Partner & Managing Director, Paris
To better understand if the upward momentum seen over the past two years in aerospace and defense M&A is here to stay, it’s important to take an analytical look back at the trends.
After a near-record year in 2017, when the aerospace and defense sector saw $80 billion worth of mergers and acquisitions in 411 transactions, 2018 blew far past that mark and set an actual record, with $126 billion transacted in 436 deals—an increase of 55% in total deal value (figure 1).
The top ten transactions alone of 2018 totaled about $73 billion, coming close to the 2017 total. This sudden increase illustrates the unprecedented dynamism of M&A activity being driven in large part by an influx of liquidity (dry powder), major manufacturers' strong interest in pushing new growth via consolidation, and lively investment fund activity on both the buy- and sell-sides.
On the other hand, while the total value of the deals grew dramatically, the average deal value shows a noticeable decrease, with valuation multiples declining from a peak of 11.5 times earnings in 2016 to 10.8 in 2017 and 10.0 in 2018. This arc in valuation multiples is even more significant when looked at as a weighted average, which shows a drop in deal valuations from 17.5 times earnings in 2017 to 12.2 in 2018. In that sense, the top ten deals closed in more moderate valuations in 2018, peaking at a multiple of 18.1 times earnings for the acquisition of Microsemi by Microchip Technology. By contrast, the largest transactions in 2017 far exceeded a multiple of 20.0 times earnings, as was the case for Safran's acquisition of Zodiac Aerospace at 26.0 times earnings, and United Technologies' acquisition of Rockwell Collins at a multiple of 22.0 times earnings.
However, this erosion of valuations did not affect all segments. Some experienced an increase in transactions that resulted in an increase in multiples, such as cybersecurity (in which the average multiple increased from 12.2 times earnings in 2017 to 14.4 in 2018), or defense electronics (in which the average multiple increased from 11.4 times earnings to 13.2), unlike the MRO sector, which saw valuation multiples fall from an average of 8.6 times earnings in 2017 to just 6.0 times earnings in 2018.
One of the key trends in this 2018 review is the growing involvement of private equity players in the most important transactions of the sector (figure 2). For example, Veritas Capital is regularly in this top ten deal list with the sale of StandardAero in 2018 and of Anaren in 2017, and its 2017 purchase of Harris' government IT activities. Also contributing to the booming M&A market are investment funds, which were involved in seven of the year's largest deals. In addition, the predominance of American players was undeniably confirmed this year, with seven of the ten largest transactions in 2018 involving US targets, including two acquisitions for Boeing. Its purchase of KLX Aerospace Solutions underscored the company's major strategic focus, while its acquisition of Embraer demonstrated its response to Airbus' acquisition of Bombardier's CSeries (now rebranded the A220).
Meanwhile, the value of European deals fell from 40% of top-ten deals in 2017 to 20% in 2018, but the transactional flow in 2018 remained steady. They were mostly concentrated in the mid-cap companies and small and medium-sized enterprises, with a particularly active year in France, continuing the consolidation of the sector under the impetus of private equity players, who confirmed their expectations of a resilient sector with attractive underlying economics and constantly growing air traffic over the next 20 years. These M&A dynamics are further fueled by the industry's coming digital transformation and accompanying need to acquire strategic skills in areas such as cybersecurity, artificial intelligence, augmented reality, and hypersonic or electric aircraft.
We expect these same trends to continue to drive the M&A market in 2019, which is already evidenced by Apollo's announced interest in GE Aviation Capital Services (GECAS). Mega-deals may be fewer, however, at least in the US defense sector, as the major transactions of recent months are finalized and any resulting divestments for antitrust reasons play out. For example, Harris is considering the sale of its night vision business due to its planned merger with L3 Technologies. Strategic refocusing will also likely drive smaller deals, particularly for private equity investors looking to refine portfolios after large acquisitions.
Successfully buying assets in this market requires a robust value creation plan, with a thorough understanding of the specific markets where these companies operate, notably assessing their operations, their intellectual property strength and potential for aftermarket recurring revenues.