- Proposed fiscal 2018 budget increases defense spending
- High valuations prompt sellers to market
- Fundraising in the sector on the rise
With tensions on the Korean peninsula ratcheting up, the defense, aerospace and government-services sectors are drawing more attention from private equity these days.
On the supply side, high prices — particularly in aerospace — have convinced more potential sellers that it’s time to explore cashing out. On the demand side, PE firms have been loading up on dry powder for new deals.
Deal totals were steady in the mid- to high teens for the five years through 2016, Thomson Reuters data shows. The 14 deals in 2017 through early September match the number for all of 2016.
In disclosed dollar value, aerospace and defense combined have been a sliver of the total deal volume by U.S. sponsors. (See charts.)
But the outlook is especially positive for defense companies, based primarily on the expectation of increased spending by the U.S. government.
“The consensus is fairly bullish for defense spending driven by a broad agreement that the threat picture is increasingly complex and requires increased investment,” said Devin Talbott, managing partner at Enlightenment Capital, a Chevy Chase, Maryland, firm that invests in aerospace, defense, and government services.
Defense budgets were capped six years ago by the Budget and Control Act of 2011, in what came to be known as sequestration. In the years that followed, spending cutbacks tempered private equity investments in the market. But the outlook under the Donald Trump administration has brightened.
While it has not yet been approved, the fiscal 2018 Department of Defense budget proposal calls for $639.1 billion in spending, an increase of $52.4 billion, or 9 percent, above the level requested the previous year.
The consensus, according to one investment banker specializing in aerospace and defense M&A, is that Congress will sign off on at least that level of defense spending. Included in the budget proposal is increased spending for cybersecurity and updating the country’s nuclear arsenal.
Over in the middle-market-dominated aerospace sector, two sources said valuations stand at an all-time high. That has led to a buildup in the deal pipeline, particularly in the market for companies that manufacture engine components.
Last month Reuters reported that Veritas Capital had begun exploring the sale of Anaren Inc, a maker of radar assemblies for the U.S. Navy. Initial estimates are that Anaren could sell for $700 million. Veritas Capital took Anaren private in 2014 for $383 million. Veritas did not respond to an email seeking details on the motivation for the sale.
The largest LBO in the space this year, Thomson Reuters reports, was Liberty Hall Capital Partners’ purchase of Dunlop Aircraft Tyres Ltd, the U.K. maker of aircraft tires and tubes. The deal, valued at $135 million, closed on June 15.
Liberty Hall, the New York PE firm, said in a statement at the time that Dunlop was a “globally recognized brand” with strong technology and “a well-balanced portfolio of platforms in the civil and military aircraft sectors.” It also said Dunlop “is ideally placed to continue to outperform the market.”
(A Sept. 18 Thomson Reuters report on U.S. aerospace and defense M&A showed that the industry’s year-to-date performance reached a record.
(Deal value totaled $40.5 billion, with two deals accounting for the bulk of it: Northrop Grumman’s $9.2 billion plan to buy Orbital ATK and United Technologies’ pending $30.2 billion takeover of Rockwell Collins.)
On the fundraising front, it appears to be all systems go. Over the past year, private equity firms specializing in aerospace and defense investments have raised some $2 billion. (See table.)
Enlightenment Capital raised $147 million for its second fund, which closed in November 2016, exceeding its fundraising target.
“PE firms are getting active again in the sector and looking for platforms to build on,” said Talbott, adding that “unmanned aerial systems and new space are growth vectors. We also expect cyber, cloud migration, border security, and data analytics to see growth.”
J.F. Lehman & Co held a final close on its fourth fund at $833 million in March of this year, exceeding its target of $700 million. DC Capital capped its first institutional fund at $450 million, exceeding its initial fundraising target by $100 million.
Action Item: Download a spending chart for the defense, aerospace and government sectors: https://d16yj43vx3i1f6.cloudfront.net/uploads/2017/09/defensespending.xls.
U.S. F-22 Raptor fighters fly alongside a KC-135 refueling plane over European airspace, during a flight from Britain to Mihail Kogalniceanu air base in Romania on April 25, 2016. Photo courtesy Reuters/Toby Melville