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Defense companies are bracing for a surge in deal activity as many companies look to put increasing amounts of cash into investing in technologies such as artificial intelligence, advanced drones and space systems.
Global conflicts, including the Ukraine war, have accelerated the development of new technologies and are expected to drive deal-making in the coming years as companies look to expand in fast-growing sectors.
The 15 largest defense contractors are expected to record free cash flow of about $50 billion in 2026, up from their total cash flow at the end of 2021, according to an analysis by Vertical Research Partners in the Financial Times.・Equivalent to almost twice the flow.
Large companies are expected to continue spending their funds on share buybacks and increasing dividends, while trading activity is also expected to increase.
Michael Xiong, a partner at consultancy Bain & Company, said he expects aerospace and defense M&A to accelerate, with an influx of capital from private equity and venture capital firms.
“Many companies are looking to expand their service offerings to prepare for advanced technology,” he said. He added that large companies will go after fast-growing defense sectors such as space and defense electronics.
Meanwhile, venture capital deal value in the defense sector has increased 18 times over the past decade, according to a new report from Bain. Growth has been driven by the increasing convergence of commercial and defense technologies.
Many investors, particularly in Europe, are also wary of backing the sector due to ethical concerns, although attitudes are changing following Russia’s full-scale invasion of Ukraine nearly three years ago.
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Recent corporate transactions in the industry include BAE Systems’ announced $5.6 billion acquisition of Ball Aerospace, a U.S.-based supplier of mission-critical space systems, in 2023. US defense company L3Harris has agreed to acquire rocket engine manufacturer Aerojet Rocketdyne. End of 2022.
In November, drone maker AeroVironment announced it would acquire BlueHalo, known for its drone fleet and counter-drone technology, for approximately $4.1 billion in an all-stock deal. AeroVironment CEO Wahid Nawabi said the company plans to be a “next generation” prime contractor focused on “defense technology.”
In a recent interview with the Financial Times, Mr. Nawabi said he wants to build a company that does “all the things that the[U.S.]Department of Defense focuses on and needs.” That includes “unmanned systems, loitering weapons, space communications, etc. . . . electronic warfare and cybersecurity.”
“There was likely activity in so-called ‘defense technology’ areas, such as drones, AI and lasers,” said Robert Stallard, an analyst at Vertical Research Partners. However, he added that consolidation at the top end of the sector among large contracting companies is unlikely.
“Even with an ‘anything goes’ Trump Justice Department, the U.S. defense industry is super-strengthened at the highest levels,” Stallard said.
In Europe, Stallard said, “We need consolidation and M&A, but getting the governments to agree is a whole different story.”
Joint ventures and teaming were “much easier measures, allowing European countries to join forces without angering politicians because of the loss of sovereign capacity.”
Bain’s Xiong said there is an opportunity for private capital to play a greater role given the modernization needs of the defense industry. He said private capital could help fill the “funding gap” between U.S. defense requirements and the defense budget.
It could help solve some of the “defense industrial base challenges” such as “expanding production capacity and improving operations and delivery,” he added.
