Bin Laden’s Death Could Bolster Defense Spending Cuts, Hurt PE Businesses

The assassination of terror mastermind Osama bin Laden could add momentum to President Barack Obama‘s plan to cut military spending, draw down forces in Afghanistan and perhaps hurt private equity investments in companies that rely on troop deployments, sources told Buyouts.

“To the extent private equity either owns or is looking at businesses that depend on the pull of deployed soldiers for revenues, if [Obama is] able to reduce forces faster than he otherwise could have would be bad for those businesses,” an executive with a defense industry consultant, who has worked with numerous private equity firms on deals in the sector, told Buyouts.

The U.S. Defense Department is leading a fundamental review of U.S. military missions at the behest of President Obama, who in April proposed cutting the nation’s defense spending by $400 billion over the next 12 years. Meanwhile, the military is scheduled to start reducing its presence in Afghanistan this summer.

The momentum has been hurting the stock of many large defense contractors, which are expected to reshuffle their portfolios by selling unfavorable assets and seeking high growth companies as they adjust to the changing climate. Shares of Lockheed Martin Corp., for example, were pricing at $78.79 in early afternoon trading on May 2, a slight drop from the previous day’s close and more than $8 short of its 52-week high of $86.98. Shares of Northrop Grumman Corp. were also trading slightly down from the previous day’s close.

Buyout shops have investments across much of the aerospace and defense spectrum, from technology and strategic consulting contractors like SRA International, which last month agreed to be taken private by Providence Equity Partners in a deal valued at almost $2 billion, to designers of tactical computing systems and mobile command structures like Chandler/May Inc., a company owned by Arlington Capital Partners.

Control-stake investments by U.S.-based sponsors in aerospace and defense have trailed off after a high of $7.9 billion in disclosed deal value in 21 deals in 2007, the most active year for private equity investment in the sector since 1990, according to Thomson Reuters data. In 2010 there were eight deals with a disclosed deal value of $255 million. So far this year, there have been at least four deals with a disclosed value of $140 million (this does not include the Providence Equity acquisition of SRA International, which is pending).

Some sources said the turmoil could present bargain opportunities for private equity if large corporations spin off out-of-favor businesses as they realign their priorities. For example, The Carlyle Group, one of the most active investors in the sector, built up its portfolio in the early 1990s, after defense spending was slashed in the wake of the Soviet Union’s demise.

“There are still some steady cash flow businesses that in theory PE firms might be interested in,” said Dan Lennon, a partner with the law firm Latham & Watkins LLP who works with sponsors in the sector.