Defense Industry to See Smaller Mergers

Given the failed merger between BAE Systems and EADS, it’s likely there will be few “mega-mergers” of large defense contractors in the coming years, an investment banking firm report said.

Instead, the largest prime contractors will try to diversify their businesses by picking up small or mid-size companies that do commercial non-defense work or specialize in high-priority defense needs, according to a January report from Mesirow Financial Investment Banking Group in Chicago.

“What we’re going to see more of, particularly from the larger transactions ... are companies looking for diversification outside of defense or, within defense, areas that are still high-growth areas,” said Andrew Carolus, managing director for the firm.

Such areas include intelligence, surveillance and reconnaissance technologies, unmanned aerial vehicles and cybersecurity, he said.

Despite a shrinking defense budget, the report predicts “healthy” merger and acquisition activity across the defense industry in 2013, with a possibility of more deals once long-term budgets are approved.

“Most of these [defense] companies are sitting on record amounts of cash,” Carolus said. “They’ve all generated healthy cash flow over the last several years with the U.S. spending upwards of three quarters of a trillion dollars.”

With less money and fewer contracting opportunities available, smaller vendors may be forced to consolidate with similar businesses if they do not have the capital or research-and-development funding needed to compete for programs, he said. 

The international market remains a bright spot for contractors as the Defense Department slows its own spending.

India, Saudi Arabia, the UAE, Japan and Brazil will increase their defense budgets during the coming years “due to the need to protect national wealth, affordability and/or significant threats to national security,” the report said. This will give contractors the chance to increase exports.

Companies will increasingly rely on foreign sales to provide some relief during the downtick in Pentagon spending, Carolus said. “That’s going to continue to be important to support this country’s strategic priorities, but it becomes more important when domestically you’ve got a shrinking budget.”

The report singled out sales of C-17 carrier aircraft, and F-15 and F-16 fighter jets as being especially critical.

Photo Credit: Thinkstock

Topics: Business Trends, Mergers and Acquisitions, Partnering, Defense Contracting