The emerging wave of consolidation is yielding more diverse competitive dynamics than emerged from the post-Cold-War restructuring.
Five years beyond the inflection marked by the Great Recession’s bottom and Iraq War’s end, the market for mergers and acquisitions in aerospace and defense is finally heating up and taking shape. At this halfway point through 2015, the value of transactions this year is approaching $30 billion, a pace roughly twice the trailing ten-year average. The deals comprising this surge have brought into focus three trend lines of corporate development along which we now can discern the first wave of restructuring to the aerospace and defense industry post-2010. Alongside these themes also is emerging a leading indicator of what may form a second wave. To the extent these trends have gone unremarked until now, it owes in part to slack deal flow but also to how the economic and business logic of what deals got done has defied conventional expectations.
Bolt-on Growth. Alcoa’s announcement in March of its agreement to acquire RTI International Metals is only the latest in a straightforward corporate development theme: Add core capacity and capabilities with which to deliver the burgeoning backlog of orders for large commercial airliners that have been flowing into Seattle and Toulouse since the end of 2010. Alcoa’s $1.5 billion purchase of RTI, a downstream titanium specialist, is actually the company’s third stroke on this trend line since just last November, when it closed the still larger, $2.9 billion acquisition of UK-based Firth Rixson. Of course, the Alcoa-RTI deal simply embellishes a trend line that runs back to the 2010 merger of Triumph and Vought, and which includes this wave’s centerpiece, the $18 billion acquisition of Goodrich by United Technologies in 2012, plus General Electric’s purchase of Avio Aero in 2013, and, not least, a five-year succession of nearly two dozen acquisitions by Precision Castparts (Primus, Heroux-Devtek, Timet, et al.).
Focus the Business Model. Two of this year’s biggest corporate-development announcements¾United Technologies’ intent to divest Sikorsky and Computer Sciences Corporation’s plan to separate its commercial and public sector businesses¾each serves to connect the dots of a second trend, which involves trading growth for profitability by narrowing portfolios around a more uniform business model. As best illustrated in CSC’s announcement, the rationale for certain expressions of this theme organizes coherence around common customer-types, a motive also underlying the spinoff of Exelis from ITT in 2011, the separation of SAIC from Leidos in 2013, and the spinoff of Vista Outdoors from ATK earlier this year. However, as indicated by the UTC-Sikorsky situation, still another expression of this focus strategy strives for business-model coherence by sorting for dissimilar risk-reward characteristics, a motive underlying the spinoff of shipbuilder Huntington Ingalls Industries from Northrop Grumman in 2011, the separation of services specialist Engility from L-3 Communications in 2012, and this year’s announcement that BAE Systems Inc. now is weighing the divestiture of a ~$1.5 billion collection of its information and technical services business units.
Consolidate the Mid-Tier. The year’s two marquee transactions¾merger of Orbital Sciences with ATK and acquisition of Exelis by Harris¾exemplify the third trend in corporate development that is shaping this first wave of restructuring. Its logic is that most traditional of all M&A initiatives: opportunistic accumulation of like-scale and complementary scope to improve the efficiency of operations and capitalizations. Among other transactions preceding Orbital ATK and Harris along this trend line were the acquisitions of Pratt & Whitney Rocketdyne by Gencorp-Aerojet in 2013, of Beechcraft by Textron in 2014, and of DRC and TASC by Engility. A similar motivation is also on display in the defense-electronics segment, where savvy small-cap firms are rolling up scale and scope: See Analog Devices, which last year acquired Hittite Microwave for $2 billion; Ultra Electronics, whose announcement earlier this month of its acquisition of Kratos Electronic Products Division (née Herley) highlights a steady diet of opportunistic buying; and Teledyne, which is quietly scoring tuck-ins to build out leading positions in niche capabilities like ocean observation.
The Next Wave. It is worth noting that the large-cap prime contractors of this industry, which conventional wisdom held would lead the wave, have stayed largely out of the water. That may be about to change but not with a “big bang”. Instead, the coincidence in April of Secretary of Defense Ashton Carter’s foray to Silicon Valley with Raytheon’s announcement of a $1.5 billion investment to control the commercial cybersecurity company Websense strikes me as a moment marking the start of a very different second wave. Violating as it does the (Norm) Augustinian rule against diversification and testing the many income investors in RTN, Raytheon’s move is undeniably bold. But the resonance it finds in Carter’s call for reengagement of the commercial technology base in national security suggests a boldness rooted in a solemn calculation that others too are, or should be, contemplating. Indeed, lurking among the footnotes of certain defense primes’ recent 10-K filings are several acquisitions that gain for these defense pure-plays new, albeit modest, exposure to civil-government and commercial customers. Among the transactions fitting this pattern are the 2014 acquisitions of energy-sector firms S.M. Stoller and Universal Pegasus by Huntington Ingalls and Lockheed Martin’s acquisitions, also last year, of Sun Catalytix, an energy-storage venture, and Amor Group, which provides information technology solutions to the energy, transport and public services sectors.
The structure of aerospace and defense resulting from this first wave in the era after 2010 is going to comprise a more varied grouping of company-types and competition-dynamics than emerged from the post-Cold-War restructuring. Outsized growth in commercial aerospace is tilting the balance of the industry’s orientation and inducing entry from multi-industrials and entrepreneurs. There will remain room for the defense pure-play behemoths, but that space will be smaller and their scope will be narrower. The mezzanine tier, so-called, is filling out with companies leveraging their capabilities across a more diverse range of products and customers. It remains to be seen whether the Raytheon-Websense transaction impels a second wave that washes into A&D lots more companies rooted in the business practices and technology bases of the commercial sphere. But it would be a healthy new dimension to our industry if it did.
Steve Grundman is the M.A. and George Lund Fellow for Emerging Defense Challenges at the Brent Scowcroft Center on International Security. An earlier version of this essay appeared in the 29 June 2015 issue of Aviation Week & Space Technology.