The strength and visibility of the defense industry has enabled a stream of acquisitions in the leveraged defense sector and the acquisition activity is expected to continue with U.S. defense spending growing substantially. "Defense companies have access to the capital markets, which is giving them the currency with which to do acquisitions," said Tom Gallagher, managing director and group head of defense and aerospace investment banking for Wachovia Capital Markets.
While it looks like all of this activity is happening now, these deals have been happening for three years, Gallagher noted. The latest of these mergers, DRS Technologies' acquisition of Integrated Defense Technologies, comes in the wake of acquisitions by Moog, L-3 Communications Holdings and Gencorp. "Any company [in the defense sector] that is in the $300 million to $500 million market capitalization range has to ask: 'Do I acquire or am I acquired?' Scale is important in this business," said Gallagher.
Consolidation has become a necessity in this arena in order to broaden a company's business scope and increase the number of contacts. "Companies are trying to get into the mid-tier area and away from being small players in order to be in a better position when approaching the government," said James Ryan, manager of public and investor relations for DRS. Ryan stated that DRS and IDT are a more complete package with a complete power systems and combat systems business and that DRS is a company with a history of picking up businesses that are strategic fits.
Gallagher stated that scale is essential in this business because as a $100-200 million small public company it is hard to get noticed. The nature of defense requirements and research development requires a large investment and, assuming a company invests 5-10% of its revenues in development, it is difficult for a small company to compete, Gallagher added. "Larger companies buy up smaller companies for three reasons: to acquire technology, to have access to a company's customers and platforms and to acquire customer service systems (such as a defense company buying a law enforcement service)," Gallagher noted.