OPINION: Federal equity investments raise troubling questions about picking winners and losers

The Trump administration’s $1 billion investment in L3Harris Technologies’ rocket motor business is just the latest sign of the government's new embrace of a questionable industrial policy – taking ownership stakes in private sector companies.

The administration's other equity investments have included Intel, Lithium America, Trilogy Metals and MP Materials. The stakes range from tens of millions to nearly $9 billion.

Each company experienced spikes in its stock price. The $35.6 million investment in Trilogy set its stock up 240%, according to the Motley Fool. A $400 million investment in MP Materials pushed its stock up 150%.

The Trump administration took a 10% stake in Intel with an $8.9 billion investment, which drove its share price up 49%.

So far, L3Harris has only seen a 1% increase since that agreement was announced Tuesday. Shares that day did jump up 5.4% to $361.49 from $342.85. Since then, however, it has settled back into the $340 range.

More investments are certainly in the works, which led Clark Street Associates and Finalis to form a partnership to help companies navigate equity investments by the federal government.

One could dismiss concerns about these equity stakes arguing that they are little different than awarding sole-source contracts or grants.

But there is a big difference. Grants generally are for a specific purpose and there is often a competitive process.

There has been little transparency about how the administration has picked its equity investments so far.

Why the L3Harris rocket motor unit instead of Northrop Grumman? What about emerging startups like X-Bow Systems and Ursa Major Technologies?

Intel has struggled financially, so why invest there instead of AMD and NVIDIA? All three companies have received large grants under the CHIPS Act, but Intel is the only one with an equity investment from the government.

The MP Materials agreement comes with several guarantees. In addition to the equity investment, the government is guaranteeing pricing and promising to buy all of the output from a new manufacturing facility.

The government has taken these actions with no apparent competitive process and limited public disclosures of decision criteria.

As part of the investments, the government has said it will not take a seat on any board of directors and will remain hands off. With Intel, the government has said its votes will only follow those of the board.

U.S. Steel has been the lone exception so far, where the U.S. government took a "golden share" in that company as a condition for it to be acquired by Nippon Steel. The U.S. government has extensive control over the U.S. Steel business, including one board of directors seat and veto authority over some corporate decisions by Nippon.

The U.K. government holds a golden share in BAE Systems PLC that grants veto power over certain decisions like hostile takeover bids or changes to the company's governance articles. No foreign entity can hold more than 15% of shares in BAE or control the company's board.

Back to our shores: many questions remain about conflicts of interest with these large investments. The U.S. government now has some financial incentive to award contracts to the companies it owns a stake in.

The L3Harris rocket motor unit will continue to compete for defense contracts, which absolutely affect the value of the government’s own investment.

There has been little-to-no discussion so far about how to mitigate these risks.

Questions are also necessary to ask about whether the government has the legal authority to take equity investments in private sector companies outside of an economic crisis.

Also, what is the government’s exit strategy and how disruptive will it be to those markets?

Some arguments do fall in favor of these investments. The government has picked critical industries to invest in, like rocket motor capacity which is is constrained.

China, a U.S. adversary, has restrictions on rare earth minerals that are essential for weapon systems. Of course, computer chips are everywhere and in everything.

The Trump administration wants to preserve and rebuild the U.S. industrial base at a quicker pace than relying on appropriations and contract vehicles.

But these investments are different than when the government bailed out General Motors, Chrysler and several financial institutions after the 2008 financial crisis.

The government took those actions in response to an economic crisis that threatened entire industries and was driving massive job losses. Those were temporary measures and the goal was stabilization, not a strategic partnership.

Here is another red flag to consider with these recent investments: The government is both an investor and the primary customer.

These investments look anti-competitive and risk stifling innovation at a time when the country needs it most. The government is guaranteeing business with these companies and is leaving too many others out.

Instead of creating an environment where the best idea wins, the government is picking the winners and potentially shutting out competitors.

That is not a good long-term policy for creating a stable and healthy industrial base.