While there have been significant M&A activity in the last nine years of growing military spending it has been driven by two factors. First, European companies have bought U.S. ones to allow easier access to the market that is governed by a complex set of rules and laws relating to citizens and export of technical information. QinetiQ has been a good example of that with the British company buying medium or small U.S. companies. VT has also done the same thing. EADS has been more careful but has said they are looking at acquisitions in the next years.
The second is a large defense company buying a niche one to gain technology or a product, or to enter a market area that they haven't been in. Lockheed Martin just agreed to purchase the privately owned Gyrocam Systems for example. Gyrocam makes vehicle based surveillance systems that have been used by the U.S. military in Afghanistan and Iraq. Often you will see a small company grow to a point where the founders want to sell and perhaps move on to another project. This is similar to how things have gone in the technology or biotech industries.
If the number of large procurement programs begin to fall as in the Nineties then there will be pressure on the big companies to merge. This is what happened with Lockheed and Martin Marietta or Boeing and McDonnell Douglas. If there is only F-35 aircraft being built the U.S. may end up with only one fighter aircraft. If there are no new destroyers it will be hard to keep multiple ship yards going. The opportunities for the non-American companies to continue to win contracts will also decline especially if the bad economy makes Congress act even more protectionist.
If there will be a severe contraction in the U.S. defense business and that is not know as the 2011 and out budget has not been released yet but major cuts should be expected right now. Iraq will be winding down and it will be hard now for Obama to sustain Afghanistan with the Democratic Congress now that he admits "victory" is not a goal. Gates has made it clear that major weapons acquisitions other then the F-35 and the KC-X are not going to happen again soon and that will affect the investment budget size. This contraction in spending will lead to a smaller number of companies winning contracts which may see them go away or merge with the bigger ones as they look for new products and markets to keep going. There is definitely some uncertainty out in the market and it will continue without some signs from the Administration as to what they will do in 2011 and later.