European Defence & Aerospace sector deals return to previous highs

The value of deals in the aerospace and defence sector is returning to previous highs according to ‘Flying High - Aerospace and Defence M&A’, a new report by PricewaterhouseCoopers. The total value of disclosed transactions reached $33bn in 2006, comfortably the highest level since 2000. Looking forward, the drivers fuelling the growth look set to sustain these high levels over the next two years.

The growing confidence in the sector is reflected in the larger average deal size which has almost tripled from a low of $99m in 2003 to $277m in 2006.

Geographically, Europe took centre stage; the value of deals involving European-based targets totalled $21bn, double the $10bn invested in North America, and a reversal of the relative proportions seen in 2005.

Acquisition money is flowing from Europe into North America, giving European corporates access to the US market. European acquirers spent a total of $5.6bn on North American targets over the last two years, more than double the amount of money coming the other way. However the report anticipates that US corporates will be looking at European and particularly UK assets as tier 2/3 consolidation and asset changes between major players continues. US defence spending growth is slowing so future growth is likely to be harder to come by for the large US contractors. There is also strong evidence that the current operational rate of US overseas deployments may reduce research, design, technology and evaluation as well as postpone platform spending.

Another geographical feature is the rise of Middle Eastern investors, who invested $2.5bn in European targets last year, up from virtually zero in 2005. Dubai in particular is seeking to build capabilities and infrastructure in the sector to take advantage of industry growth and its geographical position between Asia and both North America and Europe.

The implications of all this activity will shape the structure of the industry for the next decade.

Gregg Agens, global aerospace and defence leader, PricewaterhouseCoopers:

Competition is fierce given that for the first time in recent years both corporate buyers and financial acquirers have the resources and the appetite to compete for targets in the aerospace and defence sector.

Similar to other industries involved in large-scale manufacturing, prime contractors have been considering which of their production activities are core and non-core. This has resulted in a steady flow of transactions involving divestiture of value-added manufacturing facilities that the primes no longer consider core to their focus on design and assembly of major platforms. Outsourcing is likely to be an increasing feature at many levels in the supply chain of the future.

Outsourcing and supplier rationalisation offer significant opportunities for the best suppliers to gain market share with specific technologies. This is particularly true in the lower tiers of the supply chain as these segments of the market are still very fragmented in comparison to the primes or their tier 1 suppliers. Suppliers that can offer a broad range of products, supply chain management capabilities and a willingness to undertake risk sharing contracts, both financial and technical, will make the grade as ‘strategic’ suppliers. Those that cannot will find organic growth through new contract wins more difficult and will risk being displaced by more forward thinking suppliers.

The report also looks at reacquisition of key technologies. The complexity of modern platforms is such that no one organisation or nation can develop a new platform without access to best-in-class technologies from the global supply base. Companies that have proprietary technology have consistently represented attractive targets for acquirers seeking to access pockets of growth and cross selling opportunities. Primes and tier 1 suppliers are seeking out and acquiring targets with specific technologies, even if this goes against the notion of primes as ‘system of systems’ integrators.

Aerospace and defence is now attracting record levels of private equity investment across a wide range of deal sizes. Four of the top five majority stake transactions in 2006 involved private equity, either as a buyer or seller. Private equity has been attracted by the restructuring and globalisation seen right across the industry, in both manufacturing and services segments. These investors have participated by providing much-needed liquidity in the market as larger players divest assets and the supply chain consolidates.

Additionally, average industry operating profit margin started to recover in 2005 and when all results are in for 2006 it is anticipated there will be a significant further improvement.

Neil Hampson, UK aerospace and defence leader, PricewaterhouseCoopers LLP:

The aerospace and defence industry has regained the confidence to make the large-scale and long-term investments implied by M&A. It is only relatively recently that corporate investors have returned to the market and they have to make up for lost time to position themselves for the future. This, together with the ongoing search for strong positions in new technologies indicates high levels of M&A activity will continue for some time.

Source: PricewaterhouseCoopers

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