THE VIEW FROM EUROPE: Europe takes center stage as mergers and acquisitions fly high

June 1, 2007
The value of deals in the aerospace and defense sector is returning to previous highs according to “Flying High - Aerospace and Defense Mergers & Acquisitions,” a new report by PricewaterhouseCoopers (PwC).

By Annie Turner

The value of deals in the aerospace and defense sector is returning to previous highs according to “Flying High - Aerospace and Defense Mergers & Acquisitions,” a new report by PricewaterhouseCoopers (PwC). The report says that the total value of disclosed transactions reached $33 billion in 2006, by far the highest level since 2000.

Europe took center stage; the value of deals involving European-based targets totalled $21 billion, double the $10 billion invested in North America, and a reversal of the relative proportions seen in 2005. The growing confidence in the sector is reflected in the larger average deal size, which has almost tripled from a low of $99 million in 2003 to $277 million in 2006.

The biggest transactions last year included the $3.5 billion takeover by EADS of the outstanding 20 percent stake in Airbus from BAE Systems and the $3.3 billion takeover of Italy’s Avio by Cinven, the European private equity fund.

The drivers fueling the growth look set to sustain these high levels over the next two years.

For starters, aerospace and defense are attracting record levels of private equity investment across a range of deals. Four of the top five majority-stake transactions in 2006 involved private equity, either as a buyer or seller. The report concludes that private equity has been attracted by the restructuring and globalization across the industry, in manufacturing and services segments. These investors have participated by providing much-needed liquidity in the market as larger players divest assets and the supply chain consolidates.

Second, acquisition money is flowing from Europe into North America, giving European corporations access to the U.S. market. European acquirers spent a total of $5.6 billion on North American targets over the last two years, more than double the amount of money coming the other way.

However, the report predicts that this is about to change, with large U.S. companies looking for European, and particularly British, assets as tier two and three corporations consolidate and the major players buy and sell while seeking to define their core activities.

Another motivation for U.S. companies to look to Europe is that growth of U.S. defense spending is slowing, so in the future, large American contractors are likely to find it harder to expand their incomes at home. Also, the average industry operating profit margin started to recover in 2005. When all the results are in for 2006, it is anticipated there will be a significant further improvement.

The PwC report also claims there is strong evidence that the operational rate of U.S. overseas deployments may reduce research, design, technology and evaluation as well as postpone platform spending.

Americans are not the only interested party. Middle Eastern investors are increasingly looking to Europe too and invested $2.5 billion in European targets last year. In 2005, Middle Eastern investments in European aerospace and defense were negligible. Dubai, especially, is seeking to build capabilities and infrastructure in the sector, exploiting both industry growth and its own geographical position between Asia, North America, and Europe.

The report’s writers claim these main drivers will shape the structure of the industry for the next decade. “Competition is fierce given that for the first time in recent years both corporate buyers and financial acquirers have the resources and the appetite to compete for targets in the aerospace and defense sector,” said Gregg Agens of PwC, a global aerospace and defense leader.

Naturally, not everyone in Europe is well placed to take advantage of the rosy picture painted by the PwC report. As is so often seems to be the case in Europe, management infighting has led to big problems. This time French company Safran is in the spotlight.

Two independent auditors have found evidence of what they describe as “deliberate” failure to comply with accounting standards, adding fuel on the fierce row that has been raging since the aero-engine and communications group was created by a merger of assets from Sagem and Snecma in 2004. Many argue that the valuations of those assets were hugely inflated and staff from the two companies have fought like cats in a bag ever since, to the detriment of the entire venture.

According to the Financial Times, news of the accounting irregularities was seen by many in the old Sagem business as a ruse by Snecma management to gain the upper hand.

To add to the disharmony, former Sagem executive Jacques Paccard was sacked as head of Safran’s loss-making defense and security division: in January the company’s new chairman, Francis Mer, reported a loss of $137.4 million. Undaunted, Monsieur Paccard is suing Safran’s chief executive, Jean-Paul Béchat, former head of Snecma, for defamation.

In the meantime, Cobham, the British aerospace and defense company, is riding high amid rumors of a takeover by Italy’s Finmeccanica after the news broke that it is to seek shareholder permission to raise $1.36 billion through a share issue. It is already thought to have up to $4 billion in its war chest. Industry analysts reckon it would have to pay $5.44 billion for Cobham.

Finmeccanica is focusing on the bigger picture too. It and France’s Thales have said they are going to work ever more closely together, which is about as far as they dare go. Europe’s fragmented defense and aerospace industry clearly needs to consolidate, but over here, such talk is playing with political fire and it makes governments very twitchy indeed.

After all, consolidation could mean people (aka voters) lose their jobs, plus governments have great anxieties about losing control of national champions, not to mention intellectual property and know-how concerning defense. Clearly the continuing pantomime at EADS and its subsidiary Airbus hardly provides an inspiring example of how intra-European cooperation works either.

Although Thales is currently stopping short of a full merger with Finmeccanica, it is on the acquisition trail for smaller fry. Its CEO, Denis Ranque, recently said that his company could be interested in parts of Safran. Well, at least they are both French, which should reduce the political posturing, if not the civil wars, although as I write, everything in France is on hold because of the imminent Presidential election.

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