Clear skies or dark clouds? The international M&A outlook for aerospace & defense June 14, 2012 We will be starting shortly Grant Thornton. All rights reserved. If you experience any technical difficulties, please contact 888.228.0988 or support@learnlive.com
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Today's presenters Lou Crenshaw Aerospace & Defense Practice Leader, Grant Thornton LLP T +1 703 837 4430 Lou.Crenshaw@us.gt.com Ian Cookson Aerospace & Defense Corporate Finance Leader, Grant Thornton LLP T: +1 617 848 4982 E: Ian.Cookson@us.gt.com Ian P. Wilson Aerospace & Defense Sector Leader, Grant Thornton UK LLP T: +44 121 232 5151 E: Ian.P.Wilson@uk.gt.com Grant Thornton. All rights reserved. -5-
Agenda The future of U.S. defense spending: Vice Admiral Lou Crenshaw, Aerospace & Defense Practice Leader, Grant Thornton LLP (US). Lou is a Grant Thornton Principal and former senior resource and requirements manager of the U.S. Navy where he was responsible for overseeing an annual budget of $130bn. U.S. aerospace & defense mergers and acquisition activity: Ian Cookson, Aerospace & Defense Corporate Finance Leader, Grant Thornton LLP where he advises clients on mergers, acquisitions and divestitures European aerospace & defense mergers and acquisition activity: Ian Wilson, Aerospace & Defence Sector Leader Grant Thornton UK LLP where he advises clients on mergers, acquisitions and divestitures 6
Grant Thornton is one of the largest professional service organizations in the world Full range of services: Audit, Tax and Advisory, including Corporate Finance 529 offices in 110 countries with over 30,000 partners and employees worldwide. 52 U.S. offices with over 5,000 people. Worldwide revenues of $3.6 billion Grant Thornton Corporate Finance* has advised on more than 1,000 M&A transactions** in the last 10 years. Ranked as a top 25 advisor worldwide and one of very few on that list focused on the middle market. * the combined corporate finance groups of the member firms of Grant Thornton International **Source: Thompson Financial 7 Serving Aerospace & Defense Clients
The future of U.S. defense spending: Vice Admiral Lou Crenshaw USN (Ret.), Aerospace & Defense Practice Leader Grant Thornton LLP
The future of U.S. defense spending? Source: Fredericksburg.com 9
Defense budget spend is nearer record highs than prior lows 800 Total budget trends (including supplemental and OCO funding) Adjusted to FY 2013 (Dollars in billions) 700 600 500 400 300 647.5 Korea: FY 52-56: - 42% 373.8 554.6 Vietnam: FY 68-75: - 31% 385.4 573.9 Cold War: FY 86-98: - 33% 384.3 729.8 711.1 655.9 613.9 Iraq & Afghanistan: FY 10-17: -21% 573.3 200 194.7 100 0 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 11 12 13 14 16 17 Korean War 1950-1953 Vietnam War 1965-1973 Fall of Berlin Wall 1989 War on Terror 2001-2011 Source: United States Department of Defense Note: Projections from 2013-2017 assume FYDP plus $44.2 billion annual placeholders for OCO 10
Procurement pays the bills 800 700 Department of Defense TOA by Title (1948-2012) Military Personnel OPR & Maintenance Procurement RDT&E Source: United States Department of Defense USD $ billions (adjusted to 2012 values) 600 500 400 300 200 100 0 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Korean War 1950-1953 Vietnam War 1965-1973 11 Fall of Berlin Wall 1989 War on Terror 2001-2011
Base defense budget dollar trends Base Budget Dollar Trends Total Total (Dollars in billions) FY 11 FY 12 FY 13 FY 14 FY 15 FY 16 FY 17 FY '13 - '17 FY '12 -'21 DoD - FY '12 PB $528.2 $553.0 $570.7 $586.4 $598.2 $610.6 $621.6 $2,987.5 $6,140.6 Delta - FY '12 - FY '13 - -$22.4 -$45.3 -$52.8 -$52.3 -$54.7 -$54.3 -$259.4 -$486.9 DoD - FY '13 PB $528.2 $530.6 $525.4 $533.6 $545.9 $555.9 $567.3 $2,728.1 $5,653.7 Real Growth -1.90% -1.40% -2.50% 0% 0.80% 0.20% 0.20% -0.26% 0.10% * * Source: United States Department of Defense *Average per year 12
Strategic priorities and force development principles Strategic Priorities Remain "active" in countering threats to US interests Rebalance towards Asia-Pacific region Premium on US and Allied presence in partner nations "Evolve" European posture Develop innovative, low-cost and small-footprints Prevent proliferation of WMD Force Development Principles Maintain broad portfolio of capability "Reversibility" is key Do not sacrifice readiness Reduce "cost of doing business" Reexamine contingency plans IVO limited $$ Adjust AC/RC mix Sustain network warfare/jointness Maintain Industrial Base and S&T investments 13
Industry and community impacts Industry/community impacts More "skillful" contracting Better use of IT Better use of business systems Streamlined staffs Limits on travel Reductions in contract services MILCON deferrals Reductions in CivPay raises BRAC 14
Investment in high priority initiatives Initiatives (Dollars in billions) FY 2013 Special Operations Forces (Base + OCO) $10.4 Unmanned Air Systems $3.8 Cyber $3.4 Ballistic Missile Defense $9.7 Space $8.0 Tanker (KC-46) Program $1.8 Science and Technology (includes $2.1bn for basic research ) $11.9 Source: United States Department of Defense 15
More disciplined use of defense dollars FY 2013 President s Budget Initiative (About $60 billion in savings across FYDP) Reduce OSD and Defense Agency expenses ($-10.7 billion) Rephase military construction ($-8.2 billion) Travel and printing savings ($-0.5 billion) Enterprise IT savings ($-4.1 billion) Strategic sourcing ($-2.2 billion) Better buying practices ($-5.3 billion) Streamline installation support ($-5.3 billion) Improve financial information and achieve audit readiness Implement FY 2012 President s Budget Proposals Implementation plans in place Components focused and serious OSD conducting periodic reviews 16
Major program terminations and restructuring Terminations (Save $9.6 billion over FYDP) Global Hawk Block 30 C-27J Joint Cargo Aircraft HMMWV recapitalization Defense Weather Satellite System (DWSS) C-130 Avionics Modernization Program (AMP) Medium Range Maritime UAS Major restructurings (Save $41.8 billion over FYDP) Joint Strike Fighter Shipbuilding Ground Combat Vehicle (GCV) Program Family of Medium Tactical Vehicles (FMTV) Ohio Class Replacement-SSBN(X) Joint Air-to-Ground Missile (JAGM) RephasedAircraft Procurement MV-22 Osprey P-8A Poseidon E-2D Advanced Hawkeye 17
2013 defense legislation House Armed Services Committee HR 4310 Passed by House Awaiting conference with Senate Base: $529.1 Billion OCO: $88.5 Billion No BRAC East Coast Missile Defense Site Retires 18 GH Block 30 UAVs Veto threat by POTUS (GITMO Detainees & Nuclear restrictions Senate Armed Services Committee S 3254 Passed by committee Awaiting debate/floor vote Base: $525.3 Billion OCO: $88.5 Billion No BRAC No East Coast Missile Defense Site Retains 18 GH Block 30 UAVs Exec Salary Cap at $237,000 2013 President's Budget Base: $525 billion OCO: $88.5 billion House Appropriations Defense Subcommittee HR 5856 Reported to House Floor Awaiting Debate and Vote Base: $519.2 Billion in new obligations (+$3B from PB) OCO: $88.5 Billion Senate Appropriations Defense Subcommittee In Committee 18
U.S. aerospace & defense mergers and acquisition activity Ian Cookson, Aerospace & Defense Corporate Finance Leader, Grant Thornton LLP
The A&D sector has considerably outperformed overall M&A activity in North America M&A activity continued its expansion in 2011, with the number of A&D transactions rising 20%, climbing to levels last seen in 2007. Contrasts with North American M&A activity which remained fairly flat last year Number of transactions (A&D sector) 300 250 200 150 100 50 0 North American aerospace and defense M&A activity 2006 2007 2008 2009 2010 2011 Transactions where target is headquartered in U.S. or Canada. Source: Company press releases, Capital IQ & Factset Mergerstat 20 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Number of transactions (Total M&A activity in North America) Other MRO/distribution/related services Defense electronics Defense technology Defense components Total M&A activity in North America
Rising earnings drive M&A activity Aerospace industry saw steady growth in 2011 with sales increasing 3.6% and growth across all product groups (civil and military aircraft, missiles, space, related products and services). Orders were up 4.3% Boeing reported record backlog and Q1 revenue was up 30% on increased production Overall industry sales are expected to flatten in 2012 with ongoing increases in civil sales being offset by declines in military markets $ billions 600 500 400 300 200 100 - U.S. aerospace, backlog, orders and shipments Shipments Orders Backlog 2001 2003 2005 2007 2009 2011 (P) Sources: U.S. Census Bureau, Manufacturers' Shipments, Inventories, and Orders, and AIA estimates 21 $ billions 80 70 60 50 40 30 20 10 U.S. Civil and Military Aircraft Sales (1984-2012) Civil Military - 1984 1988 1992 1996 2000 2004 2008 2012 (E) Source: Aerospace Industries Association (AIA)
But there are more forces at play when you look at specific subsectors Component manufacturing transactions rebounded strongly (most cyclical segment due to commercial exposure) and defense technology businesses remained sought after Defense electronics, Defense IT & MRO transactions exceeded 2007 levels 100 North American aerospace and defense M&A activity by subsector Number of transactions (A&D sector) 90 80 70 60 50 40 30 20 10 0 2006 2007 2008 2009 2010 2011 Transactions wheretarget is headquartered in U.S. or Canada. Source: Company press releases, Capital IQ 22 Defense components Defense technology Defense electronics MRO/distribution/related services
Component manufacturing: M&A activity rebounds strongly Supported by pick up in commercial aerospace and ongoing replacement defense volumes from the wars Component transactions increased almost 40% and announced Transaction values soared as a result of UTCs agreement to purchase Goodrich Heavy PE involvement. In addition many acquisitions made in the peak 2007 timeframe are approaching the end of their investment period 23
MRO and support services a tale of two stories Large number of small "fill-in" transactions adding capabilities repair shops and service Substantial acquisitions by airframe manufacturers as they expand the service side of the business. Seen as less cyclical - also driven by desire to secure revenue "over life of the aircraft" 24
Defense technology accessing growth areas of defense budget Buyers filling out service offerings and adding capabilities in growth areas of defense spending: cyber security, C4ISR, unmanned vehicles Buyers from large primes to small IT firms, making acquisitions of all sizes Demand has driven up valuations and created sellers. Number of defense technology deals increased almost 20% in 2011 over prior year highs CACI announced that it had signed a definitive agreement to acquire Paradigm, which provides cybersecurity and enterprise IT solutions to federal civilian agencies Washington Technology July 26, 2011 Providence Equity Partners acquires cybersecurity and information assurance provider SRA International Inc. for $1.8 billion Reuters April 1, 2011 25
Defense electronics: ever more central to aircraft and defense equipment Secure communications, intelligence surveillance (ISR), tracking, vision systems, electrical components Ever more integral from special operations to commercial aircraft Remained fairly stable and maintained strong level of activity 26
Private equity is particularly active in A&D sector In 2011 Private Equity firms: Accounted for roughly 30% of A&D acquisitions (> 85 transactions). Almost double 17% overall US M&A activity Returned strongly with number of A&D deals rising 50% Highly active in the component manufacturing where they account for almost 40% of transactions Rationale for A&D: Fragmented industry suitable for consolidation strategies Perceived comfort on earnings visibility - order books & platforms Different cycle to rest of portfolio Still have substantial capital to deploy Percentage of private equity acquisitions in aerospace and defense subsectors for 2011 Defense components MRO/distribution/related services Defense IT Overall acquisitions by PE firms in U.S. as a whole Defense electronics 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 27
Due to concerns around the future of defense spending prime contractors have been making notable acquisitions in adjacent areas Such as health care IT, to diversify in the face of federal budget cuts. Transactions include: General Dynamics purchase of Vangent Inc., a provider of health care IT and business systems for government agencies ($1.3 billion) Lockheed Martin s acquisition of government-outsourced occupational health, injury and disability examination services provider QTC Management ($420 million) SAIC s purchase of business and health care IT solutions operator Vitalize Consulting Solutions ($198 million) Computer Sciences Corporation s acquisition of system support and application development company Maricom Systems 28
Public company earnings and valuation: Illustrate concerns about future defense spending M&A activity, like public company valuations, is typically a function of earnings growth and confidence Public company valuations reflect concerns over defense & govt. spending. EV / EBITDA by sub-segment in public markets: Defense IT: 5X Prime Defense: 5X Defense Electronics: 7x Components: 8X MRO: 11x (Asia Pacific) Median EV/EBITDA multiple 14.0x 13.0x 12.0x 11.0x 10.0x 9.0x 8.0x 7.0x 6.0x 5.0x 4.0x Aerospace/defense valuation multiples by sector Defense Components MRO/Component Repair* Prime Defense Defense IT Defense Electronics 2005 2006 2007 2008 2009 2010 2011 2012 14.0x 13.0x 12.0x 11.0x 10.0x 9.0x 8.0x 7.0x 6.0x 5.0x 4.0x Cumulative LTM earnings growth index Aerospace/defense earnings by sector 300% Defense Components MRO/Component Repair* Prime Defense 250% Defense Electronics Defense IT 200% 150% 100% 2005 2006 2007 2008 2009 2010 2011 2012 300% 250% 200% 150% 100% *MRO valuation skewed by weighting to Asia/Pacific market Source:Capital IQ, company press releases Source:Capital IQ, company press releases 29
M&A activity has weakened in the first five months of 2012 In first 5 months of 2012, overall North America M&A activity declined 15% A&D M&A activity has declined similarly down 17% for 5 months to May 2012 Component manufacturing transactions have continued to increase over 30% compared with declines of similar amounts in other segments North American aerospace and defense M&A activity May 2012 Number of transactions (A&D sector) 300 250 200 150 100 50 0 Jan. to May 2011 Jan. to May 2012 4,800 4,400 4,000 3,600 3,200 2,800 2,400 2,000 1,600 1,200 800 400 0 Number of transactions (Total M&A activity in North America) Other MRO/distribution/related services (Down 33%) Defense electronics (Down 35%) Defense technology (Down 40%) Defense components (Up 33%) Total M&A activity in North America (Down 15%) Transactions wheretarget is headquartered in U.S. or Canada. Source:Company press releases, Capital IQ & Factset Mergerstat 30
Looking to the future - we expect to see Continued interest in defense technology acquisitions - but pace slowing as firms expand their current platforms: -Only very large acquisitions really move the needle for prime contractors -Some will seek to augment slower organic growth through acquisition Weaker M&A activity in defense overall, as buyers become more cautions in face of future budget cuts Increased attention back on expanding civil side of the business including by acquisition. Private equity will be both sellers and buyers as acquisitions from peaks of 2007 come to the end of investment periods 31
European mergers and acquisition activity: Accelerating divergence Ian Wilson, Aerospace & Defence Sector Leader, Grant Thornton UK LLP
Defence: Greater cooperation expected as budget cuts bite Strong correlation to U.S. trends European governments austerity measures will have a significant impact on defence spending With equipment deliveries largely committed for 2012, the full impact of defense cuts is expected to be felt in 2013 Governments facing economic and political pressure to collaborate (Anglo-French alliance) Defence primes face the choice of 'consolidate or collaborate' Significant duplication across Europe furthers need for cross border collaboration e.g. BAE Systems/Dassault plan to jointly develop UAVs More partnerships, asset swaps joint ventures and mergers predicted Increasing focus on emerging markets by both governments and contractors Homeland security, UAVs and cyber represent the few growth segments 33
Defence: Slowing deal momentum M&A activity in Europe was reasonably strong in 2011 but has weakened in 2012 The most active dealmakers were UK businesses with U.S. interests including Cobham, Ultra Electronics and BAE Systems Favoured segments for M&A: services (EADS, Patria, Supacat) C4ISR (Sonardyne, Patria, Quadnetics) communications technology (Ruag, Vermonte, Teseq) cyber (Ultra, Digital Barriers, BAE) satellites/space technology (Astrium, Ultra) homeland security (ROK Global) Largest deal highlights collaboration trend - acquisition of military propulsion business Tognum AG by JV between Rolls Royce and Daimler. 34
Commercial Aerospace: Record orders but supply chain remains fragile and fragmented Airbus has secured a record orders and backlog Potential vulnerabilities from weaker European airlines and access to aircraft financing Many European companies also present on Boeing programs Supply chain weaknesses have constrained capacity expansion at Airbus and the Tier Ones Some suppliers struggling to fund capital equipment and working capital expansion Certain suppliers have suffered from the effects of program delays Airbus progress has been slow in target of restructuring supply base from thousands of companies to 15 primary suppliers -with technical and financial capabilities to be true partners High cost to secure position on new platforms forcing consolidation at steady pace Shift to composites will result in a shorter, more concentrated supply chain 35
Commercial Aerospace: M&A activity in commercial aerospace showing signs of recovery M&A activity in the commercial aerospace sector has begun to show signs of recovery - despite challenging capital markets Typical multiples for Tier 2 and Tier 3 component manufacturers have increased from 4-6x EBITDA in 2009/10 to 6-8x EBITDA Recent activity driven by: Private equity has returned to the sector attracted by strong growth dynamic (Bridgepoint, Exponent, LDC, Better) Engineering groups seeking to strengthen aerospace portfolio (Senior) Non-core divestitures also a driver of activity (BAE, Umeco) US acquirors were active - many interested in strengthening their positions in Europe but nervous about Eurozone macroeconomic conditions A number of PE exits anticipated over the next 12-24 months 36
In Closing
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Contacts Lou Crenshaw Grant Thornton LLP 333 John Carlyle, Suite 500 Alexandria, VA 22314, USA T +1 703 837 4430 E Lou.Crenshaw@us.gt.com Ian Cookson Grant Thornton LLP 226 Causeway St, Boston MA 02114, USA T: +1 617 848 4982 E: Ian.Cookson@us.gt.com Ian Wilson Grant Thornton UK LLP Enterprise House, 115 Edmund St, BIRMINGHAM, West Midlands, B3 2HJ, UK T: +44 121 232 5151 E: Ian.P.Wilson@uk.gt.com 39
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