Tide rising for deal makers

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If the pace and size of merger and acquisition deals are an indication of challenges and opportunities, the aerospace and defence industry is in for an exciting time in the months to come.

According to a first quarter 2011 analysis by PricewaterhouseCoopers, the number of deals announced during the quarter was the highest quarterly total for this sector in at least 30 years. And, the number of high-value deals also looks to be rising compared with recent periods.

The biggest deals of the quarter - the Rolls-Royce and Daimler joint venture $4.38 billion bid for engine-maker Tognum and Northrop Grumman's $2.01 billion spin-off of the Huntington Ingalls shipbuilding business - fall into defence rather than aerospace, where Eurocopter's intended $610 million purchase of Canadian MRO company Vector Aerospace leads the table. But several factors suggest momentum in aerospace consolidation.

First, notes PwC, there is a general drive to consolidation as financial investors move in where large corporations seek to make divestments, particularly of lower-growth operations.

And, acquisition opportunities are numerous for private equity investors owing to the difficult business environment faced by many smaller defence services companies.

Among private equity investors, expect competition to buy companies with higher-growth technological capabilities.

GETTING BIGGER

The pace of mega-deals - worth $1 billion or more - has also increased this year. PwC believes that large cash balances and supportive capital markets present "the right conditions for a robust amount of mega-deals during the balance of the year".

In an industry often dominated by US corporations, so far this year it has been European buyers driving deal activity, by both value and volume.

PwC expects Asia, particularly China, to become a key driver too, as that country looks to develop its commercial aerospace capabilities. Expect more cross-border transactions such as the recently announced purchase of Cirrus Industries by China's AVIC.

INSIDE CHINA

Chinese deals with foreign companies that yield access to new technologies should remain prominent, but PwC also notes that consolidation within China has been significant, with a rapid increase over the past several years in acquisitions by AVIC of local aerospace suppliers.

More generally, non-US companies will remain on the lookout for US targets owing to the continuing attraction of the size of the US market and the natural currency hedge that comes from basing some operations in the dollar zone.

Domestic buyers, too, will be active as local companies look to restructure.

There is interesting tension brewing over cross-border deals. According to PwC, it is unlikely that the relative number of cross-border deals will increase much beyond the first-quarter 2011 levels, owing to the aspirations in several emerging markets to build national aerospace champions and developed country concerns over maintaining a defence industrial base.

In defence, large contractors are likely to consolidate in the face of declining defence budgets. PwC sees little scope for consolidation among the large primes for reasons of competition and security, but these firms should continue looking for growth by acquisition in segments such as intelligence, surveillance and reconnaissance, unmanned vehicles, and cyber-security.

For shareholders of small- to medium-sized companies, including those that are part of diversified industrial companies, sell-offs may be a way to capitalise on aerospace market growth.

PwC's expectation is that average deal values are more likely to rise than fall. Significantly, during 2010 financial investors began to change tack, making a gradual shift from selling out of their aerospace and defence investments in favour of more acquisitions.

This trend continued in the first quarter of 2011, as continued improvement in capital markets from the 2008-9 crisis brought private equity activity back up toward historical norms. Also, there is a growing appetite for controlling-interest transactions rather than minority stakes. This trend is likely to push prices up as a multiple of company earnings.