Defense Firms Must Be More Strategic About M&A
Following years of growth, analysts are predicting flattening or declining defense budgets. This environment demands a balance of modernization, sustenance of legacy equipment, and preservation of force structure. The DoD’s strategic acquisition priorities will inform these difficult choices. To support these changes, the A&D industry must ensure the industrial base can continue to offer a strong technological advantage. World-class talent and financial capital are critical.
Attracting the right resources demands value creation through growth and capital improvement returns. But in a low budget environment, growth is challenging. M&A presents a potent opportunity for generating value and accentuating a portfolio. This proven growth strategy can generate exceptional shareholder returns and bolster corporate resilience.
A&D has witnessed unprecedented consolidation over the past five years, with deals totaling $358 billion between 2015 and 2019. The challenge now is that this wave of consolidation makes further consolidation difficult, with the combined market value of the top five defense hardware players exceeding more than four times that of the next five. Mega-deals are becoming more difficult to execute, highlighting the importance of a more strategic approach.
Programmatic M&A is the solution here. This approach involves a company engaging in two or more small or mid-sized transactions per year, with the goal of an aggregate value in excess of 15 percent of its market capitalization over five years. These deals should closely align with the company’s overall strategy to offer the most value. They must also choreograph around a specific goal, such as integrating vital capacities or scaling.
In the defense and aerospace industries, programmatic M&A should focus on a strategy focused on innovation, lower costs, and improved mission outcomes.
Yet fewer companies are taking a programmatic approach. Among those who did, the returns are undeniable. They outperform their peers by at least 10 percent. M&A was also a major factor in resilience during the last spending downturn of 2007 to 2011.
The current market environment may be a deterrent, given its competition from institutional capital, stretched valuations, and tightening squeeze on mid-tier companies. They are cautious about integrating even smaller companies into their cultures and processes. These complex circumstances demand a bold approach from players who are willing to differentiate themselves from their competitors, align their strategy with national defense priorities, and promote shareholder value. Well-executed programmatic M&A can become a foundation of your growth strategy.
A proactive deal sourcing approach, in-house execution and integration knowledge, holistic diligence, and a strategic approach can help companies transform M&A into a critical capability while mitigating the risks of reactive and ineffective projects. In the increasingly challenging environment the defense industry faces, the market will reward bold action—but only when intelligently undertaken.