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David Jasmund
PCE Investment Banking |
Florida Dealmaking: Trends
& Deals
M&A Storm before
Calm in the Defense Industry
October 27, 2004
As I sat
in the dark and listened to Hurricane Charley wreak havoc on my
home and yard, I reflected on what I heard, only days before, at
the Defense & Aerospace Investor & Corporate Development
Conference. Pentagon, industry, and Wall Street experts met in San
Diego, CA to discuss issues ranging from defense and aerospace market
drivers to who the winners and losers are in this rapidly changing
sector. The “big” take-away was not about market drivers.
Instead, it was this sector’s advancement or prompt movement
from the calm “eye” into the “back-side of this
mighty storm.”
Consolidation Trends: Let me explain. The wave
of consolidation in the defense industry that began a decade ago,
when several mega-deals reduced the number of prime defense contractors
from 100 to only five, is seeing a rebirth in merger, acquisition,
and divesture activity among the second and third tier defense contracting
companies. Having lived through three hurricanes in three months,
I know the “backside” of any storm is many times stronger
and fiercer than the first bands.
 Reports
published by the Center for Strategic and International Studies
(CSIS) show that in 1991 the 107 top-tier defense contractors were
awarded 31,885 DOD contracts with a value of $55 billion. In 2003,
the five top-tier defense contractors were awarded 35,882 contracts,
with a value of $67 billion. CSIS reported that the number of DOD
defense contractors has grown from 29,781, in 1991, to 54,819, in
2003. That is 184% increase in a little over 11 years! The graph
below illustrates the “barbell-shape” of this sector,
indicating a rich environment for consolidation for defense contractors
in all three tiers.
High Tech Warfare Changing Industry: The prompt
movement toward consolidation is being driven by industry fragmentation
and low barriers to entry, but more importantly, the Pentagon’s
demand that future military conflicts be dominated by high-tech
warfare. The Pentagon supports consolidation because it saves the
government money by squeezing overhead costs if contractors join
forces. Industry experts at the conference contended the consolidation
trend is playing out between second and third tier providers, vertically
integrating critical specialties - Operation & Maintenance,
Knowledge Management, or Defense IT - with the goal of being an
acquisition target by a first tier contractor.
Florida Contractors Can Benefit: What experts talked
about nationally is playing out on a local level. Florida is readily
positioned to benefit from the sector’s consolidation trend,
given the large presence of defense and aerospace contractors located
in the state. This year alone, our firm has been involved with multiple
mergers, acquisition and divestiture deals between local second
and third tier industry players. Because of our work and experience
in this sector, PCE has identified more than 10 value drivers to
maximize shareholder value for those defense related companies,
positioning themselves for sale or consolidation. Two such strategy
examples are:
- Allowing only a small percentage of revenue
being awarded under the Federal Small Business Set Aside program,
- Allocating less than 25% of revenue generated
from any one contract.
With uncertainty being the constant in political conditions
worldwide, the aerospace and defense industries will continue to
advance into the uncharted “backside of the storm” with
buyouts, consolidation, and structural changes driven by the increased
attention and higher investment levels. Hang on and hunker down,
it should be an incredible ride.
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