The Homeland Security Bubble

Is the War on Terror a bad investment?

Former Sen. Don Nickles wants your dimes

If you wanted to invent a bogus-sounding Washington company, the kind of ominous corporation that belongs in a subplot for next year’s 24, you couldn’t come up with a name—or a business plan—better than that of Fortress America Acquisition Corp. Fortress America is a scheme by a bipartisan group of Washington insiders, including a Rhodes scholar turned professional basketball player turned congressman, a former senator, and an offshore investment company with ties to the former head of the Central Intelligence Agency, to capitalize on the nation’s fear of terror. Fortress America Acquisition Corp. is striving to be a kind of mini- Carlyle Group. (Carlyle has pioneered the art of transforming former government officials with connections to defense and national security into businessmen.) But Fortress America is a backward step in access capitalism. Rather than seeking to raise cash from smart money as Carlyle does, it’s going after the dumbest money out there: people who are willing to write blank checks to a company that lacks meaningful assets, a track record, or a well-articulated business plan. As it forthrightly acknowledges in its prospectus, Fortress America is a classic “blank-check” company. A group of investors has set up a shell company with virtually no assets or operations. They will hold an IPO to gain the cash or currency needed to go buy companies.

While it’s not exactly Tom Clancy, the prospectus for Fortress America’s proposed $42 million initial public offering makes for interesting reading. There are ribs that have marinated for longer than this company has. Formed in December 2004, Fortress America was the brainchild of Chairman Thomas McMillen. A University of Maryland basketball star and Rhodes scholar, McMillen enjoyed an 11-year career in the National Basketball Association, primarily with the Atlanta Hawks and the Washington Bullets, before becoming the tallest congressman in American history. After three terms as a Democrat representing a Maryland district, McMillen became an investment banker who has lately specialized in homeland security companies. (Matthew Goldstein has more on his recent investing activities in the CEO Harvey Weiss is a software industry veteran and a member of the Brookings Institution Council. The company has two post players: director Don Nickles, the former Republican senator turned lobbyist, and special adviser Asa Hutchinson, the former head of the Drug Enforcement Administration and former undersecretary for border and transportation security at the Department of Homeland Security.

Fortress America also has a token investment from the Paladin Homeland Security Fund, one of whose entities is based in the Cayman Islands. Would you be surprised to learn that the fund’s management team includes former CIA head James Woolsey? (Steve Clemons of the Washington Note has more on Woolsey’s efforts to profit from the war on terror.)

These names—and their contacts—are essentially the company’s only assets. On March 9, 2005, the insiders and a few other investors kicked in $25,000 for 1.75 million shares—paying, on average, about 1.4 cents per share. Two weeks later, the company filed its first preliminary prospectus.

“We expect that the billions of dollars of governmental and private sector expenditures for homeland security should result in increased demand for homeland security products and services,” the prospectus notes. Fortress America plans to get in on the action by buying “an operating business in the homeland security industry.”

What kind of business? Well, these guys are pretty much up for anything. Fortress America is casting a wide net in four broad areas of fear-related businesses: planning, prevention, response, and recovery. It could be software or vehicle armor, consulting services or decontamination products, terrorism-related insurance or temporary housing.

For a company that plans to specialize in security, the company doesn’t offer investors an awful lot of security. The prospectus notes that “we are exempt from rules promulgated by the SEC to protect investors of blank-check companies such as Rule 419.” (For a full discussion of how Fortress America’s offering differs from a blank-check offering conducted in compliance under Rule 419, see pages 27 and 28 of the prospectus.) The company has no independent directors. One of the first orders of business after the offering will be moving out of its current low-rent quarters into more expensive ones that are owned by a company affiliated with McMillen.

The business experience of the Fortress America team is either nonexistent, in the case of Hutchinson, who was a trial lawyer before entering politics, or somewhat checkered. From 1994 to 1999, McMillen ran Complete Wellness Centers Inc., a health care company that ultimately went bankrupt in 2001. Oh, and after the offering, the insiders will control about 20 percent of the stock, meaning they will have turned an investment of about $25,000 into stock worth about $10 million in a matter of weeks. (They’re supposed to hold on to the stock for three years before selling.)

There are a lot of ways for well-connected capitalists to raise $42 million. Fortress America could have collected from institutional investors, big corporations, venture-capital funds, or private equity funds. But such well-endowed investors would ask for something in return for the risk they’re assuming: board seats, accountability, a clue as to what will be done with their money. After reading the prospectus, it’s clear why Fortress America is pursuing a blank-check IPO: The dumb money will buy it. Fortress America is evidence that homeland security may have just reached the stage that Internet investing hit in 1997. Back then, all you needed to do was put an “e” in front of your company name and your IPO would rocket. Now you can do the same with “fortress.”