What Is Hot In A&D M&A And What Is Not
When Airbus CEO Guillaume Faury announced on Feb. 18 that the European OEM was reversing years of efforts to outsource aerostructures and would keep Premium Aerotec and Stelia Aerospace within the group, stakeholders likely breathed a sigh of relief.
At least those assets will not be shopped around anymore, a rare reprieve from the ongoing flood of aerostructure divestitures that started before COVID-19 but has picked up pace. For anyone else trying to offload related assets, however, do not bother with Airbus. Aerostructures will be a core capability for Airbus, the CEO said, but it is not eyeing mergers and acquisitions (M&A) to build them up.
- Aerostructures, Tier 3s and other airliner-oriented sectors under heat
- Cyber, space and hypersonics among defense sectors on upswing
“I was not suggesting that we would go for large M&As,” Faury stressed.
As aerospace and defense M&A deals take shape in 2021, the aerostructures segment is already a busy corner of the market, albeit for unfortunate reasons. Coming off the worst of the pandemic’s effects and the nascent recovery from the Boeing 737 MAX fiasco, aerostructures suppliers will experience a tremendous revenue decline and must restructure, according to AeroDynamic Advisory Managing Director Kevin Michaels.
“With aerostructures suppliers and interiors, they are under significant financial distress, and they are going to rightsize and downsize to make it through this pandemic,” he said at the annual Pacific Northwest Aerospace Alliance (PNAA) conference in February.
Reinforcing the point was the concurrent announcement that Triumph Group had struck a deal to sell its massive Red Oak, Texas, operations to aerospace private equity investors Arlington Capital Partners. The agreement marks the second-to-last disposal of major aerostructures-related assets as part of a years-long restructuring by Triumph, which had been a Tier 1 aerostructures provider but now focuses on maintenance, repair and overhaul as well as engineering services. The Red Oak facility consists of 1 million ft.2 of factory space and employs about 400 people. Next up at Triumph could be a Stuart, Florida, facility that focuses on wing structures and assemblies, financial analysts said.
Overall, M&A activity in aerospace and defense (A&D) and related government services looks set for a mixed year at best, several dealmakers and consultants have said in recent comments. Government services remain hot, and the commercial aviation aftermarket should take off as the year progresses. Defense industry M&A may not be far behind. But consolidation in the OEM supply chain should lag for most of the year and possibly not pick up until 2022.
William Alderman of his eponymous A&D middle-market investment bank said during the PNAA conference he expects an active M&A market in the aftermarket supply chain. Buyers are pricing growth, values are recovering as industry participants eye a market recovery later in 2021, and motivated sellers are looking to take advantage of macroeconomic and commercial aviation conditions.
But in the manufacturing supply chain, Alderman sees limited M&A activity until at least later this year due to depressed values and unmotivated sellers—no one wants to sell at 2002 prices—despite the flood of buyers attracted to potentially distressed assets.
“A lot of buyers are out there—especially on the financial side of the market—looking to buy in the commercial aviation supply chain,” Alderman says. “However, there are not that many sellers because valuations are depressed, there has been ample liquidity—PPP 1 and 2—and banks are not foreclosing.”
“PPP” refers to the Paycheck Protection Program, the Trump administration loans for small businesses that the Biden administration hopes to increase but first must win over formidable conservative opposition. Alderman says an uptick in manufacturing-oriented M&A deals could occur later this year as emergency government aid wanes and bankruptcies and foreclosures accelerate.
Others see similar trends. “I do think this year is when the shoe will fall, and we will see many, many cases of suppliers failing or being acquired, or private equity coming in,” Michaels said. Tier 3 suppliers, particularly build-to-print shops serving commercial aircraft, will be ground zero, while avionics and component OEM suppliers are more protected from revenue loss (see chart).
In their own December 2020-issued look ahead, Andrew Carolus and Adam Oakley of Mesirow, an A&D investment bank, noted that large legacy A&D and government companies are well-capitalized and could ramp up precrisis vertical-integration efforts. Meanwhile, outside investors keep flooding into the sectors, looking for a piece of their long-term growth prospects at crisis-induced prices.
“Although we probably do not expect to see aerospace M&A activity to return to the precrisis levels immediately, we expect M&A activity to drive realignment of the industry landscape in the post COVID-19 environment through vertical consolidation and new private equity interest in capitalizing on the rebound,” Mesirow said.
Mesirow’s and Alderman’s expectations echo what PwC’s A&D practice said in its own December outlook. “In our view, the outlook for M&A in the sector is mixed,” said Bob Long, PwC’s U.S. aerospace and defense deals leader. “The commercial and defense subsectors present two very different narratives.”
On the defense side, PwC expects continued strength in defense transactions for: cybersecurity; federal information technology modernization; intelligence, surveillance and reconnaissance; and other technologies. Red-hot niches such as unmanned assets, space and hypersonics present attractive opportunities.
Macroeconomic factors have a large effect, too. Record-low interest rates from central banks encourage funding of deals, helping even the weakest companies get another look. “Businesses that couldn’t be sold two, three, four, five years ago are sellable now,” says Bob Kipps, managing director at KippsDeSanto.
In an all-star webinar of Washington-area dealmakers hosted in January by the Pillsbury Winthrop Shaw Pittman law firm, Kipps and others said they were watching President Joe Biden’s tax policy closely. “If he increases corporate taxes, that will have a direct effect on valuations,” said Greg Van Beuren, managing director at Houlihan Lokey.
“The tax increase is looming on the horizon,” said John Song, managing director at Baird. “Regardless of your politics . . . the reality is taxes are not going down.” He said more sellers will trickle into the marketplace in coming months and years, reluctant to sell at lower valuations than once hoped but relieved to get a deal done.
Yet even while different corners of A&D and government services appear mixed, dealmakers universally report ongoing intense levels of overall activity. “We haven’t seen any let up,” Kipps said. “I’ve been doing this a long time, 25 years, and this is the best market I’ve ever experienced.”
In a way, “everyone is a seller,” especially smaller companies, Kipps said. “The buyer universe is deeper and broader than I’ve ever seen.” Beyond strategic corporate and traditional private equity investors are family offices and a myriad others dipping their toes in the A&D and government contracting markets.
Most matchmakers said they expect 2021 largely to rival 2020 in total deal activity in the end.