Talking Deal Prices: Stellex navigates steep valuations in aerospace and defense

  • Targets industrial sector in the Rust Belt
  • Acquired ship-repair business
  • Paid single digit multiples; scaled up through add-ons

While all sectors remain pricey nowadays, aerospace and defense has carved out a niche among richly priced buyouts.

Interest in cybersecurity, drone development and geopolitical threats from North Korea and elsewhere have pushed purchase-price multiples up to 15x EBITDA and beyond on many deals.

The sustained rally in public equities also encourages loftier sector prices for comparable companies changing hands in private markets. These dynamics challenge value-oriented buyout firms.

Ray Whiteman, managing partner of Stellex Capital Management, said the New York firm has been working harder to find good deals.

“We understand the difference between price and value,” Whiteman told Buyouts. “Cheap doesn’t necessarily mean value, nor does paying a big price mean you can create even more value.”

Stellex is focused on manufacturing, industrial and service businesses with enterprise values of $50 million up to $500 million. With a co-invest partner, the firm may write checks of more than $100 million, but it tries to stay in the $50 million to $75 million range. Stellex declined to name co-investment partners.

The firm’s portfolio includes AF Global, Dominion Hospitality, MHI Ship Repair and Morbark LLC.

To avoid overpaying, Stellex is focusing more on the industrial sector in the Midwest, where multiples remain in the single-digit range.

“We spend a lot of time in the Rust Belt assessing opportunities,” he said. “We tell our team the next great investment opportunity is not going to be found on the Bloomberg screen or in NYC.”

On this front, the firm said on Oct. 24 it partnered with Bruce Swift, former CEO of Diversified Machine Inc, to create a niche manufacturing platform at Stellex.

Also on the industrial front, Stellex used its skillset in secondary traded debt for its investment in AF Global, a distressed maker of engineered and forged products for the oil and gas sector. In a deal announced in May, Stellex emerged as part of a new ownership group that invested $120 million in the company.

“We had studied the sector and came upon the company, which was the right size for us,” Whiteman said. “We are very happy with the purchase-price multiple.”

The firm may consider aerospace and defense deals on an opportunistic basis. But to pay up for a company, “you have to believe growth will be there. You need a lot of conviction,” Whiteman said.

In terms of pricing in the sector, “the private debt markets are the rocket fuel” behind rich aerospace and defense multiples, Whiteman said. Stellex prefers conservative amounts of leverage. “We still remember the lessons from the last downturn; thus we focus on improving operations rather than financial engineering,” Whiteman said.

Even smaller businesses are trading for 15x EBITDA, up from 10x not too long ago. “It doesn’t make sense — if a company has EBITDA of $150 million, you may want to pay for scale, but it’s harder to justify such multiples with smaller companies. People are pricing buyouts to perfection.”

Ship repairs

In the defense arena, Stellex in 2015 paid a single-digit multiple to purchase MHI Ship Repair, a Norfolk, Virginia, business that does about 95 percent of its business with the U.S. Navy. Stellex has been scaling it up through acquisitions. So far it’s closed two add-on deals and the firm continues to look at others.

MHI focuses on repairing ships, not new construction. The two disciplines require different expertise and capital requirements.

The collision of the USS Fitzgerald Navy destroyer with a merchant ship offshore Japan in June illustrated the need for more ship maintenance, repair and training, and reinforced the need for contractors such as MHI.

The Navy is faced with an aging fleet that’s been running harder because of increased global threats, Whiteman said. To compensate for flat budgets, the military has been reallocating money from repair into the operations budget. But the Navy can defer repairs for only so long. Given the complexity and clearances required, MHI offers a service that can’t be easily duplicated.

Looking ahead, the firm’s buyout of MHI Ship Repair remains a model for the firm. It’s in a sector that Stellex knows well: It has worked with management before and the firm was able to create a platform at a reasonable value.

After wrapping up its maiden PE fund in July at $870 million, Stellex expects to close more transactions in the near future, with an eye on directly negotiated transactions with companies in the industrial sector – it hopes at a reasonable cost.

While the aerospace and defense sector offers growth in the business of improving U.S. security, GPs need to protect themselves against high buyout prices.

Action Item: Contact Stellex: +1 212-710-2323

Photo of Ray Whiteman courtesy of Stellex Capital