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David Jasmund
PCE Investment Banking |
Florida Dealmaking: Trends
& Deals
Consolidation Trends
Continue to Stimulate Defense Industry M&A
March 31, 2005
Each March,
leading defense/aerospace and federal IT investors and corporate
development executives meet in Reston, Virginia, to take stock of
what's changed - and what hasn't - in the competitive landscape
of the rapidly evolving defense & aerospace industry.
Industry leaders at the Strategic Research Institute's 5th Annual
Defense & Aerospace Investor & Corporate Development Conference
observed that 2005 appears to be on track to meet or exceed the
M&A activity in 2004. Eighteen transactions were already announced
in the government services sector in January, compared to 8 announced
deals in January 2004. The escalated trend was reinforced the first
morning of the conference by the announcement the previous day of
the $3.9 + billion acquisition of United Defense Industries, Inc.
by BAE Systems North America.
Publicly traded defense and government services companies are continuing
to hold valuations at the top end of their historical pricing range.
A report presented by Mercer Management Consulting showed that last
year, Wall Street's defense sector mean valuation multiple was just
short of 13x EBITDA. This compares to the 20-year mean multiple
of 7x. Growth is a key factor in maintaining these current elevated
levels of pricing; therefore, these public companies should continue
to drive acquisitions. Valuation experts from around the country
all reported that M&A pricing for privately held companies on
average has remained consistently high since last year and most
expect it to continue in 2005 even if public company valuations
trend off the historic level. Excluding the niche service providers
and large businesses, the median transaction multiple reported in
the market has consistently been 7x to 9x trailing 12 months EBITDA
for the acquisition of privately held companies.
As was
the case in October, M&A activity in the defense market continues
to be pushed by industry consolidation. (click here to see PCE newsletter,
"Florida Dealmaking: Trends & Deals," October 27,
2004.) First tier contractors continue to acquire second tier companies
in an effort to expand service offerings and improve overall growth
rates, while second tier players search for third tier acquisitions
in order to expand their client base and /or service offerings.
Increasingly challenged by the contract consolidation, third tier
contractors pursue acquisitions in an effort to respond an remain
competitive.
What's
moving the marketplace?
- Continued
growth in Department of Defense spending, supporting conflicts
in Iraq, Afghanistan, and elsewhere; DoD "transformation"
efforts; and the shift in the DoD budget of a greater percentage
to operations & maintenance due to the aging of military equipment.
- Department
of Homeland Security spending kicking in due to the ongoing war
on terrorism and a move from proactive to reactive spending.
- Aging
federal workforce and long-term cost of retired health benefits
influencing the federal government to outsource many services.
- Military
and federal government's increased spending on IT to increase
productivity as they shift to E-Gov and implement technology upgrades.
What's
holding the market back?
- Budget
shifting to support the war effort causing movement away from
procurement to operations & maintenance.
- U.S.
Navy tightening the budget belt.
- the
federal government's slow response to accelerating security clearances,
restricting the ability of contractors to grow.
- Re
prioritizations
given the start of the "W" II administration, coupled
with the uncertainty of the direction of military spending with
the QDR (Report of the Quadrennial Defense Review) due
out in May.
M&A
- What are they looking for?
- Access
to new clients and programs
- Access
to new capabilities (R&D)
- IT
Services (outsourcing) versus Systems Engineering
- Re-compete
risk on major products, projects, or programs
- Prime
work as a percentage of revenue
- Historical
dependence on special bidding status (8A, etc.)
- Passthroughs
as a percent of revenue
- Post-deal
financial leverage
- Accretive
to earnings
Indications
are that the M&A trends that closed out 2004 at an all-time
high will continue through 2005 at the same place. Due to the many
defense and aerospace contractors in Florida, the state will continue
to experience the effects of the consolidation trend. Because of
PCE's expertise in this sector, we will continue to be active in
mergers, acquisitions, and divestiture deals in the defense industry.
PCE
Investment Bankers is a member of the PCE family of companies that
provide investment banking, valuations, advisory services, research
and Indexes.
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