I finally figured this one out.
... as far as building big ships against the DL, I figured out the hard way that this isn't economical. I haven't quite quantified it yet, but one would think logically that building big ships would be better for one reason: survivability. With many small ships, you may loose one or two, but the equivelent larger ships would take hits, but not be destroyed. Then you repair it, and have it back again. However this doesn't seem to be the case here. I tried this mission again, starting fairly early to build lots of tiny ships, stocking each of my planets with at least 4. The DL came by and periodically blasted then, but I could replenish them fast enough to prevent invasions. This bought me the time to build up my economy to the point where when I ran out of cash, I could still support myself by researching techs, and selling it to the AI players. Even in the absense of tech sales, I could still build reasonable amounts of ships.
The keys: don't lose your worlds. I had 5 going, two westerfield, and the one just to the right of it, and the two homeworlds. I built up speed tech fast, built a 15 speed 1000 troop ship, and kept them in reserve. Then I let the DL take Kawais (or whatever it is), then I would take it back. We exchanged this world over and over, each time I took a nice tech from them. I exchanged these techs with the AI for cash, or for other techs they took from the DL. Eventually my ships were more potent then the DL, and I pretty easily conquered them militarily. The last key is to do all this fast enough to prevent the DL from having too large of a force on the map. Make sure you start as early as feasible exchanging worlds with the DL. If you have to start with a slower troop tran, thats ok. Oh, and research troop tech early too. I built tir-quan training, and the few other techs, and that helped. Advance troop mod was key to the very long range transports. 1000 troops will take a DL world every time with a few troop techs (and I think without too). Make sure you intercept DL fleets that try and sneak behind your lines (when you have a line) as they will raid your worlds in the back without as much defense and where you keep a reserve of transports. Aphrodisiac helps too in replenishing your pop. Another big help was building orbital fleet managers, then I built omega defense on colony 21 (or the one closest to DL as that gets attacked the most). That made defending pretty easy. Make sure you trade your trade goods too. Don't over-build ships as the maintenance will kill you. Destroy old ships as you create new ones. Don't upgrade them as it is too expensive.
Other things that most people already know: buying ships and buildings can kill you. If you think about the "cost" of buying vs. building, it is way cheaper (about 1/3) to build. Building still costs you cash. I usually buy my first factory, sometimes second on the first two worlds if there is no resource boost for production. Micromanage your sliders. I set soc to 100 until 1 planet is out of things to build. Then I set research to 100, and research something else to build. Then switch back to soc and build those. I swap from research tech to prod tech, then to econ tech, and rotate through those till the research time is too high (say more than 20 turns). I never build ships as you can crank colony ships out in two turns after you have a few factories (mil at 100). Don't forget to keep enough ships on each planet!
Also, it is good to have ships early with enough speed on other planets to intercept those pesky DL transports. Of course they won't even send them if you have enough ships. Early, the DL could knock of a planet full of ships, then send in a transport in the same turn, but that is not as likely as they don't seem to be smart enough to coordinate the two on the same turn.
I did this on normal, so I imagine on anything higher, it would be harder.