Investment interest experienced by sector for some time may be starting to recede

With aerospace investments by US private equity giant Carlyle Group hitting the headlines two weeks in a row, the attractiveness of the sector to private equity investors seems unassailable. But is the trendsustainable?

Private equity has increasingly played a part in the buoyant mood of the aerospace sector in recent years, with interest from investors driving up the valuations of likely acquisition targets.

In particular, the Middle East -either through traditional investment funds or aerospace-focused entities with buying power on a par with them - has been cement­ing its presence in the booming sector. Dubai International Capital's purchase of Doncasters, Dubai Aerospace Enterprise's deals to buy Landmark Aviation and Standard Aero, as well as the acquisition by a Middle Eastern consortium of the majority of SR Technics are just some of the most recent examples of a trend that has taken in maintenance and business aircraft, component manufacture and general aviation.

Most recently Carlyle has dominated the private equity interest in aerospace. The US-based fund insists that the agreement of two deals in quick succession - the first to buy communications and systems engineering specialist Arinc from a group of shareholders including airlines, and the second to acquire manufacturer Sequa for $2.7 billion - is merely a coincidence. It has teams working constantly across all its investment sectors (see graph) and proceeds with those deals that offer good prospects at a reasonable price, it says.

Although many industry observers were surprised at the high earnings multiples of aerospace deals in recent months, Arinc and Sequa evidently fitted the bill for Carlyle on both counts. The group is adamant that it has not changed its "modus operandi" regarding aero­space and defence.

But will the sector continue to be attractive to investors as the cycle continues and the inevitable downturn moves closer? Although the consensus is that the peak of the cycle and subsequent drop-off in demand is some way off, there are signs that the extreme optimism the sector has been experiencing for a while may be starting to recede.

Shaking confidence?

Dubai International Capital refuses to comment on rumours that it is seeking a buyer for Doncasters, just 18 months after it acquired the UK-based manufacturer. But if the rumours are correct, they indicate that confidence in the sector may not be unshakeable.

And the wider picture is "not all rosy", according to Jason Steen, partner at mergers and acquisitions advisory company Steen Associates. While there is still room for upward movement before the next downturn arrives, Steen says, companies have started to factor this forthcoming downturn into the prices they are willing to pay for aerospace businesses to a greater degree. "Things are starting to be priced more sensibly - people know there is a downturn coming," Steen says, adding that "investors are being more conservative - there is no irrational exuberance".

And the sector is vulnerable, although there has been considerable private equity interest in aerospace for some time, inves­tors are aware that they can turn a profit by investing in other sectors too.

Carlyle says that, even after two high-profile deals, its aerospace team will continue to look at opportunities in the sector. Defence investments have taken a back seat recently (see graph) because of the high premiums attached to them, the company says, adding that its teams continue to look for attractively priced opportunities in defence.

Carlyle group assets

In the meantime, the wider private equity community may start to respond to the shifting climate in the industry by beginning to look at different kinds of targets.

"The subcontracting sector has become more attractive because original equipment manufacturers are outsourcing more," Steen says. While these businesses may previously have been seen as high-risk, with their lower levels of intellectual property rights, as the sector has grown and outsourcing by OEMs has gathered pace, they are seen as increasingly attractive.

The much talked about consolidation of the middle tiers of the aerospace market has not taken place to the degree that many expected, Steen says, adding that this could be an area of future private equity activity, provided the high valuations of the businesses in question do not put off investors: "It's still a strong market, but it's not crazy any more."

Source: Flight International