Aerospace and defense M&A prospects look brighter, highlights Lazard

Aerospace and defense merger and acquisitions (M&A) activity is entering a strong upcycle after a quiet few years, according to Michael Richter, Managing Director and Global Head of Aerospace and Defense Investment Banking Group at Lazard Freres.  Returning to the Paris Air Show next week (19 to 24 June), he cites a notable easing up in supply chain issues which has hindered growth these past 12 months, with a new vitality coming into the market.

There is no better time to start planting the seeds for collaboration and M&A, he suggested, reflecting on 32 years’ deal-making and the unparalled showcase this global air show affords. “Aerospace companies are seeking to diversify, build value and realise synergies.”

The upswing in commercial aviation is in part due to the primary manufacturers bolstering their monthly production rates (up to 40 units and above) especially on best-selling narrowbody Airbus A320 and B737 aircraft.   Also, OEMs have become creative and focused on overcoming supply chain disruptions and labour shortages, which combined to keep actual production rates below target.   M&A is seen as a critical tool because visibility drives deal making, says Richter. Robust health in the supply chain also delivers better capitalised suppliers, he adds.

Year to date merger and acquisition completions in the commercial aerospace and defense sector (May 15, 2023) totalled US$6 billion.

Dominant themes since the start of the year have been portfolio optimisation; smaller defence and government services transactions and a heightened focus on aftermarket MRO and Fixed Base Operation (FBO) assets.  M&A targets reflect a barbell pattern, with greater focus on large platform companies with over US$80 million in EBITDA, plus smaller deals with less than US$20 million in EBITDA.

The maintenance, repair and overhaul sector, typically delivering average margins owing to plentiful competition, is especially buoyant as airliner fleets are now back in service and airlines catch up on deferred maintenance.  Sponsor-backed M&A deals should take global spending back to 2019 levels, Lazard believes.

Engine MRO, too, is set to exceed year 2019 levels in 2023, driven by air travel demand and utilization. Newer generation engines, such as the LEAP and GTF, are larger than current generation engines, produced with more expensive materials, which in turn drives high maintenance growth over the long-term.

MRO providers with access to Intellectual Property, a breath of capabilities, and local customer access are expected to shine, especially as the market shifts to next-generation aircraft, said Richter.

Private equity-backed aerospace companies and corporate divisions are emerging as attractive acquisition targets, including those with specialized fabrication processes.

Lazard’s recent sale of Paradigm Precision to Clayton, Dubilier & Rice (CD&R) and Greenbriar Equity and its subsequent combination with Whitcraft to form Pursuit Aero, global independent provider of complex machining, fabrications and assemblies for engine manufacturers, became a noteworthy deal in early 2023.  It was the first major US aero-engine transaction in four years and is another example of recent transactions that are creating momentum in commercial aerospace.   Others include Rolls-Royce’s sale of ITP Aero to Bain Capital, SAPA, and JB Capital Markets as well as Montana Aerospace’s acquisition of Asco Industries.  Lazard served as a financial advisor on all of these transactions.

Other 2022 M&A deals included Veritas Capital’s acquisition of Chromalloy; VSE and Loar Group’s acquisition of Desser;  ATL’s acquisition of Aero Accessories, and The Sterling Group’s acquisition of West Star Aviation. Lazard also advised on HEICO Corporation’s complementary acquisition of Wencor Group for $2.05 billion.

These deals contributed to a total US$51.8 billion in M&A transactions during 2022, down from 2021’s record of $125 billion.

Special Purpose (SPAC) transactions, however, reduced in 2021.  It disappointed amidst rising interest rates and a volatile equity market environment.

The defense sector’s share of the total A&D M&A market by value (~67% of total M&A in 2022) rose as investors increasingly allocated capital in response to rising global tensions and growing defense budgets. M&A is anticipated to revert to the five-year average of 59% as commercial aerospace health returns.

Defense continues to experience a favourable environment for consolidation. Rising U.S. defense spending (which increased 10% from the start of the Biden Adminstration) and growing geopolitical competition, have shifted focus towards mergers and acquisitions to improve vertical integration or alignment with broader Department of Defense priorities. Examples include Veritas Capital’s acquisition of CAES’ Space Systems Business (a Lazard transaction); Qnnect’s acquisition of Hermetic Solutions Group, and L3Harris’ acquisitions of Viasat’s Tactical Data.

Smaller scale M&A, based on transaction value, within defense is expected to continue, while larger scale strategic M&A (transactions generally over $1 billion) may be more challenging to complete in the current regulatory environment, concluded Mr Richter.