WASHINGTON — Experts anticipate the Paris Air Show may be unusually light on sales announcements and product demonstrations, creating the opportunity for mergers and acquisitions to take center stage.
In recent years, defense firms have had to carefully massage their portfolios, with many opting for some combination of share buybacks, high dividends and downsizing to maintain healthy stock prices since 2011's Budget Control Act clamped down on the Pentagon's budget.
"Organic growth in the defense space has not been that significant," so expanding via M&A has emerged as a primary area where defense firms can demonstrate growth, said Michael Richter, managing director of Lazard's defense and aerospace investment banking group.
With its collection of defense and aerospace executives, the Paris Air Show offers an excellent environment for making deals, he said.
"Most of the CEOs and top executives are there, so it's fairly easy to execute a deal," Richter said. "There's just so much deal making that happens at the Paris Air Show, at virtually every stage of the lifecycle of the deal."
Jeff Bialos, an M&A attorney at Sutherland who specializes in aerospace and defense, agreed that the defense market has been ripe for acquisitions since the onset of sequestration, but suggested that M&A activity won't pick up until firms are more confident that the US defense budget has bottomed out and has started to rebound.
"Until you reach the end of that road, there really isn't going to be a lot of merger activity," he said. "There's no doubt companies are testing the waters and are looking for acquisitions that make sense."
Bialos doubted there would be any major merger announcements at Le Bourget, noting that large shows are not the traditional venue for that kind of news.
"It's just not the place for that," he said.
Anita Antenucci, senior managing director at Houlihan Lokey, noted that defense stocks are back to trading at multiples of earnings that are above 10-year averages and approaching historic highs. At those levels, stock buybacks make less sense, and executives are looking for other ways to deploy their capital, she said.
Besides companies' pension plans, "the only place to put it would be acquisitions," she said.
And smart CEOs, particularly at mid-tier firms, are on the lookout.
"Nobody wants to do a stupid deal, but if there are strong synergies involved, they are willing to pay up for that," she said.
Several top tier firms, including Northrop Grumman and BAE Systems, are not participating in the Paris Air Show, but Antenucci expects smaller companies to send plenty of executives, particularly those who specialize in M&A and corporate development and strategy.
While the airshow used to be a place to show potential customers equipment and products they might not otherwise have a chance to see, it has become a good environment for defense executives to meet and gauge others' level of interest, she said.
"It's much more a climate for hearing what's possible. It's a place where you can meet a lot of people, and meeting with somebody blends in" and doesn't attract a lot of attention, she said. "It's a place where CEO to CEO meetings can happen without it being quite the big deal that it is at home."
As for potential targets for acquisition, smaller or mid-sized companies with expertise in defense electronics, sensors, communications, robotics or unmanned technology will be the most attractive to the legacy contractors, Antenucci said.
"They offer synergies to so many companies," she said. "Those are going to be highly sought-after targets by strategic buyers."
Lazard's Richter added that companies specializing in cyber, UAVs and C4ISR seem to have weathered the downturn in defense spending better than other segments of the industry. He agreed that larger firms will look to them as possible merger targets.
"In cyber, it's really not related to size, it's related to capability. If you are a very small company with a very significant capability or patent, the sky's the limit for multiples" of earnings that buyers will pay to acquire them, Richter said. "These companies are highly sought after."
The increasing frequency and severity of hostile cyber incursions makes cybersecurity firms even more attractive, he said.
"There are so many hacks on a daily basis, not just commercial systems, but to advanced military and government systems, it's really becoming a major, major problem," he said. Defensive capabilities need to be built into defense products and addressed from ground zero, he said.
"The problem is there are so few companies that do that, that when they do emerge, they get snapped up very quickly at significant valuations," he said.
Richter also expected private equity firms to be a factor in the M&A environment. For a recent example, he pointed to Veritas Capital's purchase of StandardAero from Dubai Aerospace Enterprise in May, which secured a lot of debt to complete the deal.
"A financial sponsor can get six or seven times leverage in a deal, then the ability for them to pay a double digit multiple is very high," he said. "There's billions of dollars in dry powder that's sitting out there, looking for a home. And it's either use it or lose it."
Strategic buyers — larger companies looking to expand — have got to step up to compete, he said.
"It really has become a seller's market in the M&A market," Richter said.
Without a lot of major contract awards or sales to point to, it can be hard to agree on a fair price, Sunderland's Bialos said.
"Certainly there are players in the private equity field looking for defense deals," he said. "You haven't seen a lot of activity, because I think the valuations have been an issue."
Email: aclevenger@defensenews.com
Twitter: @andclev