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Life in a post-program world—approaches to growth in the defense industry.
The beating taken by credit, consumption, and investment during the recession of 2008-09 left few industries unscathed. The Aerospace and Defense industry, no stranger to the business-cycle rollercoaster, was no exception. From plummeting demand in business aviation to canceled orders for commercial aircraft, the industry felt the direct consequences of the collapse of credit and spending.
Yet with Western economies slowly on the mend and emerging markets continuing their surge forward, the future challenge to expanding industry value may arise in an unexpected place: the defense segment, where new Mergers and Acquisitions (M&A) opportunities suggest interesting potential.
Business and commercial aviation markets are both moving toward recovery, Both manufacturers’ and independent forecasts see emerging market growth, fleet renewal and new Mergers and Acquisitions (M&A) driving a doubling of commercial aircraft production over the next two decades, indicators that are only strengthened by the strong bookings recorded at the 2011 Paris Air Show. From continued work on new platforms to fleet upgrades, OEMs and their suppliers are investing to support growth in commercial aviation. While much work remains, confidence in the commercial segment is gaining momentum.
Then there is defense. Over the course of the past five to 10 years, the defense segment has supported consistent industry growth. Ongoing military operations in Iraq and Afghanistan, coupled with the development of significant aviation, electronics and naval programs have provided steady growth in the North American and European defense markets.
Governments from emerging markets across the BRIC (Brazil, Russia, India and China) countries, the Middle East and Southeast Asia have also been investing, particularly in aircraft fleet upgrades. Yet just as the commercial and business aviation segments have begun their recovery, the defense market is becoming more uncertain, particularly in developed markets.
The picture in emerging markets is promising, yet similarly uncertain. The areas of greatest economic growth may yield only limited sales to Western defense companies for reasons that range from local competition to national security concerns. To successfully navigate this environment, Western defense companies will therefore need to do two things well: first, develop an individualized personal blueprint for acquisition and market entry; and second, take advantage of the market for service and support.
As with other industries, spending on defense is on the rise in emerging markets. Unlike other industries, however, the path forward for developed-market companies seeking to engage in these regions may be more of a mixed bag.
Where should defense companies look to maximize value? Like all enterprises, defense firms have two primary levers for increasing enterprise value. They can improve their overall returns on capital and they can grow their businesses organically or through acquisition. The immediate response of defense companies to the macroeconomic environment has been a renewed focus on operating margins and capital efficiency. Lean manufacturing has become leaner.
Firms are turning their attentions to the other major lever of value creation, Mergers and Acquisitions.
The shift to services across the aerospace and defense industry has spawned a growing and higher margin market for operational support. Some of these solutions are tied to the ongoing maintenance and support of assets and systems. Others are niche—but high-value—solutions in themselves. These types of high-value areas are likely to be the focus of acquisition activity over the coming months. The shift to services also presents an attractive market proposition for prospective acquirers.
September 23, 2011
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