The capital required for critical supply chains

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Caitlin Ludwig: Hello, Making Sense listeners. You're listening to the next episode of our Security and Resiliency in Action series, where we unpack the big moves and macro trends shaping our economic future. Over the course of this series, J.P. Morgan experts will cover industries that are critical to national security and resiliency, including energy, healthcare, pharma, manufacturing, defense, and technology. This episode is all about the capital needed for critical supply chains. We'll hear from Michael Johnson, SRI lead for energy in the US government, Andrew Castaldo, co-head of MidCap M&A, and Ben Wilson, co-head of North American M&A. Over the course of the conversation, we'll cover critical mineral supply chains, manufacturing bottlenecks, and the shift from just in time to just in case inventory. If you'd like to learn more, you can visit jpmorgan.com/sri. With that, let's jump into the conversation.

Michael Johnson: The Security and Resiliency Initiative, which we call SRI, really has five sub-components to it. One is supply chain and manufacturing, which we're going to talk about today. One of the most important of those is supply chain and resiliency. It's really what started all this. In April of last year when the supply of rare earth magnets got cut off, two months later, auto factories started shutting down here. That was a wake-up call for many of us that, wait, why are we vulnerable in this? And it's supply chain that leads through so much of this.

Ben Wilson: The SRI initiative is all in service of figuring out the national security components of all these things that traditionally I don't think we as a country thought of as national defense or national security. We typically though of that as weapons and munitions, whereas today we're thinking about it as generic pharmaceuticals, grid security, technology, and that's really the purpose of the initiative.

Michael Johnson: It's interesting. I think we probably all at the same time around COVID for the first time really focused on supply chain for a different reason entirely. But then as we've started to study this, you find so many areas that we just don't make the things we need to make and so much reliance on other places. And a lot of what we're doing here is identifying those chains and finding a way to make them more resilient or bring them on shore.

Ben Wilson: I also think what has been fascinating about this process is that you realize it's not just the big companies that are incredibly important to all of these different sub-sectors and supply chains and advanced manufacturing, but there's an enormous amount of small family-owned businesses in all different parts of the country that really need the support and the capital to make the investments required to address all of these issues that we have in the broader supply chain.

Andrew Castaldo: No, look, that's exactly right. I mean, the end manufacturer has to rely on dozens of individual suppliers of components and pieces for them to produce the ultimate end product that they're producing, whether it's for the government, for the economy, or heavy industry. And so it's our job collectively to try to identify those weaknesses within the supply chain. And frankly, those are companies that probably need our help more than the larger companies. And so that's the areas that we can make a difference as a firm. I think that's the areas that our US government is also focused on. And I think collectively we can really try to fix the perceived problem of what's happened over the past 20 years.

Michael Johnson: One of the things interestingly we're doing within SRI is we're identifying that second and third tier supply chain, Ben, that you talk about. And one of the ways we're doing that, we do a lot of research, but the other way is to call our clients, call people that build power plants or nuclear plants and ask them, "What are you worried about? What's the second and third?" And what we hear is not what you read in the press. What we hear are, "Well, everybody's talking about transformers, but we need medium voltage transformers or we need molders." You find out, and now what we're doing is digging deeper and going and finding those small companies in many cases where we can lean in with advice, with balance sheet, with capital to help those. In many cases, not just de-bottleneck, but expand to meet requirements that are coming up.

Ben Wilson: We up until recently lived in a just-in-time economy. Companies were punished for having too much inventory, and now we are realizing they're realizing, people around the world are realizing the importance of having stockpiles of things like pharmaceuticals, like inputs for advanced manufacturing. A huge goal of our SRI initiative is to help people adjust to the new way they need to think about having access to the inputs they need to continue to function.

Andrew Castaldo: There are a whole host of critical materials and other supply inputs that are critical to the overall functioning of our economy, and we need to figure out ways to onshore those materials and the processing of those materials. And so what we're trying to do is identify where are the weak links in the chain across all of industry. It's not just the minerals, it's the processing, it's the refining of those minerals that really makes our overall economy go. And so I think as a whole, we're reorienting and we're helping reorient the economy in a way that makes it function for the long term.

Michael Johnson: The other thing about the conflicts that are ongoing now and have been ongoing is they impact the supply chains in multiple ways. So one is they raise the demand for certain things. Rare earth magnets is an obvious one into all sorts of things, but also they hinder the ability to manufacture those because of either physical disturbances or supply chain or shipping disturbances, and so you get hit from both sides. Again, we try to go into those situations and find out where the bottlenecks are. Many of those can be facilitated by more capital. That's one of the things we help bring to bear.

Andrew Castaldo: I'd say, look, another great example is what we've done in terms of starting to stand up rare earth magnet production in the US. Until the past two to three years, that wasn't even something that people really thought about.

Ben Wilson: But the recognition and the difference between today and as little as 18 months ago is, we used to focus on having the capability to do all of this advanced manufacturing. And then we realized no matter how great the facilities are, they can't run without the inputs.

Michael Johnson: One of the most fun things about the job that we do is we occasionally get to go walk a factory floor or see a facility. There was a notion that advanced manufacturing can't really happen in this country. That's completely false. I walked the floor of very advanced factories. I walked a floor, it was probably 300,000 square feet. I saw four people and they had robots doing cutting edge technology, making things that people use every day. And what we've had is some of our clients come to us on the heels of the SRI announcement and say, "Hey, we're really good at manufacturing. We have spare capacity. Maybe we could use some of that for some of these younger companies who are trying to advance their technology. We can help them scale up."

Ben Wilson: Our clients' need for scale and the ability to strategically and holistically think about where they're putting their capital, that's also changed. It used to be looking for the lowest economic cost. Now they're thinking more about where should those dollars go? Where is it going to be most stable? Where is that going to be part of a broader ecosystem that we are building within this country? And so you're seeing a lot of announcements and action around investments in the United States that have either never happened or haven't happened in a very long

Our clients' need for scale and the ability to strategically and holistically think about where they're putting their capital, that's also changed. It used to be looking for the lowest economic cost. Now they're thinking more about where should those dollars go? Where is it going to be most stable? Where is that going to be part of a broader ecosystem that we are building within this country? And so you're seeing a lot of announcements and action around investments in the United States that have either never happened or haven't happened in a very long

Andrew Castaldo: Time. And look, I think you are seeing, you're going to continue to see large companies make investments down the supply chain to make sure that they have the materials that they need. Again, to shore up the supply chain, I think we're going to see that be an important M&A trend over the coming two to 10 years effectively.

Michael Johnson: One clear example of the long-term impact of this investing is the Korea Zinc deal. That's a smelter that's going to be built in Clarksville, Tennessee, and that technology. And Korea's Inc. Was picked because they're the largest processor of non-ferrous metals in the world. They have the most expertise. So they're going to build that facility and we're going to train our workers on their technology, their know-how, as you said earlier, and that is forever going to make 11 of the 13 critical minerals we have. And that will establish jobs and supply chains behind that and feedstock behind that and transportation, and there's a ripple effect of that that just keeps going.

Ben Wilson: I'd build on that by saying, Michael, the key part of what you just said is we are building resiliency. The reason we call it the Security and Resiliency Initiative is because the ripple effect of all this investment over time is going to be a more resilient, more vibrant, more secure economy, therefore country, therefore world.

Andrew Castaldo: And Michael, I think you said this, but effectively it's not just. The Korea Zinc Project isn't just producing zinc, lead, germanium, gallium. Those materials are going to go into additional manufacturing processes that are going to be onshored into the US or expanded in the US. And so there's this ripple effect that's not just a zinc smelter, it's a zinc smelter that enables additional manufacturing within the country, which is just going to feed upon itself.

Michael Johnson: Three years ago, we met with CEOs who said they didn't really worry about supply chain. They built an automobile or whatever and the other parts showed up. A little bit of this happened through COVID, but more recently through some of the critical minerals and other shortages back to lithium, they've found that they just can't rely on that anymore. So they need to build, again, resilient supply chains that go one or two or three levels down. And that's going to be important now and it's going to be important in 10 and 20 and 30 years.

Ben Wilson: And building onto that, Mike, we've had multiple shocks in the last decade, right? You had COVID, now we have rising geopolitical tensions, and why it's going to be relevant is we don't know what the future holds. The last five years, six years have been pretty crazy. And so boards and management teams in my mind are now willing to spend the dollars, build the resiliency in the supply chain so that when whatever else comes next, they're not vulnerable and therefore their products, their shareholders, their employees are not vulnerable. And that is a shift in mentality that is not going to go away in the coming decade.

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