CaptureFollowing a pullback in fiscal year 2013, deal activity in the global aerospace and defense (A&D) sector has returned to its former levels.

According to PwC’s Mission Control report for Q4 2014, the past year witnessed the total A&D deal value rebound from $14.3 billion in 2013 to $22.3 billion in 2014, which is on par with the 10-year rolling average.

Canada is a major player in the A&D sector: historically it is fifth, behind the United States, France, the United Kingdom and Germany in total revenue generated by A&D but second, behind the United States, in terms of GDP generated from A&D.

Defense-related transactions gaining ground

The defense industry took over as the dominating player in the A&D sector in 2014, with defense-related transactions representing 60% of the sector by volume – the highest level in the ten years reviewed.

The PwC report suggests that, as a result of the major budgetary priorities of governments, transactions have focused on companies with businesses relating to cyber surveillance, security, intelligence and reconnaissance. In addition, President Obama recently proposed a base defense budget of $534.3 billion for fiscal year 2016, which represents an increase of $38.2 billion over the current fiscal year. This annual budget release clearly reveals the US government’s spending priorities, as it proposes to exceed the government’s own spending caps (sequestration) by $35 billion. Such budgets help to facilitate a more conducive deal environment for defense-related transactions.

Although there is some talk of shrinking military spending in Canada, U.S. spending is like to have a trickle effect in Canada. The shrinking loonie may also boost A&D merger and acquisition activity in Canada.

PwC predicts that there will be increased activity in companies with advanced, niche technologies such as unmanned aerial vehicles (UAV). As the potential commercial application of UAV technology continues to grow, such companies are better diversified to face the risks relating to government defense budgets.

Commercial aerospace retreating

On the other hand, the volume of aerospace-related transactions have fallen to 30% of the sector – the lowest level since 2005. PwC notes that the recent drop in energy prices may be a factor behind the uncertainty in aerospace demand. Companies may be reluctant to order new products, since the lower fuel prices allow them to continue using their older, less efficient models.

Emerging trends

Additional trends observed in the PwC report all bode well for considerable M&A activity and include:

  1. Cross-border deals are likely to increase, fueled by Western defense consolidation and joint ventures.
  2. Private equity sellers are showing renewed interest in the A&D sector.
  3. Suppliers are under pressure to consolidate their supply chains.

The approach to M&A

While current trends in the A&D sector can be an indicator of promising areas for M&A, a 10-year study by Deloitte provides insight on how those in the A&D sector successfully implement an M&A strategy.

Most top performing A&D companies make a significant capital investment in M&A. Total capital at risk in M&A (acquisition value relative to the acquirer’s enterprise value at the time of acquisition) positively correlates with the likelihood of outperforming the rest of the sector. However, while the value of deals is significant, successful M&A strategies involve limiting the number of deals. Deloitte observed that the more financially effective A&D companies were only moderately acquisitive, with less than two acquisitions per year.

Lastly, successful acquirers target companies whose business models can be leveraged to increase the acquirer’s market power.

While this is easier said than done, maintaining a keen understanding of the trends and movements in the A&D sector is critical in making such judgments.

The author would like to thank Matthew Lau, articling student, for his assistance preparing this legal update.

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