Acquisitions of companies valued at between $500 million and $2 billion will be the focus of the next wave of consolidation, and the pace is likely to be set by strategic investors rather than private-equity buyers, according to investment bank Lazard.

Michael Richter, co-head of Lazard's US aerospace and defence group, expects the coming phase of merger and acquisition activity to be concentrated at "the next level down" from transactions such as Finmeccanica's $5.6 billion acquisition of DRS Technologies in 2008. "Many of the large deals have already taken place," he says. Companies in the $500 million-$2 billion range tend to have less diversified businesses than bigger ones, making them "more immediate and logical targets", adds Richter.

US defence assets are likely to remain prime targets, given the size of the US Department of Defense budget, which exceeds $500 billion a year. "I think access to the US DoD remains a very significant driver for cross-border M&A," says Richter. Among the particular sectors he cites as being "of growing importance" are C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance), unmanned air vehicles and targeting sensors. Those companies engaged in "lower-end" and more asset-focused defence manufacturing services and infrastructure are "less desirable" as targets.

Merger and acquisition activity in the defence sector remains "very strong", he adds, while deal-making in the commercial aerospace sector has been hit by the credit crunch, which has confined private-equity buyers to "tuck-in" acquisitions, under which the acquired company simply merges with a division of the acquirer. Commercial M&A activity has been adversely affected not just by constrained access to debt, but also by declining air travel demand and weakening order forecasts, even if order backlogs remain strong.

The typical ratio of enterprise value to EBITDA (earnings before interest, tax and depreciation) has declined from between eight and 12 to between six and nine, estimates Richter. However, for this reason, there may be bargains to be had for cash-rich strategic investors.

"If you're a prime contractor and you have billions of dollars of uninvested cash, you are viewing M&A more seriously today than you did pre-crisis," says Richter. "The fundamental growth in the market is not as strong; therefore M&A becomes more critical to the growth of these businesses."

Source: Flight Daily News