KAL Capital Q1 2020 in Review
Please review our full Q1 Report here.
Unprecedented times. Simply put, we at KAL Capital are still trying to get our arms around the profound impact of COVID-19 as it pertains to the aerospace and M&A industries, but perhaps, most importantly, these times serve as reminder of the importance of friendships and family. From our family to yours, we truly hope that you are safe and healthy and managing through this unprecedented disruption in your business.
For our business, we are fortunate to remain active with a book of clientele that are relatively insulated from much of the disruption. Given the current environment, we are particularly pleased to announce our role in the sale of AEVEX Aerospace to Madison Dearborn Partners (details enclosed). This transaction was particularly satisfying as we represented the family owners in their original recapitalization with Trive Capital in 2014, watched the business continue to grow and finally assisted in the second exit.
We remain cautiously optimistic that later this quarter or early next, life as we knew it returns to normal. We will cover in greater detail, but as demonstrated by our recently closed transaction, defense-focused M&A activity continues to march forward, albeit subject to new social distancing complications! In the mean-time, we want to engage in as much dialogue as possible as we can assist outside of our normal scope of sell-side M&A activity. We have access to both conventional and non-conventional financing sources, should the need arise.
We will take the remainder of this Industry Review to share our specific thoughts on the current implications on M&A for each of the major sub-sectors of the aerospace world, which we break out into commercial OEM, commercial aftermarket and defense. The duration and the extent of the reduction in valuations varies dramatically by sector, but overall the M&A market has abruptly shifted away from a seller friendly backdrop to one where the market is still trying to reach a point of price discovery as many M&A processes have been paused.
Reflecting on the Great Financial Crisis of 2008-2009 has been an invaluable source of perspective and a way to articulate differences, both positive and negative from today. First, the previous crisis began as a housing/banking issue that migrated into the broader economy. This amplified the negative effect on M&A activity as a prolonged lack of access to debt capital dramatically reduced private equity activity. In comparison, today’s crisis is an economic shock that did not originate from what was previously, a healthy financial system which should somewhat mitigate the adverse effect on lending risk-appetite. Additionally, many of today’s private equity and middle-market debt capital sources are from committed funds and other non-traditional banking sources. According to PitchBook estimates, these private debt funds have $275 billion of committed capital base. Secondly, private equity’s strong performance coming out of the previous recession led to an unprecedented, exponential increase in the number of funds and total committed capital that institutional investors have allocated to the sector.
Total private equity “dry powder” sits at $2.4 trillion; simply put, this capital can only stay sidelined for a limited period before fund life and other economic considerations force equity groups to again deploy capital via M&A activity. These facts are positive but are unable to balance out the negative shock that the market is experiencing; in whole we do face the grim reality that 2020 M&A activity for many sectors will be down considerably and may in fact be lower than 2009.
For the aerospace/defense sector, the comparisons between the Great Financial Crisis and today again point to a very different near-term future for M&A activity. During 2008-2009, the resiliency of the commercial OEM cycle, driven by a deep (international) order book, allowed for M&A activity in the sub-sector to continue with only limited disruption. Ultimately, the length of this crisis will determine the impact on the OEM orderbook, but today many strategic and private equity buyers are taking a “wait and see” approach that we expect to last several months particularly now that Boeing has halted nearly all production and Airbus has announced material reductions in build-rate. While the commercial OEM market will undoubtedly be adversely impacted, the nature of today’s crisis has impacted air traffic to a degree that has the aftermarket supply-chain facing unprecedented challenges. In the near-term, we expect commercial aftermarket M&A activity to be primarily distressed sellers or restructuring as the total collapse in passenger traffic will have a debilitating effect on ground handling, component MRO and other aviation services businesses. Cargo has remained a bright spot as the global economy is still requiring the movement of goods across countries; many participants in this sector have seen revenue increases and will likely emerge from this crisis in strong financial shape. Finally, in contrast to the Great Financial Crisis, we expect defense-driven businesses to continue to transact at seller friendly multiples. While sequestration hamstrung the DoD during the previous crisis, today’s funding environment is robust with strong funding for a variety of programs and platforms. We believe that private equity and strategic buyers will be drawn to these types of opportunities driven by the comparative ease of end-market diligence and the lack of alternative deal flow that will likely characterize the remainder of 2020. Additionally, many strategic buyers (public and PEGowned) have already reached out to KAL Capital expressing a desire to rebalance existing revenue mix towards a more defense-focused model via M&A.
These are crazy times. Please stay safe and as always reach out to either of us with any questions.
Trevor Bohn & Ryan Murphy