Future of Mergers and Acquisitions in the Defense Industry

(MoneyWatch)  In the Nineties once the Peace Dividend kicked in and the U.S. defense budget began its slow decline there was an uptick in M&A activity in the defense industry. Venerable firms like Grumman and McDonald Douglas merged with other large companies Northrop and Boeing. Smaller companies were also gobbled up, even fairly substantial ones like Logitech and Nichols Research. Every company I worked for was bought by a bigger company. In some ways this was encouraged by the Pentagon as they realized that few contracts for smaller quantities of systems were going to be signed and it couldn't support the industrial base of the previous years. In the last eight years the growing defense budget of the now non-Global War on Terror led to an expansion in the market that was filled by European firms like BAE and EADS. It is now expected that with the Obama administration winding down the war and cuts to the defense budget that there will be an increase in M&A. Much of the last few years was the Europeans buying up smaller American companies in order to get U.S. market share and also to help with the Buy American and security requirements of U.S. contracts.

Now, as this Reuters article, points out "more mergers among defense suppliers this year, mainly because the industry is very fragmented and also because defense contractors with cash are looking to make small acquisitions in niche technologies." The article discusses Herley Industries, an electronics manufacturer, that was trying to sell itself through an auction. The sale failed as nobody bid high enough for the company. Herley makes parts for various bigger defense contractors as well as medical equipment. It may be that at the present time people are waiting for the dust to settle from Gate's proposals on Monday and to see the budget start working its way through Congress. The reaction from the people's representatives there has been decidedly negative from the most vocal members as they digest the possible loss of jobs and money to their districts.

The thing with a proposal that cuts some programs but adds funds to others and to the operations and support budget is it allows opportunities that were not there before. Eventually the programs being ended like Future Combat Systems (FCS), the DDG-1000 or the Next Generation Bomber will need to be restarted in some form or the other. The requirement for them is still there so a new program will have to be initiated at some point. Of course the U.S. could decide to end modernization completely and rely on existing systems as they did in the Nineties. This would lead though to money to keep them afloat or upgraded.

If the budget begins a steady decline then then there should be an increase in M&A as companies consolidate capability or look for that area that can bring in revenue and profits. If the budget maintains or grows then there will be more of a rationale for keeping a diverse group of system and support contractors available.