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M&A Activity In Defense To Grow?

It had been expected that Merger & Acquisition (M&A) activity would have increased over the last two years in the defense industry. Other then a few big events such as Northrop Grumman's (NOC) divestiture of its SETA arm, TASC, there was not as many actions as had been expected. The feeling was that if the defense budgets of the U.S. and other European countries did decline due to changes in policy and economic difficulties that would would spur activity.

Now recently there have been several transactions announced or completed which may signify a major shift in the defense industry as larger companies move to diversify or get out of certain business areas. M&A also might be happening as smaller companies see that they might not be able to sustain the earnings growth they had experienced since 2001 and might see a merger as a way to maintain viability. Earlier we had discussed QinetiQ's (QQ) problems and how that might be seen as a harbinger of this.

Recent acquisitions announced include CACI International (CACI) plan to buy by February 1st SystemWare, Inc. SystemWare manufactures security systems for both electronic and IT systems as well as physical and operational security. CACI is heavily involved in intelligence and security itself and the addition of SystemWare to its portfolio will complement its existing products and services. In 2009 SystemWare had revenues of about $16 million indicating that this will be the low end of the price paid by CACI International.

In a move that has been more common over the last ten years English based Chemring Group PLC (CHG) announced that it will merge with the The Allied Defense Group, Inc. (ADG). European companies have been moving into the U.S. defense supplier market often through the acquisition of U.S. companies such as QinetiQ buying Westar or VT Group acquiring AEPCO. This has allowed them to meet U.S. export control and citizenship requirements more easily and also get the companies existing contracts and work. Both Chemring and Allied Defense make munitions and pyrotechnics. Chemring larger international reach will enable Allied Defense products to reach a larger market.

There is also a report that Argon ST (STST) is considering making itself available for acquisition. The company also makes sensor technology for use in intelligence gathering systems. Argon ST has hired a firm to aid it in exploring a sale, merger or acquisition. The company is considered valuable as it has a large number of sole source contracts and a good reputation with its customers. Another company acquiring it would gain that good will and the existing customer base. As with Allied Defense a bigger company would also be able to market and integrate Argon ST's products to a wider audience. In December Argon ST did report increased revenue from a year ago but was below analyst forecasts for 2010. This performance might be an indication that sale or merger would be the best value for its shareholders.

If the U.S. continues to shift funding from more traditional programs into unmanned vehicles and Intelligence, Surveillance and Reconnaissance (ISR) programs these will be the kind of company's being purchased. M&A would be the easiest way for a large defense contractor to get a major foothold in this market. Lockheed Martin (LMT) has already done this through there acquisition of Gyrocam. That company made sensors for ground and vehicle based surveillance systems and this now allows Lockheed penetration there.

2010 may be the year that begins another round of consolidation in the defense industry. The recent reorganizations of Boeing (BA) and Lockheed Martin are another sign of this as companies move to streamline operations and reduce costs as much as possible. Will there be another group of companies added to the list of those that went away in the Nineties such as Logicon?