After hitting their lowest point in a decade in 2009, defense and aerospace mergers and acquisitions (M&A) worldwide appear to be picking back up, thanks to looser credit and a clearer picture of U.S. spending priorities, according to analysts and investment bankers.
March 23 alone saw aircraft components maker Triumph Group, Wayne, Pa., agree to buy Vought Aircraft Industries for $1.44 billion, and British engineering support services company Babcock International finally win VT Group with a bid for 1.326 billion pounds ($2 billion).
"It's got people thinking again," said Alex Ashbourne-Walmsley, director of Ashbourne Strategic Consulting in London, of the Babcock-VT Group deal.
"Everybody feels a bit energized by this. Maybe it's a feeling that the worst of the economic downturn is over, [so] now they can start looking," she said. "People are starting to talk about consolidation again when they hadn't been for two years."
A dramatic improvement in the credit markets over the past six months is helping mid-size companies and private equity firms make acquisitions with better borrowing rates, observers said.
There also is a pent-up demand for acquisitions, especially by large companies with lots of cash on hand.
Moreover, the priorities of the 14-month-old administration of U.S. President Barack Obama have become clearer with the release of the Pentagon's Quadrennial Defense Review and 2011 budget proposal.
"This is an industry that's extraordinarily sensitive to political change," said Stuart McCutchan, editor of the Defense Mergers & Acquisition online newsletter in Chantilly, Va., which tracks deals in defense, government and aerospace.
McCutchan noted that cybersecurity firms were snatched up last year after Obama made protecting computer networks a high-profile priority.
Now, he said, "People are starting to relax a little bit and look at other niches, look at other markets outside cybersecurity."
By McCutchan's count, 2009 saw 237 deals with a total value of $19.1 billion completed in the aerospace, government and defense sectors. This year shows a slightly faster pace of deals in the same categories: 71 deals with a total value of $5.65 billion, including deals that were announced this year and those completed already.
By the reckoning of accounting firm PricewaterhouseCoopers (PwC), the aerospace and defense industry produced M&A deals last year that were worth half the 2008 total of $21.77 billion and a quarter of the 2007 total.
Scott Thompson of PwC's U.S. Aerospace and Defense practice predicts total 2010 activity will reach between $10 billion and $20 billion, and likely be closer to the higher end. That would be higher than last year, but not quite up to the level of 2008.
Tess Oxenstierna, managing director of aerospace and defense at investment bank The Bank Street Group in Stamford, Conn., sees more deals happening among mid-size companies, helped by improved credit markets.
Oxenstierna said even smaller firms are now considering acquisitions.
"They're beginning to see movement in lending," she said. "Even a small firm with $60 million [in revenue] can now actually consider acquisitions."
But the one thing that could hold back more deals is a misalignment over asking and offering prices, or multiples, she said. Multiples and a company's earnings before interest, taxes, depreciation and amortization (EBITDA) make up a price.
"Right now, people are still remembering the days of 2007, when those multiples were well over 11 times" EBITDA, whereas today's prices are likely around half that, she said.
"That spread between seller and buyer expectation [on prices] has to come more into alignment for these deals to happen," Oxenstierna said. "And I think that will happen," with multiples trending toward a historical norm of about 8.5 times EBITDA.
Michael Richter, co-head of aerospace and defense for investment banking firm Lazard in Los Angeles, agreed that prices are improving for sellers.
"Valuations are still not at their peak levels, but they are definitely improving from a seller's perspective," he said.
Private equity buyers are still finding it harder to get credit than corporate buyers, Thompson said.
But Richter said the improving credit market is helping private equity firms re-emerge as competitors to acquisition-minded defense companies.
The first signs of an M&A resurgence actually appeared in November, when Northrop Grumman's $1.65 billion sale of its TASC advisory services unit signaled that private equity firms had returned to the defense arena, said Jay Caldwell, managing director of aerospace and defense investment banking with RBC Capital Markets in New York.
Caldwell advised the buyers in both the TASC and Vought Aircraft Industries sales.
And more private equity firms are entering the fray, he said.
"There were quite a few shops bidding for the TASC transaction. One group could win, so that means everybody else was very educated on defense," Caldwell said. "So there's still a lot of [private equity] firms that are still very interested in the space, and have yet to buy an asset."
The Babcock-VT Group deal delineates another trend, Ashbourne-Walmsley said: consolidation in the government services business.
"There's been such a diversity of service provision companies, that sooner or later those do have to consolidate in the same way that the aircraft manufacturers and vehicle manufacturers have consolidated," she said.
Richter said consolidation is likely to continue in all areas of defense, but companies in areas seen as key in U.S. defense and other government spending, such as optics and C4ISR, will be particularly attractive targets.
Steve Grundman, an aerospace and defense consultant at Charles River Associates in Boston, said some of the deals announced this year show another trend - that defense companies are continuing to expand into adjacent markets related to their core activities, in areas such as security, government contracting and complex systems integration, indicating that they can find customers outside of defense.
And with lots of cash and little debt on the balance sheets of aerospace and defense companies, "now there is enough clarity about how the market is changing to perhaps make some bets," Grundman said. ■
E-mail: aboessenkool@defensenews.com.
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