Excerpts sourced from www.FT.com
Defence stocks have proved a relatively safe haven for investors during the credit crunch, even defying fears over a slowdown in government spending in the US and UK. While the rest of the market may be suffering from the fall-out of the credit crunch, the global aerospace and defence industry is still looking healthy. Strong balance sheets mean merger and acquisition activity is likely to continue.
A report published by PwC, the consulting firm, reveals that the total value of merger and acquisition activity last year totalled nearly $31bn – the highest since 2000 and beating last year’s record of $29.2bn. “The industry has delivered a very healthy set of numbers, which are not driven by one particular deal. It is very much a mix now of private equity players and corporates driving the M&A activity,” says Neil Hampson, who heads PwC’s UK-based aerospace and defence team.
According to Mr Hampson, over the past 12 months both the leading US companies as well as tier two companies have re-entered the market as buyers. Buoyed by the strong civil aerospace cycle, coupled with revenues from operational military programmes, most of the big corporates are “all throwing off a lot of cash, more than they have done for the last five years”. Even delays to leading civil programmes such as Boeing’s 787 Dreamliner have not been able to dent strong order backlogs so far. The buoyant activity has remained centred in North America and Europe, despite concerns over cutbacks to defence budgets, especially as the activity in Iraq and Afghanistan declines.
According to PwC, the US was the most significant investor; of the $32.9bn that was invested last year, nearly three-quarters was invested in North America and only a quarter in Europe. The trend is a reflection not just of the European market being seen as less attractive but also because the weak dollar has made North American targets cheaper. While some mid-market companies have put themselves up for sale, others are buying, such as Britain’s Cobham.
Last year saw a surge in the number of transatlantic mergers and acquisitions, with their value rising from $1.9bn to $12.6bn. Two of the largest deals were General Electric’s acquisition of Smiths Aerospace and JLL Partners’ $900m acquisition of McKechnie Aerospace. But British companies in particular have continued their acquisition spree on the other side of the Atlantic. If BAE Systems has led the way – it followed its $3.5bn acquisition of United Defense with the $4.5bn purchase of Armor Holdings in 2007 – its smaller counterparts like Cobham and Ultra Electronics have not been far behind.
Jeremy Berwick, director in the aerospace and defence team at Ernst & Young, says the mid-tier market has enjoyed “a constant level of activity”. He adds: “A lot of it is driven by companies buying into the lucrative US market, mopping up technology businesses that are incremental to their existing core.” The most high-profile deal so far this year is the proposed $5.2bn acquisition by Italy’s Finmeccanica of DRS Technologies, a leading supplier to the US military. If approved, the deal will be the first significant purchase in the US by a continental European force. It is doubly significant because DRS is a manufacturer of strategically sensitive electronics equipment.
The purchase complements Finmeccanica’s 2005 presidential helicopter contract for its AgustaWestland subsidiary and its aeronautics division, which is working on Boeing’s 787 Dreamliner and building the C27 cargo plane for the US armed forces. The acquisition still needs to be approved by the Committee of Foreign Investment, which vets foreign deals, but analysts said, in spite of the sensitive nature of some of the DRS technology, Finmeccanica had managed to build up a good relationship with the Pentagon. Finmeccanica will run DRS as a wholly-owned subsidiary and maintain the company’s management and headquarters.
Rivals such as EADS and Thales have signalled that they are looking to expand in the US. The former is keen to increase the dollar element of its revenues. If the US market is still attracting the most attention, aerospace and defence companies have also turned to emerging markets. “The Middle East as a buyer and India as a destination,” are two trends that have come to the fore in the past year, says Mr Hampson.
But industrial companies still face stiff competition from private equity. Paul Edwards, who heads the European arm of the aerospace and defence practice at Jefferies International, says “private equity is still a very interesting theme”. He says: “Everyone thinks because of the credit crunch and the banks’ inability to lend, that private players have disappeared. But we are still seeing them bid aggressively. They are more focused now but they are still willing to do small deals, big deals, across sectors, willing to take out public companies. They like defence.”
In parallel with all this activity, prices have also risen. “They are high, but are they unjustifiable?” asks Mr Hampson of PwC. “No, not given how buoyant the market is at the moment.”
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