Aerospace & Defense Update:

Mergers, Acquisitions and

the Operating Environment
Winter 2011
 Contents
1 Executive summary

3 Mergers and acquisitions

update

3 Activity overview

7 Defense technology

15 Component manufacturing

8 MRO, component repair,

1
distribution and support
services

21 The operating environment

21 Aerospace market outlook

25 Defense budget outlook

31 European update

6 16th Annual Government

3
Contractor Industry Survey

39 Grant Thornton Aerospace

and Defense contacts
Aerospace & Defense Update:
Mergers, Acquisitions and the Operating Environment
40 About Grant Thornton

Grant Thornton Corporate Finance

Merger and Acquisitions
Aerospace and Defense Group

Contact information
Ian Cookson
Director, Investment Banking
Grant Thornton Corporate Finance
226 Causeway Street
Boston, MA 02114, USA

T +1.617.848.4982
E ian.cookson@us.gt.com
Executive summary
M&A update:
A strong year for deal activity driven by defense
technology transactions
Aerospace and defense (A&D) mergers and acquisitions
within North America experienced a strong year in 2010 with
the number of sector transactions up nearly 20%. Industry
earnings rose 10% when measured by EBITDA, and public
company valuation multiples remained broadly flat.
Deal activity was lead by acquisitions within defense
technology where the number of defense IT and electronics
transactions increased nearly 30% as defense contractors
sought to shift the core of their operations by acquiring
products and capabilities that match priority areas of the
defense budget. Defense contractors, government IT,
and software and electronics providers sought to acquire
capabilities, products and services in growth areas including:
cyber security, logistics command and control (LogC2),
unmanned systems, and intelligence, surveillance and
reconnaissance (ISR) technology.
Approximately a quarter of defense technology businesses
acquired over the past five years have received funding under
the federal government’s Small Businesses Innovation Research
(SBIR) program, as large firms within defense technology,
prime defense and government IT actively acquired cutting-
edge technologies.
Within component manufacturing, M&A activity
resumed after a weak 2009, with the number of transactions
increasing 6% in 2010, on the back of rising revenues (up 8%)
and somewhat recovering earnings. However, component
manufacturing M&A sector activity remained below peak
2007-2008 levels. Buyers of aerospace component businesses
were primarily large U.S. component manufacturers and
private equity groups.
In MRO and support services, M&A transaction activity
was flat in 2010, but with slightly larger deals. As if to highlight
the growth and coming of age of the private security contractor
industry, 2010 saw a number of acquisitions of such firms and
related support services by private equity groups.
As we look to the future, we generally expect these M&A
trends to continue in the coming year, driven by a combination
of both strategic considerations and financial availability.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 1
The operating environment:
Aircraft orders increase; reprioritizing of a flat defense
budget creates winners and losers; Europe mirrors U.S.
activity; government contractors insulated from recession
Despite a challenging economic environment, the aerospace
industry was relatively flat in 2010, with sales increasing just
under 1%. While commercial revenues fell slightly, the decline
was more than offset by increased military aircraft spending.
Going forward, the Aerospace Industries Association (AIA)
projects a sales increase of roughly 2% in 2011, to nearly $220
billion, on the back of increased demand from Asia-Pacific.
After two years of back-to-back declines, aircraft industry
orders rose 16% in 2010, driven by strong growth in civil
aircraft and parts. Jet leasing firms played a significant role in
the recovery, accounting for 27% of aircraft orders at Boeing
and Airbus last year, the highest proportion since 2000.
In the defense budget, despite the rhetoric regarding cutting
costs, the DoD’s financial condition is generally sound. There
are significant challenges, including reductions of Overseas
Contingency Operations funds, poor performance of some
major weapons systems acquisitions and general “over-
programming” in the budget. At this writing, Congress has
yet to pass a 2011 Defense Appropriations Act, opting for
a Continuing Resolution that precludes new program starts
and requires operating at 2010 funding levels. However, the
“Global War on Contractors” will affect a large number of
firms, and challenges will not be limited to those in service
support. Cuts proposed to major weapons system acquisitions
will hit losing primes and their suppliers, and general cost-
cutting will have an unanticipated impact on many firms.
But there are bright spots: the DoD has over $700 billion to
spend; manufacturers of proven legacy systems – filling the
void left by the cancellation of new systems – will prosper;
firms providing assistance to enable the DoD to become more
efficient will see continued demand; and companies in the 21st
century warfare renaissance of cyber security, soft power and
unmanned vehicles will see robust investments.
2 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
In Europe, defense and commercial aerospace companies
experienced broadly the same conditions as those affecting the
U.S. markets. Conflict in the Middle East and procurement
spending realignment dominated the defense arena, while
cost-cutting and consolidation by Europe’s airlines continued
against a backdrop of gradual recovery in the civil aviation
market. After two quiet years, M&A returned to the European
corporate agenda, although activity remained below U.S. levels.
With Europe’s major contractors sitting on huge cash piles,
further consolidation is inevitable as portfolios are reshuffled;
the U.S. remains a favored destination for acquisition activity;
alliances in emerging markets feature on the strategic agendas
of large and mid-sized players; and concerns about cyber
security, piracy and terrorism drive interest in targets with
intelligence and sensor capabilities.
Grant Thornton’s annual survey of government contractors
highlighted how government contractors are less vulnerable
than commercial companies to recession. During the past year,
the amount of revenue from government prime contracts grew
for 55% of survey participants, with 23% experiencing no
significant change and only 22% showing reductions. The profit
rates reported by survey participants followed a predictable
pattern given guidelines in procurement regulations. As a
percentage of revenue, 40% of participants reported profit
rates of 1%–5%, 35% reported profit rates of 5%–10%, 15%
reported profit above 10%, and 10% either had no profit or
experienced a loss. Regarding the M&A environment, 48% of
respondents expected an improvement in the coming year and
41% expected it to remain the same. The sale of a company
continued to be the most favored exit route, with private
shareholder liquidity needs and market opportunities being
the most frequently cited reasons for sale. Thirty-six percent of
respondents planned to raise capital during the year, primarily
for acquisitions or growth and operations. Forty-seven percent
of respondent companies stated they had lost employees as a
result of government in-sourcing.
Mergers and acquisitions update
Activity increases on the back of
defense technology transactions
Ian Cookson
Director, Investment Banking
Grant Thornton Corporate Finance
Ian Cookson leads the Aerospace & Defense Group of
Grant Thornton Corporate Finance in the U.S., where
he advises on transactions for clients from leading
multinationals to privately held companies.
Aerospace and defense
mergers and acquisitions
experienced a strong year
within North America in
2010, with the number of
sector transactions up 20%.
Aerospace and defense mergers and acquisitions experienced
a strong year within North America in 2010, with the number
of sector transactions up 20%. Deal activity was headlined by
acquisitions within the defense IT and electronics subsectors,
which increased 25% and 34%, respectively, as traditional
defense contractors sought to shift the core of their operations
by acquiring products and capabilities that match priority areas
of the defense budget. A&D component manufacturing also
experienced a positive year, with M&A increasing around 6%,
while MRO/other services was flat with the same number of
transactions as the prior year. A&D M&A activity showed
somewhat less of a rebound than U.S. M&A activity as a whole,
principally as it suffered less of a decline in 2009 when defense
spending insulated the sector from wider turmoil in the economy.
North American aerospace and defense M&A activity
Defense components
Defense IT
MRO/distribution/related services
Other
Defense electronics
Number of transactions
280
240
200
160
120
80
40
0
2006 2007 2008 2009 2010
Transactions where target is headquartered in U.S. or Canada.
Sources: Company press releases, certain financial information provided by Capital IQ, Inc.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 3
Buyers and sellers
Buyer composition within the A&D sector remained broadly
The greater amount of private
the same in 2010, with strategic acquirers accounting for three-
quarters of activity. Private equity groups accounted for 30%
equity divestitures during
of acquisitions in the more traditional areas of component
manufacturing and MRO and related activities, while strategic
the year can be attributed to
players were dominant in defense technology. rising valuations combined
Seller composition, on the other hand, shifted slightly with
sales by corporations and founders declining, and sales by with portfolio companies
private equity increasing (as a percentage of total deal volume).
The greater amount of private equity divestitures during the reaching the end of their
year can be attributed to rising valuations combined with
portfolio companies reaching the end of their holding periods. holding periods.
Nearly 70% of sector portfolio companies were bought and
sold within the three to five year investment window (median
holding period of four years for divestitures). However,
private equity was still a net investor in the sector during 2010,
accounting for 24% of buyers and 18% of sellers.
The past year also saw an increasing number of publicly
traded businesses being taken over by both larger companies
and financial sponsors (21 in 2010 vs. 7 in 2009), with an
average transaction value of over $500 million.

4 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Earnings and valuation
The market value of our public company A&D index rose
11% in 2010 (compared with a 13% increase in the S&P), and
reflected a 10% increase in earnings (EBITDA). Component
manufacturing experienced the greatest increase (37%) and was
the only subsector to climb back to the market highs witnessed
in 2008.
Public A&D company enterprise value multiples remained
broadly the same as one year ago, with the exception of
component manufacturers, which increased from 8x to 10x
EBITDA. Valuations of prime defense contractors lagged
at around 6x EBITDA as investors showed concern over
future growth in defense spending. Defense IT providers
traded slightly higher at roughly 7x EBITDA, while defense
electronics manufacturers remained at around 9x EBITDA.
A&D disclosed M&A transaction values were generally
higher than those of their publicly traded counterparts,
which was not surprising given the vast majority of disclosed
transactions were takeovers of public companies at a premium
to the stock price. Defense IT and electronics players
commanded the highest multiples at 18x and 14x EBITDA,
respectively, reflecting either premiums paid in large public
company takeovers or the prices demanded for high-growth
cutting-edge technologies.

Public company aerospace/defense index valuation multiples by sector Public company aerospace/defense index earnings by sector

Defense components Defense IT Defense components Defense IT

MRO/component repair* Defense electronics MRO/component repair Defense electronics
Prime defense Prime defense
Median EV/EBITDA multiple
Cumulative LTM earnings growth index (EBITDA)
14.0x 300%
13.0x

12.0x
250%
11.0x

10.0x

9.0x 200%
8.0x

7.0x
150%
6.0x

5.0x

4.0x 100%
2005 2006 2007 2008 2009 2010 2011 2005 2006 2007 2008 2009 2010 2011

*MRO valuation skewed by weighting to Asia-Pacific market Sources: Company press releases; certain financial information provided by Capital IQ, Inc.
Sources: Company press releases; certain financial information provided by Capital IQ, Inc.

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 5
M&A outlook • Private equity groups are actively seeking to deploy capital.
Looking to the future, we expect these M&A trends to The backlog of private equity capital seeking investment
continue, driven by both strategic considerations and financial is at an all-time high of over $400 billion, particularly
availability: among larger funds. Debt capital, which has traditionally
• Prime defense contractors are proactively seeking out accounted for two-thirds of private equity acquisition
acquisition targets in growth areas of the defense budget capital, is also becoming increasingly available. Loan terms
and cutting-edge defense technology. They have near have eased and banks are again demonstrating competitive
record cash piles to deploy and are ideally seeking behavior for attractive credits. On middle-market
acquisitions large enough to positively impact their group’s transactions we are seeing a variety of flexible private
overall financial results. equity transaction structures.
• Large component manufacturers maintain their
consolidation ambitions of building primary suppliers
of integrated systems to OEM airframe and engine
manufacturers. Commercial business is improving with
requests for commercial parts to be released and orders
picking up. Larger public component companies can be
expected to capitalize on their favorable capital market
valuations.

Deal activity was headlined by acquisitions within defense IT

and electronics, as traditional defense contractors sought to
shift the core of their operations by acquiring products and
capabilities that match priority areas of the defense budget.

6 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Defense technology:
A driver of M&A activity

Defense technology experienced a significant increase in North

North American defense IT M&A activity
American M&A activity in 2010, as transaction volume within
the defense electronics and defense IT subsectors rose 30% Financial
during the year. Strategic players drove acquisition activity as Strategic
they sought to acquire capabilities, products and services that
# of transactions
matched growth areas of the pressured federal defense budget,
70
including cyber security, logistics command and control
60
(LogC2), unmanned systems, and intelligence, surveillance and
50
reconnaissance (ISR) technology. Sector earnings increased
during the year, with our defense IT public company index 40

rising 6%, and earnings of our defense electronics public 30

company index increasing 11%. 20

10

0
2006 2007 2008 2009 2010

Transactions where target is headquartered in U.S. or Canada.

Sources: Company press releases, certain financial information provided by Capital IQ, Inc.

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 7
Growth in defense IT transactions: As strategic buyers
make ISR, LogC2 and cyber security acquisitions
Within defense IT, M&A transaction activity increased 22%.
Subsectors C4ISR/LogC2, cyber security and SETA/systems
integration each accounted for around 30% of activity in
2010, while simulation, training or other services comprised
the remainder. Not surprisingly, strategic buyers accounted
for the majority of defense software and services purchases at
around 80% of acquisitions, with prime defense contractors,
government IT providers, and software and electronics players
all being active acquirers.
Prime contractors Boeing, Raytheon and BAE were
involved in transactions within ISR/LogC2 and cyber security
(each making two or more subsector acquisitions in 2010), as
they sought to shift their core operations to mirror priority
areas of the defense budget. Illustrative sector acquisitions by
prime contractors included:
• Boeing’s acquisitions of C4ISR systems and solutions
provider Argon ST ($775 million), decision supporter
CDM Technologies and IP network traffic manager Narus;
• BAE’s purchase of L-1 Identity Solutions’ security and
intelligence assets ($303 million) and defense consulting
firm Durango Group; and
• Raytheon’s acquisition of cyber security experts
Technology Associates ($42 million) and Trusted
Computer Solutions.
8 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Meanwhile, government IT providers, not wanting to cede
ground, also pursued acquisitions that added capabilities and
expertise. Serial acquirers included:
• SAIC’s acquisition of infrastructure protection provider
CloudShield, the online simulation assets of Forterra
Systems, and multisensor and information system solutions
designer SET Corp.;
• CACI’s acquisition of C4ISR players Applied Systems
Research and TechniGraphics; and
• ManTech’s purchase of the North American security and
intelligence assets of QinetiQ (Analex) and engineering and
systems integration services provider MTCSC.
Defense software and electronics providers, including
KEYW, Kratos, Cubic and Global Defense Technology
& Systems, were also active as they continued to build out
growth areas of the defense budget via acquisition. Increased
DoD attention on protecting against cyber threats has also
encouraged investment by nondefense buyers, as highlighted
by Hewlett Packard’s acquisition of cyber security player
ArcSight for $1.5 billion.
 Despite the increased acquisitions by large public acquirers,
25% of sector sales were strategic divestitures. Organizational
conflict of interest (OCI) legislation passed in 2009 was the
impetus behind a number of sales, as corporations audited
existing contracts and assessed potential conflicts within large
acquisition programs. OCI-related divestitures included sales of:
• Lockheed Martin’s Enterprise Integration Group to private
equity firm Veritas Capital;
• QinetiQ’s North America’s Security and Intelligence
Solutions business to ManTech; and
• ITT Corp.’s defense weapon system analysis contractor
(CAS Inc.) to Court Square Capital portfolio business Wyle.
Strategic players drove acquisition activity,
purchasing capabilities, products and services that
matched growth areas of the federal defense budget,
including cyber security, LogC2, unmanned systems
and ISR technology.
As proof of the need to acquire leading players within
defense IT, sector transactions changed hands at disclosed
median enterprise values (EV) of around 18x EBITDA and
1.5x revenue. Explanation of higher sector valuation multiples
is twofold, reflecting premiums paid for:
• large public companies that allow buyers to rapidly expand
within the sector; or
• cutting-edge software and technology supporting high-
growth areas of defense spending including cyber warfare/
security, critical intelligence and counterterrorism.
Size also played a significant role in valuation. Top quartile
businesses (by revenue multiple) – most of which were
purchased for more than $150 million – were acquired at a
median of 2.5x revenue, while bottom quartile companies –
which were generally smaller transactions acquired for less
than $70 million – changed hands at around 1.1x revenue.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 9
Illustrative defense IT transactions

Date Target Description Acquirer [ultimate parent]

Dec-10 Innovative Technology Systems Software engineering & network services to the intelligence community. A-T Solutions
Dec-10 Centauri Solutions Program management, IT systems, & systems engineering. Computer Sciences Corporation
Dec-10 SPADAC Provides spatial intelligence and predictive analytics solutions. GeoEye
Dec-10 EchoStorm Worldwide Video and data management software technology for military/government. ITT Corporation
Dec-10 Everest Technology Solutions Provides geospatial intelligence, mission support, and cyber security. KEYW
Nov-10 Oasis Systems IT advisory and net-centric, battle management, and C2ISR services. GF Fund
Nov-10 MTCSC Engineering and systems integration services for national defense. ManTech
Nov-10 CDM Technologies Decision-support software and technology for military. Boeing
Nov-10 Abraxas Risk mitigation technology solutions for public and private sector clients. Cubic
Nov-10 Peace Technology IT, systems integration, and support services to governments. ITSolutions [Snow Phipps]
Nov-10 Signature Government Solutions IT security, intelligence analysis, & program management. Global Defense Technology & Systems
Nov-10 Trusted Computer Solutions Cyber security solutions for government and commercial organizations. Raytheon
Nov-10 Sycamore. US Software engineering and communications solutions for the federal gov’t. KEYW
Oct-10 Applied Systems Research Geospatial intelligence and measurement/signatures intelligence. CACI International
Oct-10 NetStar-1 Holdings’ IT Services IT services for military and other government customers. ITSolutions [Snow Phipps]
Oct-10 TechniGraphics Digital mapping and computer design services to GIS customers. CACI International
Oct-10 Lockheed Martin’s Enterprise Integration Group System engineering services supporting government customers. Veritas Capital
Oct-10 Platinum Solutions Systems integration and collaborative solutions for national security. SRA International
Oct-10 Johnston Mclamb Case Solutions Technology consulting services for government. CRGT, Inc. [Veritas Capital]
Oct-10 Vulnerability Research Labs Cyber threat intelligence services. Computer Sciences Corporation
Oct-10 Technology Associates Cyber security and intelligence related services. Raytheon
Sep-10 Analex’s Security and Intelligence Solutions Integrated security solutions to government and intelligence communities. ManTech
Sep-10 Novii Design Data fusion systems, cyber solutions & high-end enterprise architectures. Six3 Systems [GTCR Golder Rauner]
Sep-10 INPUT, Inc. Market intelligence, analysis, consulting, and events and training services. Deltek
Sep-10 SRA International’s Airport Operations Solutions Technology and strategic consulting services to government organizations. ITT Corporation
Sep-10 L1 Identity’s SpecTal, Adv. Concepts, & McClendon Technical and professional services to intelligence and military. BAE
Sep-10 Arxan Defense Systems Anti-tamper protection for software protecting against reverse engineering. Microsemi Corp.
Sep-10 Zytel Corporation Cyber security supporting critical intelligence & counter-terrorism. Global Defense Technology & Systems
Sep-10 ArcSight Compliance and security management solutions protecting gov’t agencies. Hewlett-Packard Company
Aug-10 Black Ram Engineering Services Engineering, system design, test, and business capture services. SM&A [Odyssey Investment Partners]
Aug-10 Akimeka IT solutions to government customers. VSE Corp.
Aug-10 Mission Solutions Engineering Systems/software engineering and integration for defense systems. Arctic Slope Regional
Aug-10 CmdLabs Forensics investigation and incident response services. The Newberry Group
Aug-10 DEI Services Deploys and supports operational and maintenance training systems. Kratos Defense & Security
Aug-10 Asynchrony Solutions IT consulting focused on cyber security and weapons of mass destruction. Schafer Corporation [Metalmark Capital]
Aug-10 CAS, Inc. DoD weapon system analysis contractor. Wyle [Court Square Capital Partners]
Aug-10 Airborne Technologies Aeronautical engineering services for intelligence and defense. L-3 Communications
Jul-10 McNeil Technologies Intelligence support, language, mission support, IT, and logistical services. AECOM
Jul-10 Research and Engineering Development Engineering support services for military and navy. DA Acquisition
Jul-10 Vision Systems & Technology Software/systems engineering & technology integration to the DoD. SAS Institute
Jul-10 Alion Science’s Expert Program Management Expert program management and technical services to the Navy. MCR, LLC [Harrison Street Real Estate Capital]
Jul-10 Narus Security, intercept, and traffic management software. Boeing
Jul-10 Intergraph Corporation Engineering and geospatial software solutions. Hexagon
Jun-10 Argon ST C5ISR systems and services. Boeing
Jun-10 SGIS Intelligence analysis, engineering and systems integration to gov’t agencies. Salient Federal Solutions [Frontenac]
Jun-10 Safe Harbor Systems Security and networking infrastructure for government and defense clients. Cubic
Jun-10 Secure Data IT and program management to address critical issues. Emtec Federal
Jun-10 TechTeam Government Solutions IT services in the areas of advisory/consulting & systems integration. Jacobs Engineering
May-10 SignaCert IT compliance solutions for organizations and government agencies. Harris Corp.
May-10 Impeva Labs Intelligent tracking solutions for military logistics. Cubic
May-10 Matrikon Intelligence solutions enhancing operating efficiency & cyber-security. Honeywell
May-10 Stanley IT services and solutions to the US defense & intelligence agencies. CGI Group, Inc.
May-10 Veratect Warning and region-specific risk surveillance services. GeoEye
Apr-10 Durango Group Consulting services in areas of acquisition, command/control, & cyber. BAE
Apr-10 Seismic LLC Cybersecurity, software engineering, & integration solutions to DoD. Applied Signal Technology
Mar-10 Intellitactics Enterprise security management software solutions. TrustWave Holdings
Feb-10 Integrated Systems Improvement Services Intelligence support services. KCB Management
Feb-10 OSI Geospatial’s Land-Based, Situational Awareness Software for capturing/viewing/disseminating strategic & tactical info. Harris Corp.
Feb-10 Forterra Systems’ On-Line Virtual Environments Software platform generating 3D internet solutions. SAIC
Jan-10 VUANCE’s Government Solutions Division Security solutions for locating, credentialing, and managing personnel. WidePoint Corp.
Jan-10 Science, Engineering, and Technology Associates Video and radar systems that detect human behaviors. SAIC
Jan-10 National Interest Security Company IT & information management solutions in support of national security. IBM
Jan-10 CloudShield Technologies IP service control and infrastructure protection solutions. SAIC
Jan-10 ICOR Partners Government/DoD management consulting service. Acquisition Solutions [Excellere Partners]
Jan-10 Enterprise Services Group Cyber security engineering services to the intelligence community. FGM, Inc.
Jan-10 SENSA Solutions Organizational consulting services for government and defense. Korn/Ferry

Sources: Company press releases; certain financial information provided by Capital IQ, Inc.

10 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Deal volume within A&D electronics rose by more
than 30% in 2010.
Growth in defense electronics transactions: Fueled by
communication equipment and homeland security systems
Deal volume within A&D electronics rose over 34% in 2010,
highlighted by the increase in larger sector acquisitions.
Companies providing communication- and radar-related
products accounted for 30% of activity, as acquirers
strengthened product offerings within secure satellite
communication equipment and microwave- and radio-
frequency components and systems. Electronics surrounding
homeland security accounted for 40% of activity, as buyers
secured technologies within optics/imaging, intrusion
detection, biometrics/identification and security inspection.
Traditional electrical components and systems comprised the
remaining third and included power transmission, electrical
testing, interconnect devices and enclosures/packaging.
Acquisitions were led by players within A&D (e.g., L-3
and Safran), specialty components/systems (e.g., Aeroflex,
Microsemi and Spectrum), electronic instrumentation (e.g.,
Ametek and Danaher) and private equity (e.g., Veritas Capital).
North American defense electronics M&A activity
Financial
Strategic
# of transactions
70
60
50
40
30
20
10
0
2006 2007 2008 2009
Transactions where target is headquartered in U.S. or Canada.
Sources: Company press releases, certain financial information provided by Capital IQ, Inc.
Transactions within defense electronics were acquired at a
median disclosed valuation of 13.5x EBITDA and 1.4x revenue.
The majority of transactions disclosing valuation data were of
publicly traded businesses and reflect premiums paid in public
takeovers, including:
• Raytheon’s purchase of C4ISR solutions provider Applied
Signal Technology (1.9x revenue, 14x EBITDA),
• Danaher’s acquisition of electronic instrument
manufacturer Keithley Instruments (2.5x revenue, 13x
EBITDA),
• Safran’s purchase of identification electronics provider L-1
Identity Solutions (2.5x revenue, 24x EBITDA), and
• Veritas Capital’s takeover of microwave- and radio-
frequency product manufacturer CPI International (1.5x
Revenue, 9x EBITDA).
Again, size played a significant role in valuation. Top
quartile businesses (by revenue multiple), all of which were
purchased for more than $150 million, were acquired at a
median 2.1x revenues. Meanwhile, bottom quartile companies,
which were all smaller transactions acquired for less than $40
million, changed hands at around 0.9x revenue.
Sales of portfolio companies by financial sponsors
accounted for a quarter of sellers in 2010 (vs. 7% in 2009), with
notable divestitures including:
• ABRY Partners’ sale of satellite communication provider
CapRock Communications to Harris Corp.,
• Ares Capital’s sale of electronic component manufacturer
TSI Group to BE Aerospace, and
• Milestone Partner’s sale of electronic contact and connector
manufacturer Interconnect Devices to Smiths Group.
2010
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 11
Illustrative defense electronics transactions

Date Target Description Acquirer [ultimate parent]

Dec-10 Ericsson Federal Network solutions for homeland security & network centric warfare. Tailwind Capital
Dec-10 Eclipse Electronic Systems Receiver hardware to the airborne ISR market. Esterline Technologies
Dec-10 CenGen Secure, mobile and fixed RF network solutions. DRS Technologies [Finmeccanica]
Dec-10 DALSA Corp. Imaging products and services for aerospace & defense. Teledyne Technologies
Dec-10 CHC Helicopter’s Flight Training Operations Flight training simulation systems. CAE Inc.
Dec-10 DSPCon Products/services supporting mission-critical signal processing applications. CDI Corp.
Dec-10 Mechtronic Solutions Sensor systems for deployment onboard both manned and drone aircraft. National Technical Systems
Dec-10 Applied Signal Technology ISR solutions for the defense, intelligence, and homeland security markets. Raytheon Space & Airborne Systems
Dec-10 Trident Space & Defense Microelectronic products and services for aerospace and military. TeleCommunication Systems
Dec-10 rVision, Inc. High-end security systems for military bases. domo Limited [Cobham]
Nov-10 Adaptive Flight Avionics system solutions for small and medium-sized UAVs. Sikorsky Innovations
Nov-10 OI Corp. Products and systems used to detect & analyze chemical compounds. ITT Corporation
Nov-10 Airco Industries Night vision technology for airborne military operations. AbelConn, LLC [RFE Investment Partners]
Nov-10 Schlumberger’s Global Connectivity Services Global communication services for remote locations. CapRock Services Corp. [Harris Corp]
Nov-10 CPI International Provides microwave, radio frequency, power, and control products. Veritas Capital
Oct-10 Summit Instruments Electronic measurement solutions and inertial sensors. Spectrum Control
Oct-10 Wavestream Corporation Solid-state power amplifiers for communications and sensing systems. Gilat Satellite Networks
Oct-10 Henry Bros. Electronics Security, communications, and control systems. Kratos Defense & Security
Oct-10 TSI Group Electronic, interconnect, and mechanical assemblies for military & defense. BE Aerospace
Oct-10 Actel Corporation Semiconductor solutions for aerospace & avionics. Microsemi Corp.
Sep-10 Keithley Instruments Electronic instruments and systems. Danaher Corp.
Sep-10 Copperlogic Industrial control products and other electrical components. Eaton Corporation
Sep-10 L-1 Identity Solutions Secure credentialing solutions and fingerprint-based background checks. Safran SA
Sep-10 RAE Systems Multi-sensor chemical and radiation detection monitors for civil defense. Battery Ventures
Sep-10 3Di Technologies Satellite telecommunication solutions to government/military. L-3 Communications
Sep-10 Vision Technologies Camera systems for security checkpoints at airports, and military vehicles. Video Display Corp.
Sep-10 Pressure Systems Precision level and pressure instrumentation for aerospace. Measurement Specialties
Sep-10 OASYS Technology Electro-optical systems/components for reconnaissance and surveillance. BAE Systems
Aug-10 PerkinElmer’s Illumination and Detection Solutions Specialty lighting and sensor components, subsystems and solutions. Veritas Capital
Aug-10 Cogent Inc. Automated fingerprint ID systems and biometrics solutions. 3M Co.
Aug-10 Harvard Custom Manufacturing Contract electronics manufacturing services for defense customers. Labinal Salisbury, Inc. [Safran]
Aug-10 American Reliance Electronic loads and dc power supply solutions for military. Ametek Inc.
Aug-10 ICx Technologies Advanced sensor technologies for homeland security & force protection. FLIR Systems, Inc.
Aug-10 Reveal Imaging Technologies, Inc. Security inspection systems that inspect airline passenger baggage. SAIC, Inc.
Jul-10 X-COM Systems RF test equipment, deployable signal sources, & military communications. Bird Technologies Group
Jul-10 Crane Wireless Monitoring Solutions Wireless sensor products for industrial security & military markets. Textron
Jun-10 Radiation Assured Devices Radiation hardened products for avionics and military electronics. Aeroflex Holding
Jun-10 Vortex Systems Intrusion detection systems for military and border patrol applications. Monument Capital Group
Jun-10 Sage Laboratories Radio frequency and microwave components and subsystems. Spectrum Microwave
Jun-10 TransTech Systems Secure identification badge systems and components. Visualant Incorporated
Jun-10 Advanced Control Components Electronic devices, RF/microwave components, & equipment. Aeroflex Holding
Jun-10 Optimum Optical Systems Optics, optomechincal assemblies, and electro-optics. Teledyne Scientific & Imaging
Jun-10 Technical Services for Electronics Custom cable assembly and precision interconnection systems. Ametek Inc.
May-10 Hybricon Corporation Electronics packaging for military & homeland security applications. Curtiss-Wright
May-10 CapRock Services Satellite communications for remote sites. Harris Corp.
May-10 AP Labs Rugged systems packaging, enclosures, and integrated real-time systems. Kontron America
May-10 EF Johnson Technologies Wireless radios and wireless communications infrastructure. Francisco Partners Management
Apr-10 Sophia Wireless Component and system configurations for use in satellite and radar. Integral Systems
Apr-10 Optelecom-NKF’s Electro Optics Coil Business Manufactures fiber optic gyroscope coils for defense. Nufern, Inc.
Apr-10 Imago Scientific Instruments Metrology and analysis equipment. Ametek Inc.
Mar-10 Retica Systems Iris-based identity management and face capture systems. L-1 Identity Solutions
Mar-10 White Electronic Designs Defense electronic components and systems for defense and aerospace. Microsemi Corp.
Mar-10 Bowmar LLC Mechanical, electromechanical and electronic systems for aerospace. Private investor
Mar-10 RO Associates Power conversion modules/solutions for military and harsh environments. Astrodyne Corporation [Audax Group]
Mar-10 Interconnect Devices Spring contact probes, test sockets, and custom interconnect solutions. Smiths Group
Mar-10 RaySat Antenna Systems Satellite antenna systems. Spacenet, Inc.
Mar-10 CVG, Inc. Satellite-based communication solutions. Integral Systems
Mar-10 Optical Alchemy Ultra-light sensor packages for manned and unmanned tactical systems. Teledyne Scientific & Imaging
Feb-10 Insight Technology Night vision and electro-optical systems. L-3 Communications
Feb-10 dB Control Wave tube amplifiers, microwave power modules, & radar transmitters. HEICO
Feb-10 Fraser-Volpe Gyro-stabilized electro-optic systems. Redstone Capital Corporation
Jan-10 Photonics Innovations Middle-infrared laser materials for eye safe range-finding applications. IPG Photonics
Jan-10 Kuchera Industries Electronic manufacturing services for defense customers. API Technologies
Jan-10 SystemWare, Inc. Systems control, signal acquisition and security monitoring solutions. CACI International
Jan-10 Ahura Scientific Optical systems for the real-time identification of chemicals. Thermo Fisher Scientific
Jan-10 PROCON’s SafeLife Systems Cellular and satellite based communication devices. Cobham plc
Jan-10 Davis Inotek Instruments Instrument calibration and repair for the aerospace industry. Sypris Test & Measurement, Inc.

Sources: Company press releases; certain financial information provided by Capital IQ, Inc.

12 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
SBIR-funded businesses: Acquired by large corporations
Large firms within defense technology, prime defense and
government IT have continued to actively acquire businesses
that have received funds under the federal government’s Small
Businesses Innovation Research (SBIR) program, as they seek
to stay on the cutting edge of defense technology.
Approximately 15% of A&D businesses acquired
in the past five years have received government funding
under SBIR, and roughly a quarter of acquired defense
technology businesses have received awards. In total, over
160 SBIR businesses have been purchased since 2006,
with L-3 Communications, SAIC, Raytheon, Boeing and
Lockheed Martin being particularly acquisitive. QinetiQ, API
Technologies, Rockwell Collins and Textron were also active,
each purchasing three SBIR businesses over that time period.
Acquired SBIR companies can be broadly categorized:
• 42% are involved in software for systems integration or
engineering, simulation or modeling, cyber security, or
command and control;
• 36% are involved in electronics and electrical components,
particularly in communication, surveillance and optical
equipment, as well as UAV support systems, and
microelectronics or semiconductors; and
• 22% are active in components and materials for aerospace,
naval and UAV applications.

A quarter of defense
technology businesses
acquired over the past
five years have received
federal funding under
SBIR programs.

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 13
 The DoD has spent over $10 billion to help fund Major acquirers
research and development of military technologies by small
Prime defense Government IT
U.S. companies through SBIR and STTR (Small Business Raytheon 6 SAIC 6
Technology Transfer) programs since 2000, with annual Boeing 6 QinetiQ 3
funding rising to $1.4 billion in 2009 (more than a twofold Lockheed Martin 4 CACI 2
BAE Systems 2 MacDonald Dettwiler 2
fold increase compared with 2000 levels). In 2009, California
and Massachusetts combined received over a third of the SBIR Defense technology
budget, while the remainder of the top 10 states (Virginia, L-3 Communications 8 Components
API Technologies 3 Textron 3
Maryland, Colorado, New York, Texas, Ohio, Pennsylvania Rockwell Collins 3 Teledyne Technologies 2
and Alabama) combined to receive 40% of the funding. Ultra Electronics 2
Phase I, which supports six months of funding to test CAE 2
ITT Corp. 2
the technical merit or feasibility of an idea or technology,
Alion Science and Technology 2
received on average $90,000 per award. Phase II, which
facilitates the expansion of Phase I to develop potential plans
Sources: DOD SBIR filing and company press releases; certain information taken from Capital IQ Inc.
for commercialization, received on average over $700,000 per
award. For FY 2011, the Small Business Administration (SBA)
has proposed amendments to raise the Phase I award threshold
to $100,000-$150,000 and the Phase II award threshold to
$750,000-$1 million.

SBIR acquisitions by target type (2006 - 2010) SBIR acquisitions by buyer type (2006 - 2010)

Electronics and electrical components 36% Public companies 74%

Components and materials 22% Private equity 14%
Defense IT 42% Private companies 12%

Sources: DOD SBIR filing and company press releases; Sources: DOD SBIR filing and company press releases;
certain financial information provided by Capital IQ, Inc. certain financial information provided by Capital IQ, Inc.

14 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Component manufacturing:
A return of larger transactions

After a weak 2009, component manufacturing M&A activity

North American aerospace and defense component manufacturing
within North America resumed, with the number of transactions M&A activity
increasing nearly 6% in 2010 on the back of rising revenues (up
8%) and somewhat recovering sector earnings (up 3%). Sector Financial
M&A, however, was still below peak 2007-2008 levels. Strategic

Within the A&D component manufacturing sector, sales

# of transactions
of aircraft component businesses (e.g., structural, interior 100
and engine components) accounted for nearly 60% of M&A 90
activity, while ground support equipment (e.g., military vehicle 80
70
equipment, armor, soldier products and shelter systems)
60
comprised roughly a third. 50
Acquisitions of composite businesses were less abundant 40
in 2010, as the subsector failed to see expected growth for a 30
20
second straight year due to continued delivery delays of the
10
Airbus A400M and A350 and Boeing 787. This created a gap 0
2006 2007 2008 2009 2010
in valuation expectations between potential buyers looking at
levels of current earnings and sellers pointing to record order Transactions where target is headquartered in U.S. or Canada.
books. Sellers, therefore, generally chose to defer transactions Sources: Company press releases, certain financial information provided by Capital IQ, Inc.

until revenues – driven by production of composite-rich planes

– materialize as expected.
Buyers of aerospace component businesses were primarily
large U.S. component manufacturers and private equity
firms. Prime defense contractors have generally avoided
backward integration, although Boeing has made a number of
acquisitions of component suppliers relating to the delayed 787
Dreamliner, including Summit Aeronautics in 2010. Boeing
previously acquired Vought Aircraft, Global Aeronautica and
BHA Aero Composites Parts (China).

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 15
Component transaction size trends upward
Sellers of North American aerospace/defense component businesses
As the economy recovers, the appetite for larger sector by ownership type – 2010
acquisitions within component manufacturing has improved,
with the average disclosed deal size increasing to over $250 Founders 55%
million 2010 (vs. $127 million in 2009). Illustrative larger Private equity 22%
acquisitions within the sector included: Corporations 18%
Public 5%
• TransDigm’s (the most active buyer) purchase of
McKechnie Aerospace ($1.3 billion) to expand its product
portfolio,
• Triumph’s acquisition of Vought Aircraft from the Carlyle
Group ($1.6 billion) to advance aerostructure systems, and
• Allegheny Technologies’ purchase of component Transactions where target is headquartered in U.S. or Canada.
manufacturer Ladish Co. ($853 million) to move the Sources: Company press releases, certain financial information provided by Capital IQ, Inc.

company upstream.

Consolidation within component manufacturing continues,

and founders still account for more than half of sellers. Sales by
private equity nearly doubled (to around a quarter of sellers)
as sponsors sought to harvest their investments in a time of
improving valuations. Sales by large corporations declined
significantly in 2010 and comprised less than 20% of activity
(compared to nearly half one year ago). This is likely due
in part to the fact that median cash holdings of large A&D As the economy recovers, the
component manufacturers have doubled over the past five
years, so with the outlook improving, these businesses are now appetite for larger component
seeking to deploy rather than accumulate excess cash.
manufacturing acquisitions
has improved.

16 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Illustrative aerospace and defense component manufacturer transactions

Date Target Description Acquirer [ultimate parent]

Dec-10 Arden Engineering Machining, assembly, and integration of structural aerospace components. PRV Aerospace [Platte River]
Dec-10 HK Fittings Fluid fittings, nuts, and sleeves for aerospace. Designed Metal Connections
Dec-10 Teledyne Continental Motors Engine components and systems for manned and unmanned aircraft. AVIC International
Dec-10 T&W Forge Precision forgings to the aerospace and power generation industry. SIFCO Industries
Dec-10 SCT Acquisition Provides emergency shelters and disaster relief housings. Gichner Systems Group [Kratos]
Nov-10 Whitcraft Formed, machined, and fabricated sheet metal aerospace components. Linsalata Capital Partners
Nov-10 Telair International’s Actuation Business Engineered electro-mechanical products and components for aircraft. TransDigm Group
Nov-10 Summit Aeronautics Group Components for Boeing aircraft. Boeing
Nov-10 Ladish Co. Forged and cast metal components for jet engines. Allegheny Technologies
Nov-10 Critical Solutions International Provides military countermine and humanitarian demining solutions. Sentinel Capital
Oct-10 Hawk Corp. Parts for brakes, clutches, and transmissions. Carlisle Companies
Oct-10 ALEXCO Hard alloy aluminum extrusions for aerospace applications. Kaiser Aluminum
Oct-10 Jameson LLC Military lighting for camps. Torch Hill Investment Partners
Sep-10 Hartzell Engine Technologies Parts for piston engine aircrafts, helicopters, and light jets. Tailwind Technologies
Sep-10 First Choice Armor & Equipment Body armor protection products for law enforcement and the military. Diamondback Tactical [Torch Hill]
Sep-10 McKechnie Aerospace DE Structural components, systems, and assemblies for aircraft. TransDigm Group
Sep-10 Hydrodyne Components for fluid control applications. EnPro Industries
Sep-10 Express Pattern Prototyping and manufacturing services to military and aerospace. 3D Systems Corp.
Sep-10 Pacific Safety, headborne systems and liners Manufactures liner helmets. Revision Eyewear
Aug-10 Semco Instruments Precision sensors, specialty electrical molded cables, and wiring harnesses. TransDigm Group
Aug-10 Crissair, Inc. Hydraulic, fuel, and pneumatic system components. ESCO Technologies Inc.
Aug-10 DeCrane’s cabin management assets In-flight entertainment, communications, and cabin management systems. Goodrich Corp.
Aug-10 TMW Corporation Landing gears, hydraulics actuators, and mechanicals assemblies. Circor Aerospace
Aug-10 Superior Air Parts Bearings, camshafts, crankcases and other aircraft components. Superior Aviation
Jul-10 M-DOT Aerospace and Astrotronics Manufactures aerospace assemblies and distributes aerospace machinery. Azmark Aero Systems
Jul-10 Maine Machine Products Custom precision components and assemblies. GenNx360 Capital Partners
Jul-10 Integrated Armor Systems Ballistic, blast, and improvised explosive device resistant armor. Protocall Technologies
Jul-10 Enginetics Aerospace Engine parts and equipment for the aircraft markets. Morgenthaler
Jul-10 STADCO Precision, close tolerance parts, assemblies, and tooling. Corinthian Capital Group
Jul-10 LifePort Designs and manufactures aviation interior components. Sikorsky Support Services [UTC]
Jul-10 HaydonKerk Motion Solutions Precision linear motion products for military and aerospace. Ametek Inc.
Jun-10 Allied Defense Group Ammunition and related products. Chemring Group
Jun-10 Cantwell, Cullen & Company Electrical interconnect wiring systems. Zodiac Aerospace
Jun-10 Millenworks Vehicles and mobility solutions for the U.S. armed forces. Textron
Jun-10 Enpro, Engineered Products Passenger seating components and peripherals for commercial aircraft. Reinhold Industries [Jordan Company]
May-10 NEA Electronics Non-explosive separation mechanisms and electrical interconnect devices. Ensign-Bickford
May-10 Accura Technics Precision grinding machines and automated machining systems. Edac Technologies
May-10 EBV Explosives Environmental Company Demilitarization services for grenades and mines, and other munitions. General Dynamics
Apr-10 W.H. Smith Hardware Company Fluid handling equipment, load securing, and material handling hardware. JWI Capital
Apr-10 Routes AstroEngineering Scientific instruments and bus components for space applications. COM DEV International
Apr-10 Gichner Systems Group Tactical and logistic shelters for military and commercial applications. Kratos Defense & Security
Apr-10 Blackhawk Industries Products Tactical gear for military and law enforcement. Alliant Techsystems
Mar-10 Vought Aircraft Holdings Aero structure products for commercial, military, and business aircrafts. Triumph Group
Mar-10 Filtration Development Co. Turbine engine filtration systems for helicopters. Aerometals
Mar-10 Cyber Aerospace Designs and manufactures unmanned aerial systems. Alas Defense Systems
Mar-10 MTI PolyFab Thermal and acoustic insulation for the aerospace industry. Aearo Technologies [3M]
Mar-10 General Dynamics, spacecraft development business Engages in development of space craft. Orbital Sciences
Mar-10 Fastener Innovation Technology Manufactures aerospace threaded fasteners. Emhart Teknologies
Feb-10 Eagle Tool & Machine Co. Landing gear and steering system components. Heroux-Devtek
Feb-10 Nordic Air Industrial heating and cooling equipment for the military. Hunter Defense Technologies [Metalmark]
Feb-10 RedTide Defense Group UAVs providing aerial surveillance solutions for the defense industry. Alas Defense Systems, Inc.
Jan-10 Airborne Systems Parachutes, and emergency, rescue, and survival equipment to the military. Hunter Defense Technologies [Metalmark]
Jan-10 United Aircraft Development Partners Manufactures light observation aircraft. Utilicraft Aerospace Industries
Jan-10 Chenega Integrated Systems Electrical control panels for four-wheeled armored security vehicles. Chenega Corporation
Jan-10 Special Devices’ defense & aerospace group Sealed propellant charges, bridgewire, lead wires, and filters. Ensign-Bickford
Jan-10 Protective Products of America Ballistic protection for military personnel and vehicles. Sun Capital Partners

Sources: Company press releases; certain financial information provided by Capital IQ, Inc.

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 17
MRO, component repair, distribution
and support services: Higher value
transactions
North American M&A transaction activity within MRO and
other related services was flat in 2010; however, deal sizes
were slightly larger than in the previous few years. Earnings
within our MRO index rose by nearly 5% (EBITDA), as the
larger MRO players gained market share. However, despite
increasing passenger air traffic (up 4.5% in 2010 vs. down 4.1%
in 2009), MRO spending overall fell 7.5% in 2010 to $43 billion,
with the average annual maintenance cost per plane declining
to $2.1 million (vs. $2.4 million in 2008). The drop in MRO
spending can be primarily attributed to the implementation
of newer, less maintenance-intensive aircraft combined with
declines in utilization. However, industry commentators expect
maintenance activity to increase over the next decade at an
annual rate of 3.2%, reaching $58 billion by 2019.
North American MRO and support services M&A activity
Financial
Strategic
# of transactions
40
30
20
10
0
2006 2007 2008 2009
Transactions where target is headquartered in U.S. or Canada.
Sources: Company press releases, certain financial information provided by Capital IQ, Inc.
18 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
As the airline industry recovers, we can expect to see
this continuing dynamic between building in-house MRO
capabilities versus outsourcing fleet maintenance services.
Larger established carriers such as Delta, Lufthansa and
British Airways have reinvested in maintenance personnel
and infrastructure after cutting heavily over the last few years.
Some airlines have hedged their bets by hiring temporary
employees, allowing for easy downsizing when work slows.
However, low-cost and startup carriers such as JetBlue,
AirTran, Southwest and Spirit continue to depend heavily on
third-party MROs for heavy maintenance, component repair
and engine overhaul, as their smaller fleet sizes do not justify
bringing work in-house.
Sector activity continued to comprise a large portion of
smaller transactions; however, the average deal size trended
upward in 2010, with nearly a third of acquired businesses
employing more than 200 people (vs. 15% in 2009 and 9%
in 2008). MROs comprised 60% of sector M&A activity, of
which half were spinoffs of subsidiaries or divisions of larger
businesses, and the other half were sales by private owners.
Notable divestitures include Volvo’s sale of VAS Aero Services
to HIG Capital and ExelTech Aerospace’s sale of its Canadian
division to Sun Capital’s portfolio company, Pemco World Air
Services. Component repair and distribution accounted for just
over 20% of activity.
2010
Illustrative MRO and other services transactions

Date Target Description Acquirer [ultimate parent]

Dec-10 Todd Shipyards Repair/overhaul, conversion, and construction of military ships. Vigor Industrial
Dec-10 M7 Aerospace Aircraft parts, government logistics support, and MRO. Elbit Systems Of America
Nov-10 Global Aerosystems Provides aerospace engineering and analysis services. Kaman Aerospace Group
Nov-10 Aviation Systems of Northwest Florida MRO, modification, relocation, and support services for aviation training. LSI, Inc.
Oct-10 Empire Aero Center Operates MRO facilities for military and commercial aircraft. Premier Aviation Overhaul [Desjardins Venture]
Oct-10 PAS Technologies MRO solutions for original equipment manufacturers. KRG Capital Partners
Sep-10 AvCraft Technical Services Provides MRO services for aircraft. Indaer International
Sep-10 Pacific Aero Tech Aircraft maintenance services for air and cargo carriers, and airlines. McNally Industries [Treval Holdings]
Sep-10 Aerothrust Corporation MRO for aircraft engines and parts. Air-Capital Group
Aug-10 Global Aerosystems Aerospace engineering, analysis, and modification services for aircraft. Supply Technologies
Aug-10 Kings Avionics Sale, installation, service, and repair of aircraft and related components. Butler National Corp.
Aug-10 RA Liquidating Aviation-related services to general and business aviation sectors. Ross Aviation [Carlisle Enterprises]
Aug-10 Complete Turbine Services Provides MRO services for turbine engines and aircraft. Neff Capital Management
Jul-10 Premier Aircraft Developing, certifying, and delivering Falcon 50-4 performance upgrades. West Star Aviation
Jul-10 VAS Aero Services Sells auxiliary power units, regional engines, and commercial engines. H.I.G. Capital
Jun-10 Vitesse Aviation Services Aircraft maintenance, charter management, and fixed-base operations. TWG Aviation
Jun-10 Nampa Valley Helicopters MRO services for helicopters. Heli-Welders Canada
May-10 Air Transport Components Overhaul and repair services for component parts of commercial aircraft. Gen Cap America
May-10 Atlantic Marine Shipyards providing services including vessel MRO and conversions. BAE
Apr-10 Exeltech Canada Provides airport services. Pemco World Air Services [Sun Capital]
Apr-10 Quality Performance Distributes military spare parts and explosive detection systems. Alas Defense Systems
Mar-10 Aviation Worldwide Services and EP Aviation Provides aircraft services for the State and Defense departments. AAR Corp.
Mar-10 Corporate Air Repair Provides aircraft repair, inspection, and restoration services. Quasar Aerospace Industries
Mar-10 Aveos Fleet Performance Airframe solutions and engine parts repair and overhaul. Air Canada
Mar-10 The Telford Group MRO services for regional, corporate, and private aircraft. C&L Aerospace
Mar-10 Fabritech, Inc MRO of aircraft components. Triumph Aftermarket Services Group
Feb-10 Soundair AMG Distributes aircraft parts to airlines, overhaul shops, and leasing companies. Jetpower, Inc.
Feb-10 Tracer LLC Wheel and brake repair and overhaul services for jet aircraft. Messier-Bugatti [Safran]
Feb-10 Wencor Group Distributes aircraft parts for repair stations. Odyssey Investment Partners
Jan-10 Global Aerospace Consulting Systems design, integration, certification, and aircraft technical publication. Southeast Aerospace

Sources: Company press releases; certain financial information provided by Capital IQ, Inc.

As the airline industry recovers, we can expect to see this

continuing dynamic between building in-house MRO
capabilities versus outsourcing fleet maintenance services.

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 19
Private security contractors account for around 20% of the
DoD’s armed forces in Iraq and 30% of the DoD’s armed
forces in Afghanistan. Contractors outnumber U.S. troops.

Private security contractors come under institutional
ownership
Private security contractors (PSCs) have become an integral part
of the U.S. response to the conflicts in Iraq and Afghanistan. A
June 2010 report to Congress estimated that PSCs accounted
for around 20% of the DoD’s armed forces in Iraq and 30% of
the DoD’s armed forces in Afghanistan. The report highlighted
that the total number of private contractors outnumbered
U.S. troops in Iraq and Afghanistan by over 30,000 (207,000
contractors compared with troop levels of 175,000). Of these
contractors, over 13% or 27,000, were armed PSCs. Between
2003 and 2007, the DoD, State Department and USAID
collectively awarded $85 billion in contracts – mostly in support
of the wars in the Middle East – accounting for roughly 20% of
total war funding in the Iraq and Afghan theaters. Arguments
for the use of PSCs include increased flexibility and the reduced
costs due to the ease of hiring and firing, the freeing up of
uniformed troops for combat missions, and being able to access
unique skills as required.
Contractor and U.S. troop levels in Iraq and Afghanistan
Armed contractors
Unarmed contractors
U.S. troops
As proof of its transition from a cottage industry, we saw
significant acquisitions of private security contractor firms by
private equity groups in 2010, including:
• DynCorp, a security and facilities services provider, taken
private by Cerberus;
• Xe (formerly known as Blackwater), a training solutions
and security services provider, which was acquired by
Forte Capital Advisors and Manhattan Capital; and
• Blue Hackle Group, a U.K. private security firm, purchased
by Torch Hill Capital.
M&A activity among suppliers of products and services to
private security and other ground forces included:
• Kratos’ purchase of tactical and logistics shelter provider
Gichner systems, as well as border patrol product
manufacturer SCT Acquisition;
• Metalmark Capital’s purchase (through portfolio company
Hunter Defense Technologies) of military heating and
cooling equipment manufacturer Nordic Air and parachute
survival equipment provider Airborne Systems; and
• Torch Hill Capital’s acquisition of camp lighting
manufacturer Jameson LLC.

Personnel levels
240,000

200,000

160,000

120,000

80,000

40,000

0
Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr
2007 2008 2009 2010

Sources: DoD, Use of PSCs in Iraq and Afghanistan, June 22, 2010

20 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
The operating environment
Aerospace market outlook:
Orders rise on return of lessors

Despite a challenging economic environment, the aerospace

industry was relatively flat in 2010, with sales increasing just
under 1%. While commercial revenues fell slightly, the decline
was more than offset by increased military aircraft spending.
Going forward, the Aerospace Industries Association (AIA)
projects a sales increase of roughly 2% in 2011 to nearly $220
billion on the back of increased demand from Asia-Pacific.
Ari Goldschneider In the long term, Boeing expects the 5% annual growth
Senior Associate of the last 20 years to continue, with the Asia-Pacific region
Grant Thornton Corporate Finance LLC
comprising over a third of new civil aircraft purchases. Rapid
Ari Goldschneider is a senior associate at growth in the Asia-Pacific region cannot be ignored by
Grant Thornton Corporate Finance and provides M&A U.S. suppliers, as offset requirements and growth of local
support services to the Aerospace & Defense Group.
production creates pressure for component production to shift
ever eastward. In addition, 2010 saw acquisitions by China
within the United States, highlighted by Aviation Industries
Corporation of China’s (AVIC) purchase of Teledyne
Continental Motors, a small aircraft and engine manufacturer,
which will likely help AVIC exploit China’s underdeveloped
U.S. aerospace shipments general aviation market.
Jet leasing firms have also played a significant role in the
Civil recovery of the aviation market, with 27% of aircraft orders
Military
at Boeing and Airbus placed by lessors last year, the highest
$ billions proportion since 2000. In 2010, lessors comprised 21% of
70 Boeing orders (vs. 12% in 2009) and 35% of Airbus orders
(vs. 5% in 2009). Investors have made financing available to
60
lessors due to their relatively attractive and consistent financial
50
performance, driven by geographic diversification and the
ability to move aircraft around the world. Carriers, in contrast,
40 have shown a far weaker, although well-publicized, profit
position. Consequently, Boeing expects lessor-owned jets to
30
account for one of every two flying within the next 10 years.
20

10

0
1997 1999 2001 2003 2005 2007 2009 2011 (E)

Source: Aerospace Industries Association (AIA)

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 21
Sales, orders and backlog
U.S. aerospace, backlog, orders and shipments
After two years of back-to-back declines, aircraft industry
orders rose 16% in 2010, driven by strong growth in civil Shipments
aircraft and parts. This increase reflects a rising demand for air Orders
travel and general improvement in the overall economy. After Backlog
a decline in 2009, backlog increased slightly in 2010 to $422
$ billions
billion, and stated backlog levels still remain more than double
500
annual shipments.
450
As a result of the weakening orders and increased
400
cancellations of 2009, commercial aircraft sales fell nearly
6% in 2010; however, the decline was more than offset by an 350

increase in military spending. The economic downturn played 300

a significant role in the decline of the civil sector, while military 250
sales benefitted from record defense spending (which will 200
likely remain flat in fiscal 2011 and 2012) and the increased 150
exporting of helicopters, missiles and rockets. Space sales were
100
flat during the year and are expected to remain so through FY
50
2015, with NASA’s year-to-year budget growth projected to
0
average 2.5%. General aviation (including business jets and 2000 2002 2004 2006 2008 2010 (P)
other private planes) declined for the second year in a row, as
Sources: U.S. Census Bureau, Manufacturers' Shipments, Inventories, and Orders; and
the sector continued to face a tight credit environment and an
Aerospace Industry Association (AIA) estimates
abundance of used aircraft on the market. However, sales of
larger cabin business jets are beginning to rebound, especially
in the Middle East.

22 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
U.S. aerospace industry sales by segment The economic downturn
Civil
Military
Related products
Missiles
played a significant role in
Space
the decline of the civil sector,
while military sales benefitted
$ billions
180

160

140
from record defense spending
120 and the increased exporting
100
of helicopters, missiles and
80

60 rockets.
40

20

0
2007 2008 2009 2010 (P) 2011 (E)

Source: Aerospace Industries Association (AIA)

Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 23
Commercial outlook
Over the next 20 years, the commercial aircraft industry
expects similar growth to that of the last two decades
increasing roughly 5% per year. Growth will likely be driven
by a number of factors, including the replacement of older
aircraft with newer fuel-efficient and less maintenance-
intensive models, demand for flights within emerging markets,
and the expansion of low-cost carriers.
Both Boeing and Airbus recently released favorable 20-
year outlooks – both expecting that fleet sizes will double in
the next two decades – however, there are dissenting opinions
regarding composition, which reflect the markets in which
they themselves are based. Boeing expects smaller, economical
single- and twin-aisle airplanes to account for over 92% (by
value) of new deliveries, as customers seek direct flights to a
wider range of destinations. Very large aircraft (VLAs) are
expected to account for 6% (by value) of new deliveries over
the next 20 years. Airbus, meanwhile, believes international
long-haul demand will continue, as airlines trend to hub and
spoke routes as opposed to point-to-point travel. Airbus
believes VLAs will comprise 18% of deliveries (by value) due
to increased traffic concentrated around mega-city hubs and
growth in the size and number of mega cities, especially within
the Asia-Pacific region.
Over the next 20 years, the commercial aircraft industry
expects similar growth to that of the past two decades,
increasing roughly 5% per year.
24 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Asia-Pacific will be increasingly important for Boeing and
Airbus as they expect the region to account for over a third of
deliveries (by value) over the next 20 years—tripling its fleet
in that region over the period and nearly matching deliveries
to North America and Europe combined. Boeing forecasts air
traffic involving the Asia-Pacific region to grow at a rate of
6.8% over the next 20 years, driven by economic development
and loosening regulations. China currently accounts for 22%
of Airbus orders and 15% of Boeing orders.
Development in China is also a cause of concern for the
two major aircraft manufacturers, as state-owned businesses
AVIC and Commercial Aircraft Corporation of China
(COMAC) take aim at the Boeing-Airbus Duopoly. AVIC’s
ARJ21 is expected to target the large Chinese domestic
short-haul market in 2011. Meanwhile, COMAC has built
relationships with Airbus and Boeing suppliers including GE,
United Technologies and Honeywell and is developing the
168-passenter C919 (maiden flight set for 2014), which will
compete with the Airbus A320 and Boeing 737. Activity is not
limited to commercial aircraft, with China now developing
high-tech military jets like the J-11B and stealth J-20.
Defense budget outlook:
Talk of cost cuts masks unchanged
budget; reprioritizing of spending
creates winners and losers
Lou Crenshaw
Defense and Intelligence
Grant Thornton LLP
Lou Crenshaw, Vice Admiral U.S. Navy (Ret.), is
Partner of the Defense and Intelligence
Sector of Grant Thornton’s Global Public Sector
Group. Prior to joining Grant Thornton, he was the
senior resource and requirements manager for the
U.S. Navy, where he was responsible for overseeing
an annual budget of $130 billion.
Predicting what will happen with defense budgets is always an
uncertain enterprise, even in the most stable of environments.
The current situation appears to be unusually unstable, and
there are many indications that there may be substantial
shrinkage in the number and amount of certain types of
contracting opportunities at the DoD. I do believe that even
with this level of uncertainty, however, there is some degree
of order and logic that those of us in the defense and defense-
related industries can rely on as we assess the future.
General considerations
First and foremost is the fact that the DoD’s financial
condition heading into the new year is generally sound, despite
the large amount of rhetoric and modest amount of action
regarding cutting costs, saving money and increasing efficiency
at the DoD. There are pressures to be sure that will present
significant challenges to the DoD leadership in running the
business of the department. Most notable are the reductions
of Overseas Contingency Operations (OCO) funds, the poor
performance of some major weapons systems acquisitions and
the general state of “over-programming” present in the budget.
Nonetheless, even in the face of a cost-reduction imperative
driven by daunting financial realities, Congress will certainly
continue to invest significant amounts of the national treasure
in our nation’s defense.
At this writing, Congress has yet to pass a 2011 Defense
Appropriations Act, opting instead for a Continuing
Resolution through March 4, 2011, which precludes the start of
any new programs and requires operating under 2010 funding
levels. Even this state of affairs is no reason for despair since it
will leave at least $700 billion in base and supplemental funding
available to the DoD. That is a lot of money, and we can be
certain that the DoD will make every effort to spend it all,
plus whatever supplementary funding Congress may award
during the year to sustain military operations. Furthermore,
the adoption of a Continuing Resolution means that the DoD
budget cuts included in the president’s fiscal 2011 budget
request will most likely fail to materialize.
On the other hand, Congress may attempt to put limits
on spending within the Continuing Resolution, most likely
targeted at major weapons systems procurements. Continued
stalemate could mean that none of the cuts in the president’s
fiscal 2012 request would be adopted as well, though some in
Congress say they plan to attach a full military appropriations
bill to a further Continuing Resolution.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 25
Economic challenges facing the United States
One cannot discuss the funding of government programs
without immediately focusing on the effects of the growing
federal deficit. The Congressional Budget Office (CBO) has
estimated that the 2010 deficit exceeded $1.3 trillion. At 9.1%
of GDP, this is the second-largest deficit in the past 65 years,
exceeded only by 2009’s 9.9% of GDP.
Sustained growth can be expected in mandatory spending
accounts, up 8.3% in 2011, and outlays for net interest on the
public debt will grow as well, from 62% of GDP this year to
66% by the end of 2011. Between 2010 and 2013, the CBO
predicts that discretionary spending as a percentage of total
outlays will remain around 38%, and that it will fall during that
time period from 8.7% of GDP to 8.4%. In other words, there
is a very low likelihood that additional discretionary spending,
which includes defense spending, will grow significantly.
Budget pundits for some time have been predicting minimal
growth – in the 1% range – of the DoD budget. Given the
economic outlook, some are now predicting a decline. At an
October 2010 TechAmerica Foundation Vision Conference,
the DoD budget was predicted to be subject to “low real
growth” in 2011–2012 and to suffer a “real decline” from 2013–
2015, resulting in “a major shock” for the defense market.
The good news in all this is that nondefense discretionary
spending is projected to fall from 49% of total discretionary
spending in 2010 to 46% in 2013, indicating that some cuts
are expected in the non-defense accounts. Baseline defense
spending as a percentage of discretionary spending is therefore
predicted to grow slightly, from $657 billion to $744 billion.
Thus, even in the midst of the direst economic predictions,
there is room for optimism with regard to well-positioned
defense-related businesses.
26 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Budget reduction pressures
There is a growing chorus of support for budget reform and
deficit reduction. In the defense spending area, this can be
seen on at least three fronts. The first involves the internal
cost-cutting initiatives announced by Defense Secretary
Robert Gates. Two other significant sources of pressure are
the Defense Business Board and the National Commission
on Fiscal Responsibility and Reform, the so-called “Debt
Commission.”
The Defense Business Board reported its preliminary
findings in Reducing Overhead and Improving Business
Operations to Secretary Gates in July 2010. The findings that
have the most implications for the defense industry include:
• there has been an explosion of overhead work relative to
warfighting due to a lack of adequate controls;
• more personnel have been assigned to conduct that work,
adding immense costs;
• the majority of that work is being done by contractors at a
cost that the DoD is unable to determine since it is buried
in Operations and Maintenance accounts; and
• large numbers of military personnel (over 340,000), who
cost more and are needed for warfighting, are performing
work that is “non-inherently government” or should be
assigned to DoD civilians.
Despite the rhetoric around
cutting costs, the DoD’s
financial condition is
generally sound.
 In November 2010, the Debt Commission co-chairs
proposed savings that would affect the entire defense industrial
community and would include cuts to major procurement
programs in addition to those recommended by Secretary
Gates in August. Those with the most significance to defense-
related industries include:
• Applying the $100 billion savings from Secretary Gates’
initiatives to deficit reduction instead of using those funds
elsewhere in the DoD. The commission’s emphasis on
continuing efforts to improve audit readiness and financial
management within the DoD should benefit firms engaged
in assisting the DoD in those areas. As an example of the
benefits that could result, the commission noted that the
“Marine Corps recently realized approximately $3 for
every $1 it invested in improvements to its rudimentary
financial operations.”
• Doubling the proposal in Secretary Gates’ initiatives to
cut defense contractor personnel who aid or augment
the DoD headquarters staff by 30% over three years in
order to achieve a savings of $5.4 billion by 2015. Even
after doubling those savings and reducing the number of
contractor personnel by half, the commission notes that the
contractor workforce would still number over 30,000 and
remain 40% higher than it was in 2000.
• Reducing procurement by 15% by 2015 through the
elimination or reduction of production of several major
weapons systems. These include the V-22 Osprey, the
Expeditionary Fighting Vehicle, the Marine Corps’
STOVOL version of the F-35, the Navy’s Maritime Future
Prepositioning Force, the Joint Light Tactical Vehicle
(JLTV), the Ground Combat Vehicle, and the Joint Tactical
Radio System. In addition, reduce the buy of Navy and Air
Force F-35s by half and replace them with less expensive
F-16s and F- or A-18s. Even with this 15% reduction,
procurement would remain only slightly below the average
for the past 10 years.
• Reducing levels of “other procurement” by $48.5
billion by 2015. The commission specifically singled
out communications and electronic equipment (e.g.,
tactical SINCGARs radios, radar, communications and
information security), tactical vehicles (e.g., High Mobility
Multipurpose Wheeled Vehicles (HMMWV), armored
security vehicles, trailers, materials-handling equipment,
ship support equipment) and other support equipment and
spares (e.g., night vision goggles). This would still allow the
services to conduct other procurement at levels 50% higher
than in 2000.
• Reducing spending in Research, Development, Test and
Evaluation by 10% to save $7 billion in 2015, with particular
reference to R&D associated with the major procurements
identified by the commission for reduction or elimination.
There is a significant contractor component in this account
and the effect of this cut could have a major impact.
• Reducing base support by $2 billion and facilities
maintenance spending by $1.4 billion.
We can be certain that the chances of all of these
recommendations actually being implemented are very low.
Nevertheless, there are obviously winners and losers in the
face of these recommendations, and it is difficult to draw any
solid conclusions in light of the myriad of possibilities and
combinations that may emerge from the discussion. Generally,
however, it appears that:
• companies providing service support contractor personnel
can expect a tough future;
• major hardware manufacturers and their suppliers will be helped
or hurt depending on what is cut and what replaces the cuts;
• suppliers of base support and maintenance contracts can
expect challenges to current levels of spending; and
• firms involved in improving the efficiency and effectiveness
of the DoD financial operations can expect continued
investment.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 27
Congressional actions
It is clear now that there will not be a 2011 Defense
Appropriations Act and that the DoD will be operating under a
Continuing Resolution at least through March 4, 2011, if not for
the remainder of FY 2011. The result will be essentially the FY
2010 budget with no new program starts.
While it appears the 112th Congress will concentrate on
non-defense cost-cutting measures, there will be unintended
consequences that will affect the defense industry. The
most notable example is the desire to eliminate earmarks.
The DoD typically omits some required budget items with
the knowledge that Congress will fund them as earmarks.
Unfortunately, as these earmarks are eliminated, DoD
organizations will be forced to either add them to an already
oversized baseline budget or let them die. Many of these
programs support small and mid-size local businesses, and they
can therefore expect their congressionally sponsored funding
to dry up.
Congress may also intervene in several recommendations to
reduce major procurements. Capitol Hill will also continue the
pressure to eliminate Overseas Contingency Operations funds
and force the DoD to focus on re-establishing baseline funding
levels appropriate for the security environment. This will put
the operations and support accounts of the armed services
under enormous pressure. Many service support contracts
reside in those accounts and vendors can expect a decline in
money available to fund these contracts.
28 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Secretary of Defense Gates’ initiatives
In August 2010, Secretary Gates announced a series of savings
and efficiency initiatives that he explained would allow
the DoD to reallocate $100 billion over the next five years,
including:
• A 30% reduction over three years in funding for service
support contractors. This could result in the elimination of
30,000 contractors.
• A freeze in the number of OSD, defense agency and
combatant commander billets as well as a freeze at the 2010
levels of DoD senior uniformed and civilian leadership ranks.
• The achievement of greater benefits in cost and efficiency
through economies of scale and the consolidation of IT
infrastructure.
• A reduction in the enormous amount of reports and studies
being conducted by the DoD as a result of congressional
action, administrative oversight and internal tasking.
• A zero-based review of all DoD intelligence organizations,
including all contracts, with the goal of eliminating
duplication.
• Flattening and trimming the DoD’s structure, including
the elimination of the position of Assistant Secretary of
Defense for Networks, Integration and Information.
In January 2011, the secretary announced that the services
had been successful in finding over $100 billion in cost-savings
measures.
It is very important in assessing the impact of these actions
to note that even if they are fully successful in ways that
previous cost-cutting efforts at the DoD have not been, they
are not intended to represent cuts to the DoD budget, but
reallocations in the name of efficiency and effectiveness.
Initiatives by the undersecretary for acquisition, technology
and logistics (AT&L)
As part of his effort to cut costs at the DoD, Secretary Gates
announced that AT&L Undersecretary Ashton Carter had
launched an initiative to improve efficiency and reduce costs in
the contracting area, “the goal being to get better buying power
for the taxpayer and warfighter in defense goods and services.”
Although a part of Secretary Gates’ initiatives, the AT&L
actions – announced in June 2010 and explained further in
September 2010 – are significant in their own right and deserve
separate treatment.
They fall into five focus areas: target affordability and
control cost growth; incentivize productivity and innovation
in industry; promote real competition; improve tradecraft in
services acquisitions; and reduce non-productive processes and
bureaucracy.
Unlike the other major areas discussed that have the
potential to impact the defense industry, these AT&L initiatives
have been or will be implemented. In general, vendors can
expect greater scrutiny by the DoD in the performance of their
contracts, and this is likely to increase costs.
Operational imperatives
While there are and will continue to be many calls to reduce
DoD procurement spending, especially in major hardware
accounts, the defense industry can expect to see continued
investment by DoD in certain key areas:
• Cyber security will undoubtedly continue to be a growth
area in the defense budget, and vendors in that space can
expect growth in DoD investments.
• Unmanned systems will continue to prosper as the
DoD has clearly established its intent to continue robust
investment in that area.
• Soft power will remain a key focus area, and elements of
the defense industry associated with this area and other
unconventional and special warfare programs will see a
sustained investment by the DoD.
And then, of course, there is the unknown but certain
influence of future, unforeseeable global events that will
force reconsideration of budget cuts and result in additional
expenditures in the defense area.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 29
In summary
The supposed “Global War on Contractors” will certainly
affect a large number of firms in that industry, and the
challenges will not be limited to just those in the service
support industry. The fact is that even though the DoD
leadership stresses “service support contractors,” there is the
danger that field personnel will only hear the “contractor”
part. Any “contractor” can therefore expect pressure from
local contracting officers to reduce their numbers.
The cuts proposed to major weapons system acquisitions
will hit losing primes and their suppliers hard. General
budget cuts and cost-cutting measures will undoubtedly have
unanticipated impacts on almost every firm doing business
with the DoD.
But there are some bright spots on the horizon:
• The DoD has over $700 billion to spend.
• The manufacturers of proven legacy systems, which will
fill the void left by the cancellation of new systems, will
prosper.
• Those firms providing assistance to the DoD to help it
become more efficient or manage its money better will see
a continued demand for their services (assuming they can
overcome the “contractor” label).
• Those industries in the 21st century warfare renaissance
of cyber security, soft power and unmanned vehicles will
continue to see robust investments by the DoD.

This is a shortened version of a full article that can be obtained from Lou Crenshaw:
T 703.837.4430 or E Lou.Crenshaw@us.gt.com

30 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
European update: View from across
the pond mirrors U.S. activity
Ian Wilson
Partner, Corporate Finance
Grant Thornton UK LLP
Ian Wilson leads the Aerospace & Defense Corporate
Finance Group in the UK member firm of Grant Thornton
International Ltd, where he advises European aerospace
and defense companies on M&A transactions.
Key developments in 2010
In 2010, Europe’s defense and commercial aerospace
companies experienced broadly the same conditions as those
affecting the U.S. markets. Conflict in the Middle East and
procurement spending realignment dominated the defense
arena, while cost-cutting and consolidation by Europe’s
airlines continued against a backdrop of gradual recovery in
the civil aviation market.
Continuing recovery in commercial aviation: Notwithstanding
the disruptive influence of ash clouds, severe weather and terror
threats, the European civil aviation sector continued its steady
improvement. According to the Air Transport Association,
improving utilization, yields and load factors have driven
European carriers’ operating cash flow generation (EBITDA)
back up to around 10% of revenues, from a trough of 3.5% at
the start of 2010. The return of lease financing to the aircraft
financing menu (notably, the launch of Air Lease Corp.) has
fueled the fleet expansion and modernization plans of both
established carriers and emerging airlines.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 31
Rebirth of M&A: After two quiet years, mergers and
acquisitions activity returned to the European corporate
agenda in 2010, although activity remained substantially below
U.S. levels. Notable deals included Babcock International’s
acquisition of VT Group for $2.1 billion and the acquisition
of energetic materials group SNPE by France’s Safran for
$405 million. Having survived both dramatic declines in
commercial aerospace activity and the worst credit market
conditions in many years, European aerospace and defense
companies found renewed confidence last year. Dramatic cost-
cutting and a relatively robust defense spending environment
resulted in substantial cash balances for primes, supplemented
by recovering public debt markets. The combined liquidity
(cash plus undrawn facilities) of Europe’s three largest primes
currently exceeds $32 billion. More attractive pricing in most
segments of the commercial aerospace sector, combined with
shifting defense procurement priorities, also contributed to
higher levels of activity. By contrast, smaller companies –
lacking access to public debt markets and therefore reliant
upon bank debt – were less active in 2010, preferring to retain
liquidity balances for what is widely expected to be a bumpy
road to recovery. While most commercial aerospace M&A
activity tended to be domestic or intra-European, the United
States remained the focus for defense acquisitions, where U.K.
defense group’s BAE Systems and Chemring were active.
European defense primes and their Tier 1 suppliers recognize
that despite growing budget pressures, the U.S. spends as much
on equipment and services as the rest of the world combined,
and it is therefore critical to have a presence “on the ground.”
32 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Fiscal constraints: Ballooning budget deficits combined with
an economic recession have forced most European governments
to take a scalpel to public expenditures. As one of the least
politically-sensitive areas of outlay, defense budgets have been
hardest hit. The impact of drastic cuts is particularly acute,
given the need to invest in technologies and assets to combat
new and emerging threats. Most notable is the U.K., where
the new Conservative-led coalition government is attempting
to upgrade its military capabilities in priority areas, while
cutting overall expenditures and plugging a £36 billion ($57
billion) hole in the procurement budget accumulated under the
outgoing Labour government. Among the more controversial
decisions of the long-awaited Strategic Defense and Security
Review (SDSR) were the early withdrawal of the Harrier and
Tornado fast jet fleets along with the brand new Nimrod MRA4
maritime surveillance capability and the Sentinel R1 Airborne
Stand-Off Radar (ASTOR) program, while committing to the
construction of two new aircraft carriers at the cost of almost
£6 billion ($9.5 billion). Undoubtedly, these decisions will
impact not only the primes, but also numerous subsystem and
component suppliers and the service providers supporting them.
However, the associated need to bolster Eurofighter Typhoon’s
multirole capability to allow the withdrawal of the Tornado
and the potential for unmanned surveillance platforms will
soften the blow for some. The only other European country
with a significant defense budget, France has also recently
been considering its procurement priorities in light of fiscal
constraints. President Sarkozy and the French government are
under pressure from the opposition party for a similar defense
spending review to the U.K.’s SDSR.
Afghanistan conflict: The continuing involvement of several
European nations in Operation Enduring Freedom has
boosted acquisitions of Urgent Operational Requirements
(UOR) equipment and supplies. Companies engaged in the
manufacturing of such products – from body armor to IED-
jamming devices –prospered during 2010 and, in some cases,
attracted the attention of acquirers. One such example is
Rheinmetall’s acquisition of personal armor manufacturer
Verseidag Ballistic Protection GmbH.
Anti-corruption legislation: A number of European nations
introduced new laws in 2010 aimed at curbing corporate
corruption impacting a number of industries, most notably
defense. The U.K.’s Bribery Act, passed into statute in April,
is considered to be the most robust legislation of its kind. The
act puts significant pressure on corporations doing business in
the U.K. to ensure that they adopt appropriate anti-corruption
measures before April 2011. While larger corporations
typically have appropriate policies and procedures in place,
these additional administrative burdens represent yet another
competitive disadvantage to smaller defense enterprises.
Growing interest in emerging markets: Like their U.S.
counterparts, European defense primes acknowledge the
importance of establishing a presence in “friendly”’ emerging
markets, such as the Middle East, Asia and Latin America.
Among the near-term targets are India’s Medium Multi-Role
Combat Aircraft (MMRCA) program of at least 126 fighters,
which is currently being pursued by Saab (Sweden), Eurofighter
(European multinational), Dassault (France) and Boeing. Other
markets in the crosshairs of Europe’s defense primes include the
United Arab Emirates and Brazil.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 33
Outlook for 2011
We expect that the key trends in 2011 for both the defense and
commercial sectors will represent a continuation of those that
began in 2010.
Defense outlook
Continuing fiscal austerity measures: Defense primes will
bear much of the brunt of cost-cutting demands and reforms
resulting from the U.K.’s SDSR and similar initiatives across
mainland Europe. Similarly, the numerous contractors involved
in the F-35 program will suffer the same pricing pressures as
their U.S. counterparts.
M&A activity: With Europe’s major contractors sitting on
huge cash piles, further consolidation is inevitable as portfolios
of both defense and commercial assets are reshuffled. The U.S.
market will remain a favored destination for acquisition activity
and joint ventures, and alliances in emerging markets will also
feature on the strategic agendas of both large and mid-sized
players. Increasing concerns about cyber security, piracy and
terrorism will drive interest in targets with intelligence and
sensor capabilities.
After two quiet years, M&A has returned
to the European corporate agenda.
34 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
International collaboration: A union born of economic
necessity, the recent Anglo-French defense treaty is billed as
a move to reduce some of the pressure on spending as well as
reshape Europe’s military industrial landscape. However, a
primary motivation for collaboration among European nations
and their prime contractors is to avoid buying “off the shelf”
from U.S. primes. Joint procurement and sharing of capabilities
has been attempted in various guises in the past with few
tangible results. The most recent attempt at collaboration was
the A400M airlifter, which encountered significant delays and
substantial cost overruns. However, if properly conceived and
implemented, such a grand plan has the potential to ensure
Europe retains existing capabilities as well as invests in R&D
for future programs. A notable example of successful industrial
collaboration is MBDA, which resulted from the merger of
the missile capabilities of the U.K. and France to produce a
“European champion.” However, the potential for a defacto
single European prime in other areas of defense procurement
may raise objections from smaller competitors.
Civil outlook
Airline mergers (Iberia-British Airways): Europe’s airlines
– from large state carriers to regional players – are looking at
consolidation as a way to deal with the continuing pressures of
economic headwinds and union unrest. The merger of British
Airways and Iberia to form International Airlines Group
will create three giant carriers (along with Air France-KLM
and Lufthansa), which is likely to prompt the restructuring
of regional players. While the budget carriers are expected to
continue to expand their fleets, it is unclear what impact this
consolidation activity will have on medium-term delivery
schedules for Airbus, Boeing and their emerging rivals in the
regional jet market.
Supply chain pressures: Assuming Airbus and Boeing proceed
with their expected production ramp-ups, the increased activity
levels will test their supply chains as they look to build more than
1,200 aircraft in 2012. Airbus is planning to boost single-aisle
production to 40 aircraft per month, having dropped to 34 units
in 2009. The airframe giants are most concerned about the smaller
Tier 2 and Tier 3 suppliers, which both Boeing and Airbus have
encouraged to consolidate to better handle the financial and
organizational pressures imposed by their customers. Having
cut skilled labor and resources in 2009, many of these companies
may struggle in the continuing credit-constrained environment to
ramp up production to the required levels.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 35
16th Annual Government Contractor
Industry Survey

Grant Thornton has released its 16th Annual Government

Contractor Industry Survey, which summarizes a wealth of
financial and nonfinancial information provided by survey
participants. Responses were received from government
contractors in 26 states and the District of Columbia. Survey
highlights are presented below.

Kerry Hall Revenue trends

Government Contractor Industry Practice Leader
Grant Thornton LLP
Kerry Hall leads the Government Contractor Industry
Group of Grant Thornton LLP, where he provides
value-added services to companies providing
technology-based products and services to federal
and commercial customers.
During the past year, the amount of revenue from government
prime contracts grew for 55% of survey participants. Twenty-
three percent experienced no significant change and 22%
experienced reductions. This continues a long-term trend from
our surveys that indicates that government contractors are far
less vulnerable than commercial companies to recessions in the
overall economy.

Mergers and acquisitions

We asked respondents about their expectations regarding
the M&A environment over the next 12 months. Forty-eight
percent of respondents expected the M&A environment to
improve, 41% expected it to remain the same and only 11%
expected it to worsen. The sale of a company continued to
be the most-favored exit strategy (62% of respondents) with

The sale of a company ESOPs (20%) a distant second. The most frequently cited
reasons for exit were private shareholder liquidity needs
continues to be the most (50%) and market opportunities (28%). Thirty-six percent of
respondents planned to raise capital during the year and were
favored exit route for equally divided between issuing stock and incurring additional
debt. Acquisitions were cited as the primary reason for raising
satisfying private shareholder capital (44%), followed by growth and operations (41%).

liquidity needs.

36 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Profit before interest and taxes
The profit rates reported by survey participants followed
a predictable pattern given the profit guidelines in the
government procurement regulations. As a percentage of
revenue, 40% of participants reported profit rates of 1%–5%,
35% reported profit rates of 5%–10%, 9% reported profit
rates of 10%–15%, and 6% reported profit rates above 15%.
The remaining 10% of surveyed companies either had no
profit or experienced a loss.
Revenue from the stimulus program
We asked surveyed companies whether they anticipated any
significant revenue impact from the government stimulus
program over the next 18 months. Seventy-two percent of
respondents anticipated no significant growth from stimulus,
while the remaining 28% expected modest growth.
Funding notices
For cost-reimbursable and time-and-material contracts,
contractors are required to monitor spending against contract
funding and to give the government advance notice when
additional funds will be required to complete the contract.
Fifty-two percent of survey respondents reported that their
procedures for giving the required notices were very effective,
while 48% reported the procedures were only somewhat
effective or ineffective.
Identifying claims for out-of-scope work
We asked surveyed companies to rate the effectiveness of their
procedures for identifying out-of-scope work. Only 31% of
respondents considered their procedures to be very effective,
while 69% rated their procedures as either somewhat effective
or ineffective. The failure to effectively identify and seek
compensation for out-of-scope work is a contributor to the
low profit rates described above.
Bid protests
Surveyed companies filed a total of 22 bid protests during the
past year, and 11 were sustained by the GAO or the court
hearing the bid protest. This appears to be a higher sustainment
rate than has historically been the case, and we’ll be monitoring
this closely in the future to see if a new trend is emerging.
Government in-sourcing
Historically, government regulations gave a preference to
outsourcing work to commercial companies rather than
performing the work in-house by government employees.
Recently, the government reversed this policy and has begun
recruiting contractor employees into government service. We
asked surveyed companies whether they had lost employees as
a result of government in-sourcing and 47% reported having
lost employees.
Labor multipliers
Survey participants were asked to provide their labor
multipliers inclusive of all costs plus fees. On average, the
labor multipliers reported are 2.3x for work on the company
site and 1.9x for work on the customer site. The difference in
multipliers is generally the cost of facilities, which is normally
recovered only on contracts performed on the company site.
Proposal win rate
On average, survey respondents reported a 36% win rate on
proposals submitted in a competitive environment for new
work. Respondents also reported a 35% win rate when special
business units such as joint ventures were established to seek
the new work. In our prior surveys, the win rate when special
business units were established was significantly higher than
when the business was pursued by the established company.
We will monitor this closely in future surveys to see if a new
trend is emerging.
Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 37
Earned value management systems
We asked a series of questions about earned value management
systems (EVMS). Twenty-eight percent of surveyed
participants reported having contracts that required EVMS.
Of those, only 37% believed that EVMS is a cost-effective
management tool. Further, only 25% of companies required to
report under EVMS would adopt that system if not required
by the contract.
Relationship with DCAA
The relationship with the Defense Contract Audit Agency
(DCAA) has deteriorated during the past year at 14% of the
surveyed companies while it improved at 12% of companies.
The remaining 74% of surveyed companies reported no change
in their relationship with DCAA.
Government efficiency in resolving contract issues
Only 26% of surveyed companies believed that the
government is efficient in resolving contract issues, while
74% considered the government to be slow and inefficient
in dealing with issues. Of those detractors, 56% believed
the inefficiencies were caused by the DCAA, while 18%
believed the contracting officer was primarily responsible for
government inefficiencies.
38 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
Codes of business ethics and conduct
Government procurement regulations impose requirements on
government contractors regarding Codes of Business Ethics
and Conduct. Eighty-one percent of surveyed companies have
established formal policies and procedures to satisfy these
requirements. Nine percent of surveyed companies reported
that they have faced allegations of violations of the Codes of
Business Ethics and Conduct.
Other information in the 16th annual survey
The highlights presented are only brief examples of the
information provided in the full survey. By popular request,
this year’s survey provides trends for certain data comparing
this year’s results to data from earlier surveys. The full survey
also includes useful information on how best to succeed in
sensitive areas in government contracting including: complying
with the new compliance regulations regarding business ethics
and conduct; documenting the file to improve the likelihood
of being paid when working at risk; receiving early payment
for indirect rate variances and fee retentions; identifying
and challenging the vulnerabilities in DCAA’s techniques
for auditing and questioning executive compensation costs;
preparing a proposal for a GSA contract that reduces the
likelihood of post-award challenges to the pricing; and
identifying sensitive areas for investigation during due
diligence reviews.
If you wish to participate in next year’s survey or would like information on
purchasing the full results of this year’s survey, please contact Margaret Jackson at
703.637.4088 or margaret.jackson@us.gt.com.
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Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment 39
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40 Aerospace & Defense Update: Mergers, Acquisitions and the Operating Environment
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