The two paths of the aerospace and defense industry are at a crossroads. On the one hand, the outlook for commercial aerospace companies is at its brightest since the turn of the millennium. From new fleet growth in emerging markets, to fleet renewal in developed markets, commercial aerospace backlogs are robust and growing. The same cannot be said, however, for the defense market. From draw downs in overseas deployments, to severe budget cuts in traditional defense markets, prospects for growth through new system procurement have largely shifted to emerging markets.
Yet emerging market opportunities are limited in number and perhaps further limited by security and intellectual property concerns. As defense companies aspire to achieve their growth targets, they are looking to a familiar tool: mergers and acquisitions (M&As). Yet they may find that the greatest opportunity for value in M&A lies in an unexpected market--the United States.
Accenture arrives at this conclusion in its new research report, Targeting M&A Opportunities in the Defense Industry.
Why the U.S.?
The market for new programs in the “developed” defense markets of Western Europe and the United States is stagnant. Budget pressures and the draw down of overseas engagements have put a damper on procurement of new platforms, even transformational ones. Still, opportunities for Western firms in emerging markets are not necessarily more promising. While they are driving much of the globe’s current economic growth, emerging countries may yield only limited sales to U.S. and European defense companies for reasons ranging from local competition to national security concerns.
In China, security and geopolitical obstacles effectively remove it from consideration for Western defense companies seeking to expand. While foreign firms have made inroads into Brazil and India, particularly in each nation’s ongoing jet fighter competitions, significant growth for foreign defense firms in these markets is highly uncertain. Both nations are intensely committed to developing their own domestic defense industries, which will likely limit opportunities for foreign companies. Offset requirements, which are conditions national governments place on manufacturers as a condition of buying their products, mandated technology transfer, and other policy tools may give foreign firms pause in pursuing further investments in these countries. Recent political unrest will also give Western firms pause in the Middle East and North Africa as these political climates evolve.
Why M&A?
Several factors make M&A activity in the U.S. attractive. The first is scale. Despite announced and forecasted cuts, the U.S. defense market vastly outstrips any other on the planet; and firms, particularly European companies seeing their domestic markets decline, will continue to seek to expand their share. The second factor is services. While the market for new acquisitions in the U.S. may be tempered, the market for sustainment operations will continue to be robust, particularly as delays in procurement force continued service life extensions of older platforms. As defense companies increasingly turn to their services businesses to provide more predictable, higher margin revenues, the continued scale of the U.S. defense market, and the potential of its services segment, make strategic acquisitions in the U.S. an attractive proposition for companies searching for growth.
In light of this situation, prospective acquirers will likely take one of three approaches.
Acquisitions to Develop New Offerings
Defense companies that provide legacy products may understand complex engineering and product development. But they are relatively new to the services game. As such, they often need to acquire the people, approaches, and capabilities required to provide services and solutions. These are often complex integration exercises that merge cultures and business approaches. These purchases require significant investment in post-merger integration, coordination, and executive sponsorship; or the strategic decision to operate the acquisition as a stand-alone entity.
Expand the Current Portfolio
For those who have already established a foundation of services and solutions offer¬ings, acquisition to expand and enhance service portfolios is a viable strategy. While the companies that take this approach are already pursuing service and solution oppor¬tunities, the balance between expansion and enhancement will differ based on how far a company has traveled on its services journey.
Expanders often have a service and solution strategy in place and are looking to move to new markets or platforms. Although these companies have experience in deploying and running services businesses, they seek new expertise to enter new markets or strengthen existing offerings. In such cases, acquisitions augment the existing portfolio. Initially, the acquired companies may be allowed to operate as independent subsidiaries linking to the new corporate parent for financials, strategic development, and performance-monitoring and management.
Enhance Current Offerings
Defense companies making acquisition to enhance their portfolios tend to possess a more mature set of offerings and are looking toward acquisitions to boost their market presence, or to intervene in preventing competitors from improving their competitive positions. Enhancement acquisitions typically embed the purchase within an existing business unit, though some are kept separate for national security or other concerns. These acquisitions are usually smaller and more frequent than typical acquisitions. Companies that seek to enhance capabilities through acquisition should be well-practiced in post-merger integration and managing multi-layered, complex organizations.
The Future
As military procurement slows, defense companies will seek new areas of growth to meet the financial expectations of internal stakeholders and public stockholders. Many companies have launched or expanded services businesses to meet these targets. But organic growth may not be enough. Targeted acquisitions, particularly those that grow services revenue, will be at the top of mind of many defense companies. With its still substantial base of defense spending and growing need to maintain platforms, the U.S. will emerge as the primary target for global aerospace companies seeking to grow through acquisition.
Richard Bergmann is the managing director of Accenture’s North American aerospace and defense practice and the company’s global manufacturing practice. He can be reached at richard.f.bergmann@accenture.com.