Longtime aerospace and defense merger and acquisition (M&A) advisor Bill Alderman got a call last summer from a well-positioned, family-owned commercial aerospace supplier whose principals wanted to cash out of the industry. Instead of hustling to line up a deal that would have provided his eponymous midmarket firm with sorely needed revenue, Alderman told them to go away.
“When the phone has rung over the past two years from someone with a commercial business, we would look at the numbers and say: ‘You’re fully liquid, you got [Paycheck Protection Program] money from the [U.S. COVID-19 aid law], you have very little debt, you’re not in crisis mode, and you’re worth the lowest value you’re ever going to be worth in the history of the company,” Alderman recalled during an Oliver Wyman webinar recently.
“Go away and call us back in two years,” he advised the owners. Commercial aerospace business values have hovered near rock-bottom since COVID-19 erupted, but that is changing. “Value goes up 1% every week; just please wait,” Alderman suggested. “If you can make 75 basis points by going to sleep, you should.”
For small and midsize commercial aero businesses looking to make a deal, such delayed gratification could start paying off later this year. Alderman and other seasoned dealmakers say late 2022 or early 2023 could see a long-awaited—-and potentially dramatic—-revival in com-mer-cial aero M&A among small and midsize enterprises (SME).
Indeed, many expect the commercial aerospace deal flow could return with a vengeance. In several recent industry events, including an Aviation Week M&A conference, dealmakers and executives described an ongoing drought of commercial aero M&A—an outcome that has surprised almost all of them.
“If you had asked any one of us two years ago, we would have said by mid-2021 that we were going to get going, and people would be opportunistic,” another well-known midmarket A&D M&A advisor admits to Aviation Week. But those predictions were off in their timing for many reasons, some of which are obvious only in retrospect.
For starters, industry insiders expected an almost immediate wave of distressed commercial aerospace assets. Consolidation already was strong before COVID-19, as OEM supply chain squeezes and other existential business demands wiped out brands and factories while survivors suffered weakening profit margins.
But instead of crashing out, companies were saved by government safety nets such as Paycheck Protection Program loans under the U.S. CARES Act and U.S. Federal Reserve guarantees to backstop corporate debt, as well as lenders looking the other way on loan covenants and the absence of tax increases under the Biden administration so far.
“Right now in the commercial aerospace market, the pickings are really slim,” Astronics Chairman, CEO and President Pete Gundermann says. “Nothing’s moving; nobody wants to sell anything unless you absolutely have to—and if you have to, it’s not a healthy situation.”
That points to another set of reasons why SME deal flow has not picked up yet. Astronics, which has seen half of its annual revenue disappear during the pandemic, does not have the money or credit to make deals—a plight common among many A&D players below Tier 1. Meanwhile, private investors awash in cash do not like the asking prices they have encountered.
Several dealmakers said the bid-ask spread in commercial aero in recent years far exceeds the usual gulf that separates sellers who price too high and buyers who push for lower prices. But Alderman, who sees commercial aero enterprises returning to roughly 80% of pre-pandemic values this year, thinks the bid-ask spread will significantly narrow by the end of 2022.
Other factors could drive up dealmaking, according to many insiders, starting with firmer production ramp-up plans for new large commercial aircraft by Airbus and Boeing. Both OEMs are expected this year to outline production forecasts that suppliers are likely to find more reliable.
Dealmaking sentiment will also be boosted if COVID-19 finally becomes more manageable, and healthy companies need to in-source work from distressed suppliers. Diversification into defense work and business jet revenue also could push purchases.
What is more, top-tier companies increasingly are using M&A rather than internal research and development to obtain new technologies and capabilities for environmental and sustainability goals, cut costs as part of Industry 4.0 factory advances or expand into new markets such as space or advanced air mobility.
“There is a need to ensure technical innovation, which is more likely to be led by smaller nimble companies that can think outside the box,” Jefferies analysts said in an A&D M&A report.
Finally, top-tier deal activity is expected to continue and could increase modestly with divestures by aerospace conglomerates, while risk appetites may grow for quality Tier 2s. Observers point to last year’s announcements by Parker-Hannifin to buy competitor Meggit and Bain Capital Private Equity’s purchase of ITP Aero from Rolls-Royce as harbingers of more upper-middle market positioning in coming years.
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