Tag Archives: Mergers and Acqusitions

How Did The Aerospace And Defense Industry Perform In 2019?

Image: “PWC


For better or for worse, an unanticipated shift in the Middle East, America’s presidential race or Britain’s exit from the European Union could impact the global aerospace and defense industry in 2020

But it was the announcement of the Raytheon-United Technologies Corporation merge that mostly influenced the global A&D sector in 2019.


In that context, let’s take a look at how the market fared based on PwC’s findings:

Illustrations by Brandon-Mykal Rambus


What’s Left In The Dust of Massive Defense Company Mergers?

Image: HR Magazine.com.uk


“There’s a phrase — the mid-market squeeze — that encapsulates a truism in defense contracting: If you’re not really big, and you’re not categorically small, then you’re going to have a harder time competing.


“That is oversimplifying the issue, but there are practical reasons for this to be at least notionally true. Agencies and prime contractors both have set-aside goals that they’re expected to meet in terms of divvying a percentage of contract dollars to small businesses — goals they notoriously miss. That makes a small business designation for a company a valuable marketing tactic when competing to be on the team of a prime or to win a contract direct from a defense agency (less common, but it happens). I wouldn’t say it makes competition for small businesses simple, but it helps.

At the other end of the spectrum, you of course have the prime contractors, who have both the benefit of a direct relationship with the customer and, at least for the top tier, the sheer scale to meet more requirements at a lower cost.

That leaves the mid-tier suffering the Jan Brady effect.

And it stands to get worse as some of the biggest mid-tier players — cognizant of the squeezeand the benefit of scale — combine. The challenges of the midmarket were definitely a factor in the L3-Harris merger that closed July 1, Bill Brown, chairman and CEO of the newly formed L3Harris Technologies, told me during an interview ahead of the Paris Air Show.

The squeeze is driving consolidation and frankly is why there’s not many mid-tier players left, he said. “L3 and Harris were two; put them together and they become bigger.”

It’s a simple concept that nonetheless stands to redefine what a mid-tier company actually is — or, more accurately, to create a whole new category unto itself. L3Harris still doesn’t build platforms — Brown is quite adamant about that, as was Raytheon CEO Tom Kennedy when I spoke to him about the merger with United Technologies. That used to be a qualifier for the mid-tier — creating systems that often go in and on platforms built by the tier-one manufacturers.

But now, the fact that these merged companies are or will be large enough in terms of revenue to rival some of those tier-one defense manufacturers makes them quite different. What we have in L3Harris and the future Raytheon Technologies are companies with phenomenal scale and diversity.

We’ve watched a similar market shift among the IT services companies in the last few years, with medium companies combining to become mega providers that can price low, and offer more.

So where does that leave the other mid-sized defense companies? Probably looking around to see who they could perhaps merge with to leapfrog to that new category — or close to it. That’s not easy, though. As Brown noted, the pickings are becoming increasingly slim. And other factors matter: lack of market overlap, namely, to ensure a merger won’t raise antitrust issues and will promote diversity to put together more comprehensive systems.

If you look at this year’s Top 100 list, it’s hard to identify mergers that would fit the bill — though as Brown told me in June: “I wouldn’t have seen six months ago United and Raytheon.”

Me either.

Plus, with big mergers come divestitures. L3Harris expects a “pretty significant” piece of business to be shed either as a sale or a spinoff in its first six months. One can figure the same from Raytheon and UTC, once the deal closes. That provides options for those mid-tier players looking to expand.

And down the road? Who knows. These things often happen in cycles, where an era of consolidation makes companies a whole lot of money, and then a couple years later they break up.

As Brown and L3Harris Chief Operating Officer Chris Kubasik told me: “It’s worked for bankers.”


Industry Consolidation: What Will It Mean For DoD?


Photo: iStock


“Although industry will continue to use mergers and acquisitions as an important part of their growth strategies, that alone cannot deliver results.

Primary industry strategy must be focused on improving innovations, typically smaller and more differentiated — and internal investments in development programs and innovative capabilities.”


“There has been an uptick in industry consolidation and mergers and acquisitions activity in recent years. The recent announcement that Harris Corp. and L3 Technologies were coming together in a “merger of equals” is a notable example.

While mergers such as this are eventful for industry and financial markets, what does the trend mean for the Defense Department?

At best it may help it a little, but much more profound change across the entire industry is required to help speed technology and innovation to the warfighters — better, faster and cheaper. The department is hungry for real innovation. In the past, large mergers and acquisitions generally hurt innovation, agility and speed as large firms focused on protecting established business areas and large programs.

But is this time different? Firms of all sizes recognize the department’s demands, and have been experimenting — some more than others — with more creative, higher-risk agile business models.

They realize that if they don’t deliver innovation the Pentagon is getting better at finding it from nontraditional industry competitors and smaller prime contractors.

The stakes are high, and with the nation’s technological dominance being seriously challenged and threats growing more complex, the Defense Department is more serious about innovation.

Underscoring threat complexity, the battlespace is now far broader — from the heights of space to the bottom of the oceans, in the cyber domain as well as the physical — a further blurring of military and non-military realms, and increasingly overt political and public opinion battlegrounds.

The department is determined to better engage industry to help deliver better results. Achieving these improvements requires commitment and investment by industry, deeper collaboration and a different framework of performance-driven financial incentive. Those contractors who are willing to transform their businesses to meet new demands will be the winners — regardless of their size.

While traditional prime contractors will and must protect revenue streams on legacy platforms, they must leverage the profits to invest and prepare for market disruption. Industry consolidation and strategic mergers and acquisitions can help support the mission but only with effective execution, a dramatic change in industry and government’s view of research and development, and innovation in business models.

Large primes must find new and better ways to work with smaller industry primes and nontraditional industry players to deliver better solutions — trying to maximize workshare with use of in-house suppliers exclusively will not be as successful a strategy as it has been in the past as the threat of being out-innovated is real.

The demands and complexity of today’s defense challenges are technology and innovation-driven and require very different business models to successfully execute. Adding to the challenge is the aerospace and defense industry’s risk aversion and historical reluctance to invest in research and development. While government business models have limited research, there are more opportunities to do so now. And the defense industry lags far behind nearly all other industries in R&D investment by a significant margin. With the department opening up to nontraditional firms, this gap will hurt primes. Industry must develop a culture of intelligent risk-taking in research as the Pentagon has made it easier for companies to leverage innovation into higher returns.

The future of defense innovation will be profoundly different. Large, leading-edge companies and venture-backed startups in the private sector are solving complex problems through massive-scale big data, artificial intelligence, blockchain, machine-human learning, adaptive learning, augmented reality, cybersecurity, supply chain resiliency, robotics, autonomy, sensor technologies, advanced electronics and additive manufacturing.

“The department is working to improve the incentives for industry to reward innovation.”

These massive investments — and the ruthless value assessment of different offerings by commercial clients — are creating strong, high-value capabilities that the Defense Department is and will increasingly leverage. New offices continue to be stood up across the department with descriptors like rapid, development, innovation, experimental and future. These terms underscore that the department’s innovation focus is not going away.

Back to mergers and acquisitions, we are seeing signs that this time is different, and firms are appreciating the need to adapt to deliver on innovation demands. Whereas the consolidation of the 1990s was dominated by full integration of acquired firms into a “one firm” approach, we are now seeing more tailored approaches. Some acquired groups are fully integrated to achieve efficiencies, while others are seen as critical sources of innovation and are allowed to operate more autonomously so as not to disrupt the culture and mindset.

Of course, mergers and acquisitions are driven by an insatiable demand from shareholders for growth and profitability. Unless firms can see a clear expedited path to profitable revenue streams and long-term government contracts, it will be difficult to justify and sustain increased R&D investment. Shareholders demand profit growth and use of free cash to buy back stock, pay dividends, or both. Industry needs business leaders with the skill and vision to focus these accounts effectively into disruptive new capabilities that can deliver high value, long-running programs.

And the classic challenges remain: good capability synergies between entities; excellent change management and post-merger integration; aligned leadership and vision; disciplined review and shaping of the business portfolio and divesting capabilities; and businesses that are not aligned with the strategy.

The department is working to improve the incentives for industry to reward innovation. But there is much more to do to convince companies and shareholders that the prize is real. Incentives for industry can be enhanced by clearly defined and jointly developed requirements; a more efficient and effective acquisition process with shorter award cycles; collaborative planning and execution across the entire lifecycle between industry — broadly defined — and government; an environment of experimentation and joint development; smarter use of performance-based contracts; and, of course, financial rewards that are aligned with stakeholders’ expectations.

All of this is needed to ensure that industry will devote more investment in research and development, and that shareholders ensure that corporate leaders are capable of leading the investment to innovation to profit journey. The path to innovation success will depend on government’s ability to shorten requirements to award cycles, embrace new and creative business models, reward intelligent risk-taking, and a willingness to think differently and embrace paying an incentive-based premium for performance and results.

More efficient development programs and optimized lifecycle costs will surely more than offset the profit premium for innovators, and the premium is essential to incent industry to deliver.

Aerospace and defense industry consolidations and strategic mergers and acquisitions are not new, but this most recent round comes at a time when industry is adapting to a change in the defense business model. Delivering on the next generation of big bets and speeding technology to warfighters requires a different mindset and strategy that requires traditional prime defense contractors to consider nontraditional companies, technology startups and innovation leaders as a sustained part of the department’s ecosystem.

The race is on and the stakes are even higher. Successful execution of the mission will require the best thinking and the best execution from both industry and government. The nature of our threats is evolving. The Defense Department recognizes this, and if traditional contractors fail to evolve they will be left behind. “


Defense Company Merger Mania and Manic Spending


Mergers and Bloated Waste


“Rather than saving money, the mergers created industrial behemoths with greater leverage over the Pentagon.

With only a handful of major firms to turn to in the procurement of major weapons systems, the Department of Defense’s ability to keep a lid on mushrooming weapons costs has been diminished.

And a company like Lockheed Martin, which has $46 billion in revenues and claims to have a presence in every state in the union, has enormous financial and political clout. This gives Lockheed Martin the ability to prolong programs that serve its corporate interests whether or not they are in the national interest.

Lockheed Martin held its annual media day this week, and CEO Marillyn Hewson assured those attending that the company was financially sound and poised to lead the industry in developing the next generation of military technology, from military lasers to hypersonic weapons. But the bulk of the company’s revenues rely on old-fashioned techniques — buying up other companies, profiting from the sale of big-ticket weapons systems, and pushing foreign sales.

The news of the year was the company’s purchase of Sikorsky from United Technologies, a move that will make Lockheed Martin the primary source of helicopters for the U.S. military. It was the company’s largest acquisition since the 1990s, when Lockheed and Martin Marietta merged, aided by hundreds of millions in taxpayer subsidies to pay for such questionable items as golden parachutes for executives impacted by the merger.

Lockheed Martin wasn’t the only company to grow through merger during that era — Boeing bought McDonnell Douglas, Northrop and Grumman merged, and dozens of other deals were made. At the time, the argument for allowing — and subsidizing — these combinations was that it would reduce overhead and result in better weapons prices for the U.S. government. But as former Pentagon official Lawrence Korb noted at the time, “past history indicates that these mergers end up costing rather than saving the government money.” And so it has been, as Lockheed Martin has racked up multi-billion dollar cost overruns on major programs like the F-35 combat aircraft and the Littoral Combat Ship (LCS).

A case in point is the F-35 program. If it goes forward as planned, Lockheed Martin will end up being the only supplier of fighter aircraft to the U.S. government, leaving the taxpayers in a “take it or leave it” position with regard to the company’s product. A recent analysis by the Project on Government Oversight has catalogued the myriad performance problems with the F-35. Most importantly, even as the Pentagon accelerates spending on F-35s and assures us that the plane is ready for prime time, the Pentagon’s office of independent testing has noted that it won’t even be known whether the aircraft will be sustainable in combat until 2022. Thus far, test aircraft at Edwards Air Force Base have only been able to fly about six sorties per month due to excessive down time for maintenance. The high tech testing simulator that is supposed to assess the F-35s capabilities has itself had serious development problems. And the aircraft coming off the assembly line now have even more problems than the ones that came before.

Given this reality, entrusting the entire future of this segment of the combat aircraft industry to this one company makes no sense. This is particularly true when one considers that, as a 2015 report by the National Security Network has shown, the F-35 is destined to be inferior to the aircraft it is replacing.

Despite all of the above, the Pentagon wants to push forward a 400-plane “block buy” of F-35s that would put billions of dollars in Lockheed Martin’s coffers without providing evidence to suggest that the aircraft being purchased will perform as advertised. Over the next few years, Lockheed Martin will almost certainly put more effort into securing this funding bonanza than it will to creating innovative new products.

Rather than throwing all of its eggs in one basket, the Pentagon should scale back the F-35 program and fill in any gaps in fighter numbers with upgraded versions of current generation F-16s and F-18s. Not only would this save billions of dollars per year, but it would dilute Lockheed Martin’s emerging monopoly over the fighter aircraft market and provide an insurance policy in case the F-35 continues to have debilitating problems that raise questions about its ability to serve as the aircraft of the future for the Air Force, Navy and Marines. Expect Lockheed Martin to fight any movement in this direction tooth and nail. Instead, the company will lobby get even more F-35s funded than the Pentagon is requesting. One of Marillyn Hewson’s proud proclamations at this week’s media day was that fact that Congress appropriated funds for 11 more F-35s last year than the number called for in the president’s original budget request. Expect more of the same this year.

Defense companies thrive when global conflicts drive up military expenditures, and Lockheed Martin is no exception. The company has made increasing its exports a top priority. In her media day speech, Hewson pointed to turbulence in Europe, the Middle East and Asia as good signs for Lockheed’s export prospects. She wasn’t so crass as to point out that war is good for business. Instead, she said that “It’s clearly a complex threat environment our customers are facing, and we want to remain well-positioned to help them address these unprecedented challenges.”

One step in helping its customers cope with “a complex threat environment” has been the expansion of production facilities for the company’s Hellfire missile system, which is used on Predator and Reaper drones as well as on helicopters and fixed-wing aircraft. Lockheed Martin has no expectation that peace will break out and undercut this burgeoning market. As company vice-president Frank St. John put it in an interview with Defense One, “I don’t see events in the world changing dramatically over the next couple of years . . . [T]he conflicts that are requiring the use of our systems are lingering, so anticipate that we’ll be producing at a pretty high level for some period of time.”

The Hellfires are just the tip of the iceberg in terms of Lockheed Martin’s foreign sales. Attack helicopters and combat ships for Saudi Arabia and missile defense systems for European allies are the biggest moneymakers on the horizon.

Pushing costly, untested weapons systems and profiting from foreign conflicts is hardly innovative. If we are going to realign Pentagon spending with the realities of current challenges and rein in dangerous arms transfers to regions of conflict, Lockheed Martin will have to adjust its financial strategies accordingly. Explaining how it will do so would be an excellent topic for one of the company’s future media days.”


New $110 Billion Air Force Strike Bomber Program May Force Additional, Mammoth Defense Industry Consolidation


northrop-grumman-ad                                                                  Screenshot/www.youtube.com


“The competition for the $100 billion Air Force long-range strike bomber  program includes three of the Pentagon’s top contractors. The contest pits Northrop Grumman against a Boeing-Lockheed Martin team. Big programmatic decisions — like selecting a prime contractor for the F-35 in 2001 and now one for the bomber — unleash market forces that the Pentagon cannot control.

Whoever loses the bomber is likely to come under pressure from investors to make a big move — to either merge with a competitor or acquire a piece of one, predicts aerospace industry analyst Richard Aboulafia, vice president of the Teal Group. “It’s a fascinating horserace … and the outcome could precipitate a big merger or acquisition,” Aboulafia told executives at a recent meeting of the National Aeronautic Association.

Only Lockheed Martin can afford to lose the bomber contract and still have certainty that it will remain a combat aircraft prime contractor, as it will be producing the F-35 joint strike fighter for decades. But Boeing’s and Northrop Grumman’s future as a combat aircraft prime depends on winning the bomber. “If you are not Lockheed, you’d better win this one,” Aboulafia said.

Under one scenario, if Northrop wins, Boeing could seek to acquire if not the entire company, maybe Northrop’s aerospace unit that would have the bomber contract and also builds sizeable components of the F-35. Aboulafia believes this would be the only option for Boeing to remain a combat aircraft prime contractor if it does not win the bomber deal. If Northrop loses, its investors might conclude that it is more lucrative to break up the company and spin off the aerospace division.

The Pentagon in recent years has frowned on mega-mergers of top weapons contractors, a policy that is likely to continue under soon-to-be confirmed Defense Secretary Ashton B. Carter.

But Carter could face challenges to that policy in the near future as defense contractors weigh their options in a tight market. There is growing speculation that such a test might come in 2015 or 2016, following the award of a major Air Force contract to build a new stealth bomber.

Whoever loses the bomber is likely to come under pressure from investors to make a big move — to either merge with a competitor or acquire a piece of one, predicts aerospace industry analyst Richard Aboulafia, vice president of the Teal Group.

The Air Force said it plans to make an award some time in 2015. It has budgeted nearly $14 billion for long-range strike bomber research-and-development work through 2020, and procurement would begin some time in the next decade. Additional funding is said to be tucked in the Pentagon’s classified “black” budget.

For the companies, the contest is a matter of long-term survival because the bomber is the only combat aircraft program up for grabs that is likely to go into production in the next decade.

Boeing continues to manufacture Super Hornet fighter planes for the U.S. Navy and international customers, as well as F-15s. But the last of its current Super Hornet orders would be delivered in 2017 and the last F-15s in 2018, said Aboulafia. Northrop Grumman designed the most recent stealth bomber the Air Force bought in the 1990s, the B-2. The company has military aircraft manufacturing capabilities for both manned and unmanned systems.

Although the Pentagon has drawn a hard line on prime contractor mergers, there might be cases when it might have to reconsider, Aboulafia said. Since the last big wave of industry consolidation in the 1990s, the market has changed dramatically, including the definition of what constitutes a prime contractor. If Northrop doesn’t win the bomber, even if the company is financially healthy and successful, its days as a military airframe prime would be numbered, said Aboulafia. “Does that mean it can sell one or more of its units?” The Pentagon might not be able to make a strong enough case to stop a sale, he said.

“The money you spend is the only real leverage you have,” he said of the Defense Department. “This is a changing environment in terms of investor expectations and company structure. Maybe we’ve forgotten that people do expect either growth or a compelling story to invest their cash.” The companies that are left out of the bomber program will feel pressure from investors, he added. “How do you make your case to Wall Street? An acquisition might be the way forward.”

If the government doesn’t have enough work to keep prime contractors in business independently, it is not clear how it can dictate which units a company can sell, said Aboulafia. “That sounds problematic.”

During his time as chief weapons buyer and deputy secretary of defense, Carter stood firmly behind the idea that market competition is essential to ensure innovation and protect the Defense Department from becoming dependent on monopolies.

Carter told the Senate Armed Services Committee that he continues to believe that the Pentagon should carefully review the implications of industry consolidation before allowing mergers. “I support the review of each proposed merger, acquisition, and teaming arrangement on its particular merits, in the context of each individual market and the changing dynamics of that market,” Carter said in written answers to committee questions submitted before his Feb. 4 confirmation hearing.

“I believe the government must be alert for consolidations that eliminate competition or cause market distortions that are not in the department’s best interest,” Carter said. “During my time as the undersecretary of defense for acquisition, technology and logistics and the deputy secretary, the department took steps to improve and preserve competition in defense procurements, and I would support the creation or continuation of competitive opportunities.”

For military aircraft manufacturers that want to be viable beyond the coming decade, the bomber is the only game in town. The Air Force has plans to buy a trainer aircraft, and both Boeing and Northrop have announced their intent to develop clean-sheet designs for the competition. The Air Force, however, has said it might choose to buy an existing airplane rather than a new design.

The Pentagon also is eyeing a “sixth-generation” fighter, but that program is too far into the future to satisfy the shareholders of whichever company doesn’t get selected to build the bomber. “A sixth-gen fighter is not going to come soon enough to save a military airframe prime that doesn’t get this,” said Aboulafia.

If the Air Force sticks with its goal of buying 80 to 100 bombers, the program could be worth more than $100 billion. The Air Force has championed the bomber as one of its top three acquisition priorities.

In his statement to the Senate Armed Services Committee, Carter said he would support the program. The Air Force, he wrote, “requires a new generation of stealthy, long-range strike aircraft that can operate at great distances, carry substantial payloads, and operate in and around contested airspace.”