitalists and consultants promising to help. And the government is ready
to spend money to confront these problems - or at least to look like it's
doing so.

Feature:
Fear, Inc.
Plus:
Profits of Doom
The industry, sparked by 9/11 and fueled by devastation in Bali, Madrid,
London, and now New Orleans, is centered inside the Beltway but reaches out
across the country to government labs, corporate boardrooms, city councils,
and inventors' garages. Businesses from small tech startups to huge defense
contractors are selling everything from biometrics and data backup to
cryptography, vaccines, and every type of WMD sensor or explosive sniffer
imaginable.

Unsettling times are boom times. The government is spending billions of
dollars subsidizing R&D for technologies that both threaten privacy, like
video surveillance and data mining, and those that protect it, like
encryption, network security, and anonymization applications. VCs and Wall
Street are spending billions more. Private corporations, increasingly
concerned for the safety of their operations and data (think about those
empty office towers in downtown New Orleans) have joined the security
frenzy. Spending projections echo the dotcom predictions that once poured
forth so liberally from research firms like Forrester and Jupiter: a $400
million-security sensor market for 2005; an $800 million video analysis
market by 2009; $10 billion for biometrics and $36 billion for physical
security technology (such as body armor and explosives screening) by 2007.
The industry is thought to be worth up to $200 billion today.

Dotcommers once excited prospective investors by touting the potential of
ubiquitous connectivity. "Imagine a world where ... ," the refrain began.
Players in the security industry usually preface their pitches with "God
forbid that ... ," and close with a call for government money to prevent
this or that inevitable catastrophe. "In a perfect world it would be nice
not to have to spend these dollars," McMillen says. "There are very few
industries that have a constitutional imperative. It doesn't say in the
preamble to provide for health care, to provide for welfare, to provide for
education. But it does say to provide for the common defense."

For the leaders of the disaster economy, this is a chance to mix business
with service to country. But make no mistake - business is business. "This
is not a green movement," McMillen says. "Most people look at it a little
more dispassionately."

In the disaster economy, all roads lead to the federal government, which is
spending liberally on massive initiatives, from the $5.6 billion Project
BioShield, launched last year to procure bioweapon vaccines and treatments,
to $172 million to protect the food supply and the $6 billion to $10 billion
for the purchase of avian flu meds. Much of the money is tangled in red tape
- biodefense companies complain that Project BioShield is plagued by delays
- but the sums that escape amount to a massive injection of capital. The
Department of Homeland Security, created in 2002 in response to 9/11, has a
$49.9 billion budget, of which $9.5 billion is considered "actionable for
the private sector," according to a report from DC analyst firm Civitas
Group. That makes DHS the single biggest funder of disaster-related
technologies, awarding contracts ranging from a $244,000 project to design
an "underwater loud-hailer," intended to warn divers who are approaching
restricted areas, to a $10 billion immigration data and biometrics system
called US-Visit.

The department's Science and Technology Directorate, the hub of the
government's homeland security R&D efforts, occupies two floors of an office
building in downtown Washington. A mishmash of subdepartments and programs,
including the Homeland Security Advanced Research Projects Agency (or
Hsarpa, a conceptual cousin of the Pentagon's Darpa), the directorate will
dole out $1.4 billion in R&D money next year. For anyone seeking cash to
build a homeland security widget, this is the place.

In a generic conference room, three of the department's directors sit down
with me to explain how the money gets dispensed. "The true source of
innovation is the private sector," says Peter Miller, acting director of
Hsarpa's Mission Support Office. Miller says that Hsarpa is inundated with
companies responding to proposal requests or simply offering up their own
security products. "People are really thinking," Miller says. "The
innovation is there."

The directorate's budget has jumped 13 percent for 2006, reflecting a
growing DHS emphasis on private technology development. "We don't make
things," says Jane Alexander, Hsarpa's deputy director. "If it doesn't come
from industry, we are not going to be able to get it." When a disaster like
Katrina exposes flaws in the government's response, it creates even more
opportunities for technology. Finding federal dollars for your $150 million
robotic levee may prove considerably easier now than it would have been in
the past.

In selecting investments, Miller and his colleagues start with what they
consider the most urgent threats and try to establish whether technologies
can be quickly developed to mitigate them. The final products generally need
to be cheap enough to attract the largest buyers of security goods: state
and local governments. They can spend federal grant money on interoperable
communications - or, says Richard Clarke, waste it on "bullet-proof vests
for canine-unit dogs."

Because the Science and Technology Directorate has little authority to
mandate that government agencies adopt its investments, it operates more
like a VC firm than a traditional national security R&D lab. It places
wagers on almost-there technology that it hopes the public sector will
embrace - and it leaves blue-sky research to others. "We're not into the
idea of just raising the level of science because science is beautiful,"
Alexander says. "We want deliverables."

"Homeland security is too important to be left tothe government," says
retired lieutenant general Ken Minihan. That might as well be the slogan for
the Paladin Capital Group. Minihan, a former director of the National
Security Agency who earned a bronze star in Vietnam, offers up the phrase
shortly after I meet him in the VC firm's offices, four blocks from the
White House. Homeland security, he continues, "is where you live; it's where
you work."

Venture capitalists are following the government money into this world of
eternal vigilance, looking for smart bets among the thousands of
security-related tech firms. Paladin raised a $235 million fund last year
devoted entirely to small to medium-size companies that help "prevent,
defend, cope, and recover" from disaster. That covers everything from
network protection to alternative energy. The fund's portfolio includes 14
companies developing technologies like "millimeter wave" screening machines
that see through clothes, software that runs emergency operations centers
(including one in post-Katrina New Orleans), and a silver-based substance
that kills bacteria. Each week, 10 to 20 potential investments walk through
the door. "I've been in private equity since the early '90s," says Michael
Steed, Paladin's managing director, "and I've never seen a sustained deal
flow like this."

Feature:
Fear, Inc.
Plus:
Profits of Doom
Paladin may be the highest-profile VC firm in DC - the Kleiner Perkins of
homeland security - but it's hardly alone. Other defense-oriented venture
firms, like the powerful Carlyle Group and the CIA's own In-Q-Tel, are
joined by the West Coast VC firms more commonly associated with Internet and
biotech startups. "Every fund is seeing how big the trough is and asking,
How do I get a piece of that action?" says Roger Novak of Novak Biddle
Venture Partners, a Bethesda, Maryland, firm that invests heavily in
homeland security startups. "When the IT industry shut down, post-bubble,
guess who had all the money? The government."

Getting a piece of that money takes more than a good business plan. It
requires knowledge of policy and access to government decisionmakers -
whether members of Congress who oversee budget allocations or Hsarpa
managers who hand out contracts. Which is why Paladin employs a cast of
former government heavyweights, including Minihan from the NSA; James
Woolsey, a former director of central intelligence; and H. Lee Buchanan, a
former deputy director of Darpa. "The complexity here is understanding the
government's business model, where the money is," Minihan says. Fortress
America is also backed by extensive political contacts. "We can make a good
strategic introduction to any elected official in the United States," boasts
Weiss, "from the president to every governor and mayor in the country, or
any major defense contractor."

Government money is notoriously flighty - commonly a victim of budget cuts,
always chasing after the latest panic - and so homeland security VCs talk
about dual-use investments. "They have to have customers on the commercial
side and on the government side," says Steed. One Paladin company, SafeView,
has sold millimeter-wave screening machines to airports and the Army, for
example, but anticipates selling thousands more to prisons, courthouses, and
office buildings.

Because the private sector owns as much as 90 percent of the critical
infrastructure in the US, VCs are betting that pressure from both the
government and insurance companies for more security spending will continue.
After all, says Jonathan Silver, managing director at Washington-based VC
firm Core Capital Partners, "We only inspect 2 percent of the containers
that come into the country. It's not like the problem has been solved."

"Business incubator" - the phrase evokes Silicon Valley, circa 1998, a bland
office park housing 18 startups in various stages of development, all hoping
to hit it big in a fledgling market. Move the building from Palo Alto to a
leafy commercial district outside of Annapolis, Maryland, and you have the
Chesapeake Innovation Center, "America's first business incubator focused on
homeland and national security."

There's no talk at CIC about dotcom this or e-that, no scooters racing down
the hallway or foosball tournaments in the break room. Here it's all about
security. Mysterious figures come and go, declining to offer a name or a
business card. And companies in "stealth mode" are just as likely to be
hiding their ideas from terrorists as from competitors. "We're not just
trying to make money here," says CEO John Elstner. "We're trying to create a
mechanism for technologies that will help save our children from a bunch of
wackos."

CIC hosts a diverse roster of startups. Moozatech, a security assessment
company founded by a former Israeli intelligence agent, has its one-room
headquarters here, not far from a three-person outfit that's developing
network monitoring technology started at the NSA and "based on thermodynamic
principles." Upstairs are the offices of Red Cell Associates, a firm founded
by James Liddy, a former Navy SEAL and the son of G. Gordon Liddy. On the
bottom floor, PharmAthene, the largest of CIC's companies, is working on
potential treatments for anthrax and nerve gas exposure.

Elstner's shop serves as matchmaker, introducing these startups to officials
at government agencies like the NSA and to big contractors like Northrop
Grumman Entrepreneurs file into the incubator's offices daily, PowerPoint
presentations in hand, hoping to get financial support from CIC and
piggyback on the company's infrastructure. The real goal, of course, is to
score a big contract.

How does the incubator choose from among the legions of companies with a
security technology and a story? "We don't actually take business plans,
because we don't want to read all the bullshit," says Elstner, a former
hydrogeologist. "We ask very specific questions about what we want to know."
Elstner mostly wants technologies that the government is already interested
in. CIC's real customers, he says, "aren't little companies. They are the
agencies, the intelligence communities, the military, the prime contractors
- the investors that are charged with creating full solutions to the
problems associated with homeland security."

Combined, CIC's in-house firms have raised more than $100 million in
funding. CIC itself is a microcosm of the homeland security industry, where
the players are motivated by a mixture of hard cash and higher calling. "We
are not celebrating that there is this huge industry blossoming around
protecting ourselves from terrorism," Elstner says. The ebullience of the
dotcom era is a relic, he adds. "But there is big business going on, and CIC
is in the middle of it."

On July 7, when US markets opened to the news that four bombs had exploded
on the London public transportation system, homeland security-related stocks
took off. To cite just two examples, Verint Systems, which makes software
for surveillance systems, closed up 12.5 percent, and Viisage, a
face-recognition and biometrics firm, climbed 8.4 percent. Over the past
four years, homeland security indices like the one managed by Cronus Capital
Markets have outpaced the Dow Jones and the Nasdaq. In uncertain times, the
companies prosper; in mass panic, their stock prices spike. "People view
homeland security as a hedge," Fortress America's McMillen says. "If a
Stinger missile is shot at a plane in this country and the president has to
shut the [airline] grid down, most of the market will come crashing down
except for these homeland security stocks."

The disaster industry can already claim its share of flashy IPOs:
Fingerprint-recognition company Cogent Systems raised $229 million on the
Nasdaq last year; shares jumped 50 percent on opening day. But going public
is only one exit strategy. The largest defense contractors, like Lockheed
Martin, Boeing, and Northrup Grumman, together with systems integrators like
L-3 Communications, Unisys, Computer Sciences, and SAIC, are all busy
scouting homeland security-related acquisition targets. These are the
Microsofts and HPs of the disaster economy. They know how to squeeze money
out of fixed-margin contracts, and they have employees with the proper
security clearances to do sensitive work. "We look at the changing budgets
for defense- and space-related activities," says Gordon McElroy, VP of
Lockheed Martin's Intelligence and Homeland Security Systems division. "The
growth engine is going to be in homeland security and law enforcement."

Feature:
Fear, Inc.
Plus:
Profits of Doom
The big players, accustomed to billion-dollar contracts for fighter jets and
satellites, are adapting to a world where money trickles out in smaller
increments. In August, Lockheed Martin was awarded a $212 million contract
with New York City's Metropolitan Transportation Authority to create a
command-and-control security network featuring thousands of cameras and
sensors. Boeing has its own lineup of homeland security contracts, including
one for hundreds of millions to improve airport screening efficiency and to
design next-generation cargo containers. Even failed projects can be
lucrative: Earlier this year, the FBI scrapped an information-sharing system
built by SAIC after spending $170 million over nearly four years. SAIC -
which has hundreds of millions in other port security and IT integration
contracts - recently filed for a $1.7 billion IPO. Its prospectus noted
succinctly that government spending since 9/11 has had "a favorable impact"
on business.

The contractors often hand off bite-size subcontracts to smaller players. As
part of the MTA project, for example, Lockheed Martin will subcontract a
technology designed to detect a suspicious person or package in a restricted
area. There are dozens of companies to choose from.

In other cases, the big companies merely buy one or more of the tech
startups that, in effect, serve as secondary R&D labs. In 2004, General
Electric capped off a homeland security spending spree by acquiring the
baggage screening company InVision for about $900 million. Four months
later, the giant data aggregator Lexis/Nexis acquired Seisint, a data
analysis firm that had a number of homeland security projects underway. (The
deal has since been marred by privacy and data theft concerns.) At least a
dozen $50 million-plus homeland security acquisitions have closed in the
past two years alone. Judy Marks, Lockheed Martin's president of
Transportation and Security Solutions, says this type of dealmaking will
drive innovation. "There are threats we can imagine that will spawn
technologies we haven't even thought of," she says.

There's little fear in the industry that government spending will abate any
time soon. If anything, insiders insist, the government is in catch-up mode.
Washington may be a squabbling, partisan bureaucracy, but there is one thing
that politicians can agree on: It's important to look tough on disasters. No
elected representative wants to be seen as having rejected funding for the
prevention of a catastrophic event that actually occurs.

"We are in year four," says Scott Greiper, a global security analyst at the
investment bank CE Unterberg-Towbin, referring to an industry calendar that
begins on 9/11, "but we are on the 10-yard line when it comes to the money
that has to be spent."

The 10-yard line. It's a familiar metaphor, echoing the old "first inning of
the Internet" mantra that was so common in the late '90s. To entrepreneurs,
it's a clarion call, beckoning them to pack up their ideas and bring them to
Washington in search of funding. Some of those ideas are a waste of
resources, opportunistic bids for government pork. Some may even be
dangerous distractions from real problems. Others represent innovation at
its best, offering us protection from the next disaster. In a frenzy, it can
be tough to know which is which.

"I have a stereotypical startup's office," says Chris Sleat, the CEO of
Realinterface, a medical software company that occupies a sunny corner of
the Chesapeake Innovation Center. "It's a shit hole." On the floor, books
like the Physicians' Desk Reference Guide to Biological and Chemical Warfare
Response lie next to copies of Bio-IT World and piles of cables, monitors,
and bills.

The 38-year-old - a successful dotcom era veteran - founded Realinterface in
2003 to commercialize a software program to help hospitals find and register
patients for clinical studies. Several university hospitals bought the
technology, and one day a doctor suggested to Sleat that the same techniques
could be used by first responders to determine whether a patient's symptoms
indicated a bioterror agent. "He told me their EMTs wouldn't know smallpox
if it sat on their shoulder," Sleat recalls.

So Sleat and his 11 employees developed an application for EMTs, called
ThreatScreen. Last year the company bagged its first contract, with the
state of Mississippi for $1.2 million. It's a simple tool, Sleat says, but
it could head off a catastrophe. "Domestic terrorists distilling castor
beans into ricin," he says, "are not going to make it in approved labs and
transport it in airtight containers. So there are tremendous opportunities
to get them at the source, when they accidentally infect Reggie at the
7-Eleven."

Sleat is philosophical about his own entry into the save-society market, and
the thousands of startups around the country doing the same. The homeland
security industry "has been kind of like, 'I have an electric toothbrush.
Can I make it the homeland security toothbrush?'" he says, adopting his best
infomercial voice as we walk to the break room.

"A lot of people are kind of glomming on to this market," he adds, laughing
as he pours himself a cup of coffee. "That's capitalism."
Contributing editor Evan Ratliff ([EMAIL PROTECTED]), coauthor of Safe:
The Race to Protect Ourselves in a Newly Dangerous World, wrote about
intelligent design in issue 12.10.



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