Sky-high prices being forked out by investors to clinch merger and acquisition (M&A) deals in the aerospace sector indicate that the cycle could be reaching its peak and valuations are set to fall, according to some analysts.

Confidence in the outlook for commercial aerospace is raising the stakes for buyers and, while many observers believe the bullish sentiment can be sustained, others are beginning to voice doubts.

Jason Steen, director of mergers and acquisitions advisory firm Steen Associates, believes it is possible to gauge the point in the cycle that the notoriously cyclical commercial aerospace industry has reached by examining the multiple of earnings before interest, tax, depreciation and amortisation (EBITDA) at which deals take place.

When measured over the cycle as a whole, the average multiple of a company's EBITDA paid to acquire it is around seven, Steen says. But the latest high-profile deals in this booming sector of the market show much higher multiples.

These high values do more than demonstrate the health of the target businesses, according to Steen. "The high multiples companies expect for deals - and the fact that there is now more unwillingness to pay these kinds of prices - indicate that the cycle is nearing its peak and that upcoming deals will have lower valuations," he says.

The high prices are not likely to put off M&A activity altogether, Steen says: "At the moment, there is potential for several deals, although the industry is already pretty consolidated. There is especially potential for consolidation from the UK to the USA and many owner-managers are looking to sell. But buyers are not willing to pay such high prices, as the euphoria people were feeling last year about how the cycle is progressing has abated," he adds.

But other industry experts argue that the high prices merely indicate confidence in the sector, and demonstrate that there is likely to be investor interest in aerospace and defence for some time. They add weight to the theory that there are several years to go before the peak of the current cycle is reached, say some analysts.

"High valuations have not put off potential buyers. The backlog of deals is growing exponentially," says Mike Richter, co-president of Jefferies Quarterdeck, who believes the cycle has some way to go before it reaches its peak. "We see continuous growth for the next 24 months," Richter adds.

Richard Apps, director of consultancy Counterpoint Market Intelligence, agrees: "It hasn't peaked, and we see commercial aircraft delivery numbers not peaking until around 2009." Even then, the ramp-up of deliveries of the Boeing 787, a high-value aircraft, will make for only a "mild downturn, barring unforeseen events", Apps says.

Significant military programmes are expected to keep bullish sentiment going in the defence sector on both sides of the Atlantic too, says Apps. "Given the state of the global military market and tensions, there is unlikely to be a reduction in budgets," Richter adds.

Steen agrees: "The defence market is a different story with strong multiples continuing particularly for [Lockheed Martin] F-35 suppliers and electronic warfare companies." Even so, the high multiples being commanded may be affecting strategy at some of the biggest names across the aerospace industry.

Immediately after the death of its chief executive and founder Frank Lanza in early June, L-3 Communications' share price saw a spike (see graph) as many observers expected that the company could be an attractive takeover target. But some analysts pointed out that the high multiple any such deal would involve would put off potential buyers. Nearly three months later L-3 has not changed hands, and the consensus is that L-3 will continue with its existing strategy.


L-3 recently agreed to purchase Nova Engineering, the latest in a long line of acquisitions, and a continuation of the acquisitive strategy on which it was built. Some analysts believe that L-3 could now be tempted to consider larger transactions.

Another US-based defence specialist, DRS Technologies, is likely to grow through acquisition in the longer term, although chief executive Mark Newman says the company is taking a breather after its laatest major purchase. "We expect to see them back on the acquisition trail in a major way in 2007," Richter says.

Steen argues, however, that the multiples being commanded in the commercial aerospace sector have already proved too high for certain deals that could otherwise have been concluded in recent months. "Average commercial aerospace assets do not command as much buyer affection as last year, though the good ones are still getting premium numbers," he says. "This is a sign that the market is beginning to see the top of the cycle."

Source: Flight International