Defense Firms Seek Mergers to Survive Budget Cuts
Policy + Politics

Defense Firms Seek Mergers to Survive Budget Cuts

AP Photo/Gervasio Sanchez

With more budget cuts on the horizon, military contractors are shoring up their defenses by seeking refuge with former competitors through mergers and acquisitions.

Persistent spending reductions mean the pool of procurement funds isn’t as deep as it once was, and that’s prompting some middle- and lower-tier firms to combine forces with other firms in hopes of weathering what may be a long-lasting storm. The automatic budget cuts known as sequestration are scheduled to return in October 2015 and continue into the next decade.

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Aerospace is one industry seeing an uptick in mergers and activity.

“As budgets decline, it’s very logical for these firms to go out looking for ways to combine businesses,” Stephen Perry, managing director at Janes Capital Partners, told the Los Angeles Times. The aerospace investment firm said there were 56 mergers and acquisitions in the defense field during the first three months of the year, a 14 percent increase compared with the same period in 2013.

That momentum hasn’t shown signs of easing up in the second quarter. Last month, an all-stock $5 billion merger between Alliant Techsystems and Orbital Sciences was announced.

“Aerospace-focused deals continue at a robust pace,” Scott Thompson, U.S. aerospace and defense leader at PricewaterhouseCoopers, wrote in a report last month. “Despite the uncertainty about spending, the valuations of publically traded defense companies have increased significantly. We believe this multiple expansion results from defense companies using their cash for stock buy-backs.”

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Thompson’s report cited 12 M&A deals in the first quarter of 2014 valued at $3.3 billion, up from 11 at $1.8 billion during the same period last year. Going in the other direction, though, is the Pentagon’s procurement budget.

In March, the White House sent Congress its fiscal 2015 budget request, calling for $496 billion in defense spending. That amount included a $3.8 billion, or 4 percent, reduction in procurement dollars compared with current levels. Congress is in the process of deciding whether it agrees with that amount.

Consolidation isn’t commonplace at all levels of the military supply chain, though. Pentagon officials this year reiterated an unofficial position they first mentioned in 2011: The Defense Department isn’t keen on approving mergers and acquisitions among the few remaining prime contractors, meaning firms such as Lockheed Martin, Boeing and Northrop Grumman.

For some companies, that means tapping into overseas demand. Transnational deals are permissible as long as foreign suppliers are reliable.

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“We anticipate that U.S. defense contractors will aggressively address this revenue shortfall with foreign military sales, acquisitions, new product introductions and growth in adjacent markets,” Tom Captain, head of global aerospace and defense at the consulting firm Deloitte, said last week in a statement.

A Deloitte study found that overall revenue in the defense field declined 2.6 percent last year, even as profits increased, suggesting many larger firms are using acquisitions as a way to maximize profit. Reducing expenditures such as labor costs can improve a company’s bottom line and boost its stock price.

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