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Cerebus Leads The Way As Defense M&A Suddenly Picks Up

In the last week, the defense industry has announced four deals. Does this sudden spurt of activity indicate that the long-expected contraction in the defense industry is happening?

2009 was a bad year for mergers and acquisitions (M&A). The value of total deals in the industry was only $10 billion, 54 percent less then 2008. Larger deals -- those valued at $50 million or more -- fell by 62 percent.

The biggest of the recent deals was the surprising announcement on Monday that Cerebus Capital Management LP, a private equity group, would buy DynCorp International (DCO). DynCorp International makes a great deal of money providing intelligence and training services to the U.S. State and Defense Departments. They just won a protest of a contract the Army gave to Xe Services (formally Blackwater) to train the Afghan National Police. The company has done similar work in Iraq.

It may cost up to $1.5 billion to purchase all of DynCorp's stock. Cerebus is most famous for acquiring Chrysler from Daimler Benz a few years ago and then basically transferring ownership to the Obama Administration last year to avoid bankruptcy. This is Cerebus's second major defense acquisition.

The other deals were smaller:

  • Medium-sized defense contractor Kratos Defense & Security Solutions (KTOS) agreed to buy Gichner Holdings, which manufactures tents, shelters and other tactical equipment. Their products are also used to support Unmanned Aerial Vehicle (UAV) operations, U.S. Navy ships and other military services. Kratos provides training aids and services to the U.S. military including things like operating test and training ranges that support live fire and operational exercises. The move into hardware is part of the company's plan to grow its business and size. The deal is worth about $133 million.
  • Alliant Techsystems (ATK) is a large manufacturer of ammunition, explosives and fuel for rockets and missiles. They have seen business boom over the last ten years to the point where revenues approach $5 billion a year. The company plans to buy the private maker of small arms and tactical gear for military and law enforcement, Blackhawk Industries. No details of the cost were announced.
  • Vought Defense Systems will acquire Quality Performance Inc. for less then $10 million. Quality provides engineering and maintenance support to the U.S. Navy. Vought will change its name to ALAS Defense Corp. when the merger with Quality is complete. Vought has been investing in UAV capability over the last year and plans to move aggressively into that market. The addition of Quality will aid that by providing engineering capability for support of UAV and their control systems.
There were different reasons for each deal. Cerebus is trying to invest its money into growth areas. Obviously, auto manufacturing and financing didn't work out so well, and DynCorp is well placed to gain a great deal of work in Afghanistan. The other three acquisitions either expand or enhance the buyer's capability in certain markets.

In the 1990s, as defense budgets dropped, the industry consolidated. This could happen again as the U.S. moves to deal with its large budget deficit and operations overseas are decreased. These four deals, all relatively small and focused, are not necessarily a harbinger of a new wave of M&A. But they hint at least that the winds of change are coming.

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