Article discusses intangible assets in aerospace and defense transactions.

1. Carve Out of the Intangible
Gap in Aerospace, Defense, and
Government Acquisitions
Jeremy L. Krasner, CFA – jkrasner@srr.com
Dominic M. Brault – dbrault@srr.com
Stout Risius Ross (SRR) analyzed Aerospace, Defense, and of intangible asset amortization and associated impact on EPS.
Government (“ADG”) transactions consummated over the past These key variables include:
several years to assess industry norms regarding identification
and capitalization of intangible assets and goodwill. Specifically, ■ Value drivers of the target company (e.g., does
we analyzed the most frequent types of intangible assets identified technology drive business or customer relationships)
and capitalized in the context of the total purchase price. ■ Potential synergies (buyer-specific vs. market
participant levels)
We assessed two distinct sub-industries: aerospace & defense and
government & technical services (“GTS”). Aerospace and defense ■ Market participant expectations regarding the intangible
is comprised of companies that support the commercial, military, assets (e.g., defensive value)
and general aviation markets (original equipment manufacturers ■ Structure of deal (e.g., asset vs. stock, contingent
are excluded from this analysis). GTS is comprised of companies consideration, etc.)
that provide technology applications, engineering, and technical
services and solutions to federal government agencies. Regardless of industry norms, any estimate of amortization must
be based on a keen understanding of the target company and
Impact on EPS ■ ■ ■ its value drivers. For example, most GTS companies do not
Although the level of amortization arising from a transaction report material allocation to trade names or technology, which
generally does not have a cash impact on the business, is reasonable since an acquirer’s focus is generally on gaining
companies are nonetheless often concerned with the earnings access to customer relationships/contracts. However, if a
per share (“EPS”) impact and potential dilution to current share target company has a proprietary technology related to cyber
price. Accordingly, the percentage of goodwill and identifiable security interests, then it is highly probable that the identified
intangibles relative to the total purchase price is an important intangible assets will include a higher level of technology-
aspect of any transaction that should be considered and related assets. Whether or not goodwill is impacted is uncertain,
understood prior to closing. Despite complex analyses required but without careful consideration to the critical value drivers
to accurately determine intangible asset allocation levels, a of a target company, any estimated impact on EPS will
buyer can explore certain key variables during the due diligence likely be significantly misstated; potentially making a deal that
process to help determine an initial assessment of the magnitude appears accretive actually dilutive once a final purchase price
allocation is completed.
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2. Financial Accounting Standards Board (“FASB”) Accounting The final structure and terms of a deal also impact the level of
Standards Codification (“ASC”) Topic 805, Business Combinations intangible assets and goodwill. Asset deals (or a 338(h)10 election)
(“FASB ASC 805”) and Topic 820, Fair Value Measurements and generally increase the purchase price (ceteris paribus) due to the
Disclosures (“FASB ASC 820”) alter the Fair Value definition ability to step-up the asset basis, which provides incremental tax
utilized in the purchase price allocation process to a more market- shields. As a result, overall goodwill may be higher in such deal
based measurement. Specifically, ASC 820 implies that expected structures. Furthermore, structuring an earnout payment adds
synergies must be allocated between “market participant” an additional layer of complexity under ASC 805. Deals prior to
and buyer-specific synergies. In developing market participant 2009 did not record a contingent consideration payment at the
assumptions, specific market participants need not be identified. time of closing but made an adjustment only upon payment.
Rather, characteristics that distinguish market participants Now, an earnout must be valued under the current regulations
generally should be identified, considering factors specific to and incorporated as additional consideration, thereby increasing
(i) the asset or liability, (ii) the principal (or most advantageous) goodwill in many circumstances (see “M&A Facilitators: The Value
market for the asset or liability, and (iii) market participants whom of Earnouts” on page 10 for details on valuing earnouts).
the reporting entity would transact within that market.
Another consideration is the multiple paid or the number of
As such, under FASB ASC 805, the acquirer must determine if any buyers involved in the process. A target company that has several
expected synergies are buyer-specific. To do so, an acquirer must interested buyers is more likely to see an escalation of bids and
establish who a market participant (and, thus, next likely buyer) generate a higher implied multiple on the deal. As the implied
is for the target. If the most likely buyers are other ADG industry multiple paid increases, the potential for a higher level of goodwill
participants, then most of the expected synergies may not be also increases. Of course, a company may pay a higher multiple
buyer-specific, since a competitive ADG company likely realizes for unique assets, but in many cases it relates to buyer-specific
similar synergies. As a result, the expected synergies represent synergies that would not translate into higher intangibles but
market participant levels and are credited to the seller. Such a would increase goodwill levels.
situation generates higher identified intangible asset values since
the forecasted synergistic cash flows must be used to value the Another interesting aspect to consider is the interaction between
intangible assets. Assuming that a likely market participant is a the level of amortizable intangible assets and period of
private equity firm with no established platform in the ADG industry, amortization. For example, a GTS company that acquires an
the private equity firm would probably not be able to realize similar intelligence community (“IC”) focused company may see a higher
synergies, thereby implying that the expected synergies are level of value ascribed to customer relationships or trade name,
specific to the buyer in the above scenario. Accordingly, the cash given the mission-critical nature of those agencies. One would
flows utilized in valuing the intangible assets would exclude the expect an increased dilution on EPS given the higher level of
buyer-specific synergies, resulting in a lower value for intangible amortizing intangibles versus goodwill. However, an offset to the
assets (and, thus, higher residual goodwill value assuming no higher level of intangibles might be a longer amortizing period.
change in purchase price). Given the highly specialized and essential nature of IC work,
customer relationships are often longer, and, therefore, could imply
The concepts of defensive value and the market participant a greater life on these customers than other, less mission-critical
perspective, which are new under ASC 805, could impact future customer relationships/contracts. Therefore, despite having a
intangible asset levels as compared to the industry levels illustrated higher asset value, the annual amortization could be consistent
in our study. Previously, if an acquirer planned to eliminate an with prior deals. On the other hand, a target company that has
intangible asset upon closing a deal, that asset was not identified a unique technology is likely to not only have higher intangible
and recorded on the books, thereby generating higher levels of assets but also an overall shorter amortization schedule since
goodwill. However, if a market participant (i.e., next most likely technology is generally a short-term asset in the GTS segment.
buyer) would retain that same asset, then, regardless of the
acquirer’s intent, that asset must be recorded. Given the likely The industry norms provided below illustrate the compilation of
market participants in the aerospace and defense industry, there a wide cross-range of deals. As such, they provide interesting
may not be a big differentiator between current and prior deals, data, but may not necessarily be useful in providing potential
but understanding this concept is important to verify that any amortization levels and resulting EPS impact of a specific deal.
estimate considers such a situation. Understanding the key drivers outlined above and how they may
impact the specifics of any particular target company provides a
more robust analysis and is less likely to generate large variations
upon finalizing the allocation.
2 ©2010

3. Percentage Allocation from PPA - Aerospace & Defense Sector
Dollars in Millions Identified Intangibles
Trade Names
Deal Price Customer and Non-Compete Fixed Working Fixed
(EV) Relationships Trademarks Technology Backlog Agreements Other Assets Capital Goodwill
Average $ 243.0 19.3% 6.9% 12.8% 2.2% 1.6% 0.7% 5.7% 13.4% 52.0%
Median $ 40.6 20.7% 6.5% 7.8% 2.1% 0.7% 0.7% 2.5% 12.0% 54.0%
Aerospace and Defense Breakdown ■ ■ ■ life of a platform in the aerospace and defense industry, which is
illustrated in the chart below. From design to maintenance, repair,
We found over 20 transactions completed within the past several and overhaul, most platforms last for over 30 years. For example,
years in which the acquirer disclosed the purchase price allocation. the Apache helicopter program has been in existence for over 30
The purchase prices ranged from $2.0 million to $1.8 billion, with years. A supplier on this platform can expect a very long cash flow
an average price of approximately $243 million. Goodwill was forecast, especially considering the long aftermarket or service tail.
recorded in nearly all of the transactions. On average, goodwill Valuing these assets can be difficult since long-term forecasts are
represented just over half of the total purchase price, while required but the acquirer generally only compiles an immediate-
identifiable intangible assets comprised 27%. The most significant term (five to ten year) forecast. In order to generate a long-term
tangible asset recorded was net working capital at an average of forecast, industry sources such as Forecast International or the
13% of the purchase price, while property, plant, and equipment OEMs production forecasts are utilized.
averaged 6% of the total purchase price. The key identifiable
intangible assets carved out of the purchase price were technology
(patented and unpatented), customer relationships, contract
backlog, trade names, and non-competition agreements. Platform Lifecycle
Servicing and
Patented and Unpatented Technology spare part revenues
(7x OE revenues)
Technology was most frequently identified as a key intangible
asset in 80% of the transactions that we reviewed. On average, Original
equipment
this asset represented 13% of the total purchase price. Technology revenues
assets in the aerospace and defense industry typically have very
long economic lives and consequently low depreciation, since the 0 5 40+ yrs
original equipment manufacturers are risk adverse and, therefore,
do not value constant change. In other words, most parts on Design & Test
airplanes (commercial, military, or general) are substantially the
same as what they were over 20 years ago. Most incremental
Contract Backlog
improvements on aircraft are targeted at electronics and materials
(lighter parts for greater fuel efficiency). A contract backlog was recorded in approximately 40% of the
deals we analyzed. The value of the backlog was not material,
Trade Names
comprising 2% of the purchase price. A contract backlog includes
Identified in approximately 70% of the transactions, trade names purchase orders or booked sales on orders that have not been fully
were the second most common asset identified in the purchase completed. Due to the contractual nature of the backlog, this asset
price allocation. However, the value of the trade names represented, can be recognized separately from goodwill.
on average, only 7% of the purchase price. Trade names in this
Non-compete Agreements
industry can be valuable, as a company’s name may resonate with
customers related to a long history of quality and reliability. Non-compete agreements were booked in roughly half of the
deals we analyzed, with the value comprising approximately 2% of
Customer Relationships
the total purchase price on average. Non-compete agreements are
Just over half of the acquirers recognized a “customer relationship” often booked but did not have significant value in the aerospace
asset. However, when recorded, the value of the customer and defense deals we analyzed. A low non-compete value is
relationship asset was the most significant out of all the intangible usually common in an industry with high barriers to entry (i.e., need
assets at approximately 20% of the purchase price. The relative a proven technology) and high customer switching costs (i.e., risk
value of the customers can be considerable given the economic adverse nature of the industry).
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4. Percentage Allocation from PPA - GTS Sector
Dollars in Millions Identifiable Intangible Assets
Trade Names Goodwill
Deal Price Customer and Non-Compete Working Fixed (including
(EV) Relationships Trademarks Technology Software Agreements Backlog Other Capital Assets Workforce)
Average $ 117.2 14.3% 4.9% 3.7% 0.7% 1.0% 3.6% 5.9% 9.4% 2.9% 70.5%
Median $ 66.4 13.4% 4.5% 2.6% 0.7% 0.4% 2.7% 1.9% 8.3% 1.0% 74.7%
Goodwill Other Intangible Assets
Goodwill was capitalized in essentially all of the deals we analyzed, Other identified intangible assets included non-compete
representing just over half of the total purchase price. Goodwill agreements, technology, and software. However, combined, these
can represent synergy value (now buyer-specific synergies only), represented only 5%, on average, of the total purchase price,
new platform opportunities, new technology (future state that is with a range between 1% and 13%. The low level seen for these
beyond in-process), and a trained workforce, among other items. assets is reasonable due to industry dynamics. Given contractual
terms, difficulty in getting selected on a contract vehicle, and other
GTS Breakdown ■ ■ ■ potential switching costs, the ability of one individual to materially
impact the target company is minimal. Therefore, the non-
The past several years have seen an active GTS M&A market. We
compete agreement value is generally de minimus. In addition,
analyzed publicly disclosed transactions in which the acquirer
most technology or software developed by GTS companies
disclosed sufficient data to assess the purchase price allocation.
is in connection with a contract and, therefore, owned by the
The table above provides the summary of the findings.
government agency. Accordingly, unless unique circumstances
Goodwill and customer-related intangibles (customer relationships exist at a particular target, these assets generally will not impact
and backlog) were recorded in every transaction. On average, the overall allocation.
goodwill represented an astounding 70% of the total purchase
price, while customer-related intangibles represented nearly 20%
Conclusion ■ ■ ■
of the total purchase price. The remaining 10% was a mix of fixed The information provided herein is a great starting point for
assets, working capital, and other intangible assets. estimating reasonable levels of amortization, which is a key input
in any accretion/dilution analysis. However, the acquirer must
Customer-Related Intangibles
perform due diligence on the potential intangibles to ensure that
Of the customer-related intangible assets, customer relationships/ differences do not exist between the overall industry and the
contracts were the primary identified intangible and averaged specific target. The evidence presented, however, does indicate
approximately 14% of the total purchase price, but ranged from a fair degree of goodwill and customer relationships in the ADG
a low of 4% to a high of 46%. Customer relationships/contracts industry, particularly for GTS companies.
were identified in all but one transaction. Despite representing
Jeremy Krasner, CFA is a Managing Director in the Valuation &
only approximately 4% of the total purchase price, backlog was
Financial Opinions Group at Stout Risius Ross (SRR). He specializes
recorded in 50% of the transactions, by far the second highest of
in corporate strategic planning, intangible asset valuation, goodwill
any intangible asset. The backlog, as reported by GTS companies,
impairment testing, and other tax, corporate, and litigation
simply illustrates the near-term funded nature of its customer
related matters. Mr. Krasner can be reached at 703.848.4959 or
relationships. Accordingly, in many situations, backlog is not
jkrasner@srr.com.
separable from the customer relationship/contract.
Dominic M. Brault is a Manager in the Valuation & Financial Opinions
Trade Names
Group at Stout Risius Ross (SRR). His experience includes valuation
Trade names were identified in approximately 25% of the of equity, debt, and derivative securities, as well as intangible assets
transactions, but represented only 5% of the total purchase price and private equity carried interests. Mr. Brault can be reached at
on average. Trade names in the GTS segment are generally not 216.373.2984 or dbrault@srr.com.
a big business driver as many acquired companies are either
co-branded or completely re-branded under the acquirer’s name.
4 ©2010