Improved Visibility Clears M&A Deals For Takeoff
This week’s Farnborough International Airshow promises to be another busy one for dealmakers like Michael Richter, managing director and head of aerospace and defense with investment bank Lazard. Even compared with the periods around the 2012 Farnborough show and the 2013 Paris Air Show, he sees rising levels of mergers and acquisitions (M&A) activity in the commercial aerospace sector. He also anticipates some degree of recovery in defense industry M&A activity, reversing a period of relative inactivity in a sector that has been impacted by uncertainty over military budgets.
According to Lazard, commercial aerospace M&A is being driven largely by the quest for consolidation in the supply chain and greater certainty over positive build rates for products. Visibility–meaning a high degree of certainty–over airliner build rates is a key factor supporting the bullish M&A environment surrounding airliner manufacturers and their suppliers.
“The overall health of the [airline] industry is about as strong as we’ve seen it and so there is very strong visibility on the order books [of airframers],” Richter told AIN. “There is now confidence that 2014 and 2015 [production] is sold out and 2016 looks good, with diminished visibility for 2017 and 2018. This all makes it easier for [M&A] buyers and sellers to come to agreement on price.”
For the most part, airliner order backlogs have held up well, but Emirates Airline sprung an unwelcome surprise when it canceled its order for 70 Airbus A350XWB widebodies. “I don’t think it’s clear that this represents a deeper-rooted problem,” said Richter in an interview last month. “It seems to be more to do with Emirates not needing as many aircraft as it had ordered earlier. Time will tell, and if there are other cancellations the situation will have to be reviewed.” He added that the continuing squeeze on airline profit margins simply bolsters the case for them to invest in new, more fuel-efficient aircraft.
On the defense side of the industry, Lazard sees strong pent-up demand, balance sheets and cash positions for companies bolstering the case for M&A deals to be consummated. “Overall, it’s hard in the defense sector,” said Richter, “which can’t agree with any level of certainty on what the cash flow will be. But we do now see a slightly greater level of visibility [in terms of production rates] compared with the total cloud cover we’ve had in recently years. Some [M&A] deals are now trickling out.”
According to Richter, much of the M&A activity in the past 12 months has been concentrated on the aerostructures sector, which he described as having “a pivotal position in the supply chain.” From an investor’s point of view, these tier one-and-a-half and tier two companies are attractive propositions in part because they build parts specified by the tier-one manufacturers rather than shouldering the principle design risk for programs, said Richter.
In March, Lazard advised Marvin Engineering on the $625 million sale of California-based Aerospace Dynamics International to Precision Castparts. The company makes items such as landing gear beam assemblies for the A350. Back in June 2013, Lazard also assisted in the $600 million deal that saw Precision Castparts buy fastener manufacturer Permaswage.
Favorable conditions in the debt markets are spurring private equity groups to get more active in aerospace M&A deals. An example of this was Warburg Pincus’s recent purchase of aircraft parts maker Wencor Group.
“Strong [build rate] visibility and order books mean banks are very willing to lend capital [to fund acquisitions],” said Richter. So whereas investors might have previously been able to secure loans of up to around three or four times an acquisition target’s earnings before EBITDA (earnings before interest, taxes, depreciation and amortization), Lazard has lately seen cases where up to seven times this measure has been provided in support of deals.
“Aerospace is one of the few bright spots and there are now few other sectors attracting so much debt capital,” said Richter. At the same time, lenders have loosened the covenant terms under which capital is provided and this, plus historically low interest rates, has helped to push up purchase prices for strategic acquisitions.
So does any of this M&A activity materially contribute to the overall health of the aerospace and defense industry? “Deep down the OEMs do appreciate what we are doing here because it reduces the points of failure,” concluded Richter. “They will have more capable, better capitalized suppliers instead of disparate and under-capitalized suppliers, presenting much less risk of a supply chain shock caused by smaller companies not having the capital they need to increase production rates.”