Merger and acquisition activity is a sign of financial strength and confidence, and this was on show in the aerospace and defence industry in 2007. The total disclosedvalue of deals reached nearly $31 billion, the highest since 2000, with seven billion-dollar deals and a further 41 worth more than $100 million.

In particular, transatlantic deals returned with a vengeance. After a pause for breath in 2006, the value of such deals leapt from $1.8 billion to $12.6 billion, evenly split between money going to and from Europe. The two largest deals of the year were both UK-US: General Electric spent $4.8 billion on the acquisition of the aerospace division of Smiths Group and BAE Systems invested $4.5 billion on Armor Holdings.

In contrast, Europeans were reticent about buying closer to home. Deals involving a European buyer and target fell by 80%. The weak dollar has made North American assets cheaper, making this a great time to be building scale in the USA. Additionally, the dollar's slide has tended to depress European profits, giving an extra impetus to "dollarise" the cost base.

The Middle East features prominently for the second year in a row, with Dubai Aerospace Enterprise's $1.8 billion acquisition of Standard Aero and Landmark Aviation in the USA following Dubai International Capital's acquisition of Doncasters in the previous year. Other investors from the region may follow suit.

Other emerging markets are also stepping up their M&A. Deals outside Europe and North America represented one in five of all transactions in 2007, up from one in 10 in 2000. Brazil, Russia, India and China (the "BRIC" countries) accounted for most, and deals were mostly domestic, indicating a scaling up by local players. Some of these companies may soon shop internationally.

Private equity participation in the industry has been steadily increasing since 2000 and reached a high in 2007. Deals involving private equity as buyer or seller reached 36%, and accounted for five of the top 10.

Private equity investors are drawn to industries going through structural change, as change throws up opportunities as well as the ability to exit. The restructuring and globalisation in aerospace and defence over the past few years has provided just such an environment, and private equity has provided liquidity as larger players divest assets and the supply chain consolidates. Add in the fact that many corporate buyers were financially constrained until 2004-5, and it is no wonder that the industry has been such a happy hunting ground for financial investors.

Activity in private equity deals is likely to temper in 2008. The credit crunch has limited the ability to support high acquisition prices with aggressive debt packages, so the balance of power has swung to the corporate buyer for the first time in years. The crunch has slowed financing in the larger end of the market (over about $500 million), although there is a good level of activity in the mid-market ($50-500 million). Given the uncertainty in many consumer-facing segments of the economy, more private equity investors may find the aerospace and defence sector attractive, with its greater visibility of revenues and exposure to international growth markets.

We expect M&A to continue in 2008, albeit not at the level seen in 2007. The past two years have been notable for high levels of M&A. Whichever way the market is divided - by geography, deal size, segment - companies have been buying and selling, and trends driving this have some way to play out. The European supply chain needs to consolidate emerging markets need to acquire assets and skills and transatlantic M&A is needed by plenty of "unbalanced" corporates. The current wave of M&A is shaping the structure of the industry for the next decade.

Matthew Alabaster is director of strategy at PricewaterhouseCoopers


Source: Flight International