The great industrial competition: Mergers, acquisitions and geopolitical events fuel revenue

WASHINGTON — For the third straight year, overall defense revenues for the Top 100 defense companies in the world have increased, as defense budgets around the globe continue to climb in what has been dubbed a new era of great power competition.

Total fiscal 2018 defense revenues for the Top 100 companies came in at $490 billion, easily eclipsing 2012, the last time the Top 100 combined to top $400 billion.

That growth is largely driven by a first for the Top 100 list since 2001: the inclusion of Chinese defense firms. The list included eight Chinese companies in the top 25 spots, with six in the top 15. Even without eight new Chinese firms, that overall total is down to $393 billion, which would still represent an approximately $17 billion increase over the previous year’s $375 billion total.

Click here for this year’s Top 100 list of global defense companies.

The top 25 companies accounted for just less than 75 percent of total defense revenues in the year, and the top 10 firms accounted for about 50 percent of total defense revenues in the year.

Geographically, 41 of the top 100 firms are based in the U.S., which accounted for about 52 percent of total defense revenue, slightly down from 2017. Thirty-two firms are located in Europe (including the United Kingdom and Turkey but excluding Russia), accounting for roughly 20 percent of defense revenue. Non-Chinese firms from the Asia-Pacific region claimed 11 companies; Israel housed three; Russia two; and Canada, Brazil and South Africa each are home to one.

The annual Defense News Top 100 list is compiled through a mix of open-source figures and self-reporting from companies, many of whom provide estimates rather than definitive data for their defense percentages. Hence, while the list is the industry standard, the numbers come with some variance; they also do not take into account major industrial movements that would be reported after the end of FY18. Defense News researched more than 150 firms from around the world.

Top 10

Combined, the top 10 firms brought in $246.5 billion in defense revenue in 2018, just over 50 percent of the overall total of the top 100 — evidence that while traditional defense firms are facing increased competition from new entrants into the market, the largest companies maintain a stranglehold on the defense industry.

The biggest change in the list is the inclusion of Chinese firms. Combined, the eight Chinese firms contributed just under $97 billion in defense revenue, behind only the United States and Europe. Because of their presence on the list, the top 10 spots have experienced their biggest shake-up in recent Top 100 history.

Three Chinese firms — Aviation Industry Corporation of China (5th on the list, with $24.9 billion in defense revenue), China North Industries Group Corporation Limited (8th, with $14.8 billion) and China Aerospace Science and Industry Corporation (10th, with $12.1 billion) — crashed the top 10, helping to displace firms previously in that group such as Russia’s Almaz-Antey (8th on last year’s list, and 15th on this year’s list), Leonardo (previously 10th, now 13th) and Thales (previously 9th, now 16th).

But China’s presence was not enough to keep Lockheed Martin from remaining the top defense contractor in the world for a 20th straight year. Lockheed’s $50.5 billion in defense revenue represents about 10 percent of the Top 100’s total defense revenues, and dramatically outpaces the No. 2 company on the list, Boeing, which brought in $34 billion in defense revenue.

Click here for more information on how we calculated Chinese defense revenues.

Lockheed’s continued dominance is no surprise, said Byron Callan of Capital Alpha Partners. He’s confident the company will remain the leader for many years to come.

“The only way you knock Lockheed off its perch is if they are somehow forced to break up or divest, or the F-35 gets canceled, and that’s not going to happen,” Callan said. “Is there maybe another big deal out that, something massive like Boeing buying Northrop, that could top Lockheed? Possibly. But that just gets you where Lockheed is, and Lockheed would probably react.”

Northrop Grumman ($25.3 billion) and Raytheon ($25.2 billion) round out the top five. Overall, eight companies on the list increased their defense revenue by $1 billion or more over FY17 figures: Lockheed ($2.6 billion), Northrop ($3.6 billion), Raytheon ($1.6 billion), General Dynamics ($4.5 billion), Airbus ($1.9 billion), United Technologies ($1.5 billion) and Boeing ($13.5 billion). The eighth firm, Aviation Industry Corporation of China ($2 billion), was not included on last year’s list of FY17 figures.

However, Boeing’s large increase comes with a similarly large asterisk. For last year’s list, the company changed how it reported defense revenue thanks to the creation of its Global Services business unit. The move had dropped the company down to fifth overall. For this year’s list, Boeing reorganized its revenue reporting so that all defense revenue is accounted for; it therefore has a 66 percent defense revenue increase year over year.

Boeing aside, the largest percentage increases in defense revenue belong to John Cockerill Defense (73 percent), Korea Aerospace Industries (72 percent), KBR (57 percent), STM Savunma Teknolojileri Muhendislik ve Ticaret A.S. (53 percent) and Fluor (44 percent).

Roman Schweizer, a market analyst with Cowen, said the overall shape of the defense market is one that is “top-heavy, not a lot of mid-cap guys left in the middle, and then some smaller guys. It’s really an inverted pyramid, which is just a function of consolidation over several decades. And that’s unlikely to change.”

He also said to expect defense revenues to continue to grow – at least in the near term.

“It can take anywhere from one to five years for budget authority to roll into contract obligations and turn into revenue. So the big budget increases from 2016 through 2019 will have a tail for another couple of years,” he said.

However, after that, “revenue would start to flatten out and conceivably drop depending on the trajectory of the budget,” he added.

New, missing and mergers

Including Chinese firms, there were 16 companies listed in this year’s list that did not appear in the previous edition, notably the privately held firm Sierra Nevada Corporation (58th overall, $1.5 billion in defense revenue).

Another notable is TransDigm, which reported $1.3 billion in defense revenue and landed at 62nd place. The company is currently under scrutiny from Congress following a Pentagon report that found the contractor was making “excess profits” off of the department.

However, the list was also altered by a number of companies that declined to participate. Some Russian firms that had placed in last year’s Top 100 refused to share information with Defense News this year, and 2018 annual reports for those firms are yet to be released. Among those no longer listed are United Aircraft (14th on last year’s list) and Russian Helicopters (36th on last year’s list), the latter of which had previously complained when not ranked. American firm Accenture, number 57 on last year’s list, also declined to participate this year, but left open the possibility of rejoining the list next year.

Also missing from the list are a number of Japanese firms that were previously featured, a reflection of how Japan’s Ministry of Defense awarded only a fraction of dollars in FY18 when compared to the previous fiscal year. Looking back, Tokyo awarded about $12 billion to Japan’s top 20 contractors in FY17, but just under $1 billion in contracts to the top 20 in FY18. That is reflected in the fact that Kawasaki Heavy Industries dropped from spot 50 to spot 100 in the new list, reporting approximately $1.4 billion less in defense revenue.

Accordingly, Kawasaki had the largest percentage drop in defense revenue (-94 percent) from the previous year, followed by Melrose Industries (-61 percent), Chemring (-42 percent), Cubic (-41 percent) and Denel (-39 percent).

Since the start of 2017, the defense industry has undergone a series of major mergers and acquisitions activity. Due to the time frame captured in this year’s list, some — but not all — of that activity has been illustrated. Among the M&A activity of note:

• The acquisition of Engility (79th on last year’s list) by SAIC (42nd on this year’s list).
• The acquisition of Orbital ATK (previously 30th) by Northrop Grumman.
• Israel’s IMI Systems (previously 86th) absorption by Elbit Systems (currently 35th).
• The takeover of Rockwell Collins (previously 41st) by United Technologies (currently 17th).
• General Dynamics’ (currently 6th) takeover of CSRA; the latter declined to participate in the list last year, as the takeover was pending. On the 2017 list, which measured FY16 data, CSRA landing at 39th place in defense revenue. The addition of CSRA to General Dynamics helps explain GD’s approximate $4.5 billion defense revenue increase on this year’s list.

However, this year’s list misses two of the largest shake-ups in the defense industry in years. It does not reflect the October 2018 announced merger of L3 Technologies and Harris Corporation. Combined, L3 ($8.2 billion, 18th overall) and Harris ($4.6 billion, 26th overall) would have a projected $12.8 billion in defense revenue, ranking them 10th overall. It also does not reflect the recently announced merger of Raytheon and United Technologies. Based on this year’s figures, the combined company’s estimated defense revenue would reach $34.5 billion, ranking it in second place, behind only Lockheed Martin.

Daniel Gouré of the Lexington Institute believes the shape of the merger and acquisition market has changed in recent years, moving from attempts by companies to add whole new business units – for example a rush of companies buying cyber firms at the start of the decade – only to abandon them shortly thereafter when the pieces didn’t fit.

Now, “rather than try to [move] into new areas, companies are sticking closer to home and doing things that make sense from an integrated product side, completing sub-tier integration like L3 and Harris. So it seems to be a series of relatively smart mergers and acquisitions — not nearly as speculative.”

However, Gouré said, the shrinking mid-tier market means M&A in the American defense industry may slow down in the near term. “We may be seeing in some respects the end of the wave in the next year or so. There’s just not a lot of things left where there isn’t such an obvious conflict of interest where you could add stuff to your portfolio and the Pentagon can say they still maintain two production lines,” he noted. “It’s a little harder to find those places.”

Callan also questioned how much consolidation may happen abroad. While Europe appears fairly fragmented, the desire by individual countries to have indigenous “national champions” means no one will be giving up their local defense firms anytime soon.

However, he noted, there may be room in the U.K. and Russia for consolidation. And consolidation is already happening in China, where it is expected China State Shipbuilding Corporation and China Shipbuilding Industry Corporation will merge, creating a single major shipbuilder in China, with a combined defense revenue of about $14.7 billion — boosting it to No. 9 on the overall Top 100 list.

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