Retrospective on M&A performance in Defense


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My 2008 study from the SRI conference in Reston, Virginia on how various portfolio strategies had fared over the past decade.

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Retrospective on M&A performance in Defense

  1. 1. JAMES HASIK • 512-299-1269 • A retrospective on M&A performance in defense: some further (working) results Briefing to the SRI Aerospace & Defense Investors Conference The Hyatt Regency, Reston,Virginia • 19 March 2008 A long line of literature finds that mergers and corporate acquisitions are largely a waste of shareholder value for the acquiring firms, and frequently a net loss of value overall. More recent evidence, however, suggests that management is capable of serial learning in ongoing acquisition campaigns1, and that many companies may be improving their performance as acquirers, making smarter deals at better prices.2 Smaller firms (those in the bottom quartile of overall market value on the NewYork Stock Exchange) have also been found to be, across all sectors of the US economy, statistically better acquirers than large firms.3 In the arms industry, a further thesis holds that selected vertical integration can be important for taking advantage of the militarily and industrially transformational effects of advanced technologies for command, control, communications, comput- ing, intelligence, surveillance, and reconnaissance (C4ISR). Incorporating network- centric C4ISR technologies within the walls of a corporation, the argument holds, can efficiently exploit scope economies, internalize inefficiently leaky information, 1 Matthew L.A. Hayward,‘When do firms learn from the acquisition experience? Evi- dence from 1990–1995,’ Strategic Management Journal, January 2002, pp. 21–39. 2 See Sam Rovit & Catherine Lemire,‘Your Best M&A Strategy,’ Harvard Business Re- view, March 2003, pp. 16–17; and 3 Sara Moellner, Frederik Schlingemann, and Renee Stultz,‘Do Shareholders of Acquir- ing Firms Gain from Acquisition?’ National Bureau of Economic Research Working Paper #9532,August 2003 [introduction]
  2. 2. and fully expropriate the quasi-rents of specific intellectual assets (or, forestall shakedowns by the firm with greater power in the market).4 As retired French admiral Jean Bétermier argued at the ‘Euro-Forum’ of the Cen- ter for Strategic and International Studies (CSIS) in June 1999, NATO’s air cam- paign over Kosovo made the United States “material and technological dominance within the NATO alliance overwhelmingly apparent,” presenting a challenge to in- dustry worldwide to restructure to match these advances.The impact was felt in the United States as well.The strategic efficacy of the precision bombing campaign (if not its tactical effects), and apparent “irrelevance” of heavily armored ground forces (using the word of then-US Army Chief of Staff General Eric Shinseki), com- bined to call into question existing priorities in military procurement. In a speech at the Citadel that September, US presidential candidate George W. Bush stated that his administration would challenge the status quo and envision a new architecture of American defense for dec- ades to come.We will modernize some existing weapons and equipment, necessary for current tasks. But our relative peace allows us to do this selectively.The real goal is to move beyond marginal improvements – to replace existing programs with new technolo- gies and strategies, to use this window of opportunity to skip a generation of technology.5 The attacks of 11 September 2001 and the subsequent decision to depose Saddam Hussein rather interfered with this goal.A few years into the campaigns in Afghani- stan and Iraq, the demands of counterinsurgency had made clear that while ad- vanced C4ISR technologies would continue to be important, steel plating had en- during value. All the while, a wide range of arms makers, and particularly US-based defense con- tractors, continued to acquire firms large and small as they restructured the indus- try.While the nature of what was needed militarily changed, the pace of the indus- trial change did not abate. But did these efforts prove useful, and under which political-military conditions: the state of the world after the bombing of Kosovo, or that after in invasion of Iraq? Thus, I decided to ask whether systematic acquisition campaigns, particularly of firms with C4ISR technologies, can produce superior shareholder returns for defense contractors, or whether other approaches may be more financially rewarding. Testing requires methodology. Somewhat arbitrarily, I set a start date of 10 June 1999, the end of the Kosovo campaign, as the start of the real change in military force structure. Both the Task Force Hawk debacle and the 5th Allied Tactical Air Force’s relative inability to inflict significant damage onYugoslav forces on the bat- A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 2 of 18 4 For more on when these conditions apply for smaller defense contractors, see James Hasik, Arms & Innovation: Entrepreneurship and Alliances in the Twenty-first Cen- tury Defense Industry, University of Chicago Press, forthcoming,August 2008 5 See for the transcript.
  3. 3. tlefield indicated that something had to change across military forces, and both military officers and industrialists began thinking more seriously about how to do that. Next, I set an end date of 9 June 2006—seven years later, if only to ensure a good run of data. I further restricted the sample to quoted, US-based, defense hardware and software producers. I specifically excluded recently formed enter- prises, such as Rockwell Collins, for whom financial data do not reach back to 1999; companies focused on commercial markets, such as Boeing and Honeywell, whose value depends too greatly on matters outside the military realm; services specialists, which would not be subject to quite the same industrial network dy- namic; and largely European and Asian firms, which did not benefit as greatly from the huge run-up in US arms spending that US firms did. 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 LockheedMartin Boeing BAESystems NorthropGrumman Raytheon GeneralDynamics EADS L-3Communications Finmeccanica UnitedTechnologies Thales KelloggBrown&Root SAIC GeneralElectric Honeywell RollsRoyce ITT DCNS CSC AlliantTechsystems DRSTechnologies SAFRAN Saab BoozAllen MitsubishiHeavy Textron RockwellCollins AlmazAntei EDS Rheinmetall ArmorHoldings URS IAI HindustanAeronautics Dassault Qinetiq Goodrich Harris Elbit GKN KMW Oshkosh CACI Bechtel VT Cobham KawasakiHI Mantech Rafael MitsubishiElectric Nexter Diehl WashingtonGroup STEngineering BabcockInternational Batelle IndraSistemas BharatElectronics NEC EDO TacticalMissiles Fincantieri TheAerospaceCorp. JacobsEngineering Sukhoi Patria Irkut MiG Tenix Teledyne Cubic AAI UltraElectronics Russia’sHelicopters CurtissWright UfaEnginebuilding Ruag ARINC KoreanAerospace SevernayaShipyard AerospaceEquipment Meggitt CAE IMI Kongsberg Alion Bearingpoint BallAerospace IHIMarine Fujitsu KBInstrumentDesign Toshiba Rotem MMPPSalyut Orbital IHI Aselsan Komatsu AdmiralityShipyards Chemring As illustrated in the chart above, these restrictions reduced the sample set to just thirteen firms, for which the table on the following page provides some detail. While a disappointingly small sample, they remain, nonetheless, a diverse group of firms that undertook some 197 significant transactions over the course of the seven years in question.The data came from a wide range of sources, including news reports, press releases, and annual reports; though foremost from CRA In- ternational’s database of aerospace and defense industry transactions, which has been published for the past several years as a well-packaged chart.6 A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 3 of 18 6 An electronic copy is available at Largest military suppliers worldwide by 2006 military contracting revenues (US$ MM) less state- and privately-owned enterprises less foreign companies less services specialists less companies focused on commercial markets less recently formed companies [methodology]
  4. 4. Defense News rank for 2007 Company Symbol approximate 2006 defense revenues (US$ MM) reported 2006 total revenues (US$ MM) approx. market capitalization on 10 June 2006 (US$ MM) # of significant transactions, June 1999 to June 2006 1 Lockheed Martin LMT 36,090 39,620 29,786 16 4 Northrop Grumman NOC 23,649 30,148 22,094 20 5 Raytheon RTN 19,500 20,291 19,124 8 6 General Dynamics GD 18,769 24,063 25,710 27 8 L-3 Communications LLL 9,989 12,476 9,676 51 17 ITT ITT 3,659 7,808 9,009 12 20 Alliant Techsystems ATK 3,066 3,565 2,821 10 21 DRS Technologies DRS 2,736 2,821 2,074 17 31 Armor Holdings AH 1,898 2,361 2,100 5 60 EDO EDO 686 715 534 8 71 Cubic CUB 564 821 489 7 75 Curtiss Wright CW 549 1,282 1,391 16 95 Orbital Sciences ORB 321 803 895 0 197 Next, I calcu- lated returns to shareholders: not just share price apprecia- tion, but total returns, includ- ing reinvested dividends.As shown in the chart on the next page, those returns over the seven-year time interval can be broken into two categories, conveniently breaking into two equal groups at the level of 200 percent return on investment (which is shown in the chart as an indexed return of 300). Indeed, the best performers, DRS and Armor Holdings (recently acquired by BAE Systems), provided their shareholders more than a four-fold return over those seven years.The remainder in the top half includes Alliant Techsystems (ATK), Cur- tiss Wright (CW), EDO Corporation (EDO), and L-3 Communications (LLL).The bottom half, which still includes some firms with impressive financial performance, is comprised of Cubic (CUB), Orbital Sciences (ORB), Raytheon (RTN), Lockheed Snecma Gespac Integration Boeing Corinth facility Snecma Sabena Engine Service stake Teuchos Sopartech Sagem e-Software Leica Vectronix Morpho Systemes ARNAV Systems Sagem Aerospace and Defense Industry Restructuring (January 1992–December 2006) Aerospace Veritas Capital Montek Division to Moog E-Systems BAe Corporate Jets General Dynamics Applied Remote Technology Chrysler ESI &CTAS JPS Communications Honeywell ADS Australia Photon Research Associates UTD Virtual Technology Solipsys AlliedSignal Communications Hughes Aircraft Amber Engineering TRW LSI Products Optical Systems to Goodrich Sonobuoys to Ultra Electronics MMIC Operations to TriQuint Microwave & Power Tube Division to Litton Aircraft Services FBOs to Mercury Air Flight Training to L3 AIS to L-3 Texas Instrument DSEG RF Components to Fairchild Semiconductor Aerial Targets to Composite Engineering Systems Composite Products to Specialty Materials Fastening Systems to Platinum Equity Fuel Systems to Woodward Governor Turbine Engine Components to Utica Avco to Associates First Capital Textron Aerostructures to Carlyle Group Commercial Infrared to L-3 Ground EO/FPA to DRS Raytheon Racal Instruments to Thomas Weisel/JF Lehman Aeronautical Services to SAS Antennas to Co Avimo Group Experlan Global Control Arisem ADI stake Racal Electronics Sextant Avionique Raytheon Rediffusion Simulatio ADI Acoustics to JF Lehman High Tech Optic Candover Inves Thales Navigati Shah Capital Pa Shorts Missile Systems Alcatel Military Communications Magellan Altech African Defense Syste Wormald Technology Deutsche System Thorn-EMI Texen to Barco N.V. AlliedSigna Aerospatial Canada Thomson-CSF Finmeccanica Textron Fort Worth to LockheedElectronics mfg to Elbit/Crossroads Electronics to Carlyle Group Missile operations to Hughes Cessna Aircraft to Textron Lucent ATS Bath Iron Works Teledyne Vehicle Systems Lockheed Martin Defense/Armaments NASSCO Holdings Computing Devices International Galaxy Aerospace Primex Technology Santa Barbara Saco Defense GTE Government Systems Gulfstream Aerospace Space Systems to Martin Marietta Space Propulsion to Aerojet Applied Remote Technology to Raytheon Motorola IISG Eisenwerke Kaiserlautern Command System Advanced Technical Products Datron IMCO Steyr Spezialfahrzeug stake MAYA Viz Itronix Chamberlain Mfg Scranton facility Anteon FC Business Systems Datamat BAE Systems military and secure comms AMS Air Traffic Mgmt Tadpole Computer Engineering Technology Veridian GM Defense Creative Technology Digital System Resources TriPoint Global Spectrum Astro Aeronautics Services to Wyle Labs Airborne Electronic Systems to Astronics C4 Systems Interactive to KoolConnect Technologies General Dynamics Aeronautics & Transportation Testing to Calspan Propulsion Systems to L-3 Jeppesen Sanderson SBS International Conquest Frontier Systems Carmen Systems Aviall Hughes Space & Communications Preston Group McDonnell Douglas Alliant Marine Systems Magnavox Electronic Systems Litton Itek CAE Link GD Missile Ops Hughes St.Louis fabrication operations to GKN Sensors & Electronic Systems to DRS Rockwell Aerospace & Defense Litton Precision Gear Precision Gear to Derlan ACESII Ejection Seat to Goodrich de Havilland to Bombardier Information Services to SAIC ARGO Systems to Condor Civil helicopters to RDM Autometric Hawker de Havilland Flight Training to GECAS Avicom to Rockwell Hughes Aircraft to Raytheon Inertial Systems to Litton Rediffusion Simulation to Thomson-CSF Ordnance to ATK Spokane facility to Triumph Electron Dynamic Devices to L-3 Wichita/Tulsa facilities to Onex Rocketdyne to United Technologies Digital Cinema to AccessIT Flight Safety Boeing Training stake Continental Graphics On Demand Mfg to RMB Products Arnprior facility to Consolidated Industries Boeing Commercial Electronics to BAE Corinth facility to Snecma HughesBoeing Aeroframe Services to Linden Street Capital EADS Sogerma Services maintenance to TAT Group Sextant ATE SODERN Cogent Defense Systems Australian Aerospace Nortel Cogent Astrium stake Racal Instruments Dutch Space Talon Instruments IFR Sofrelog Nokia professional mobile radio Paradigm Comms stake Aerospatiale Matra DaimlerChrysler Aerospace Siemens Defense Electronics Matra Hautes Technologies Construccionnes Aeronauticas CAC Systemes Sycomore Giravions Dorand Aeroformation Elekluft Elektronik to Serco MTU to DiamlerChrysler CMS Group to Primex Dornier Luftfahrt to Fairchild Telefunken Sendertechnik to Tech-Sym Airport Systems to Honeywell Daimler-Benz Aerospace Aerospatiale Shur-Lok Group Special Metals Air Industries SPS Technologies Western Australia Specialty Alloys AE Turbine Components Precision Gear to Boeing Intevac E-OSystems Vought Aircraft Imo Electro Optics PRC PRC AEGIS Services to Tracor Teldix Racal Marine Avondale TASC Denro Weather Services to Landmark Communications Scaled Composites to Burt Rutan EADS Les Ulis naval and ground Overwatch Systems Innovative Survivability Technologies US Helicopter M&O Petroleum Helicopters Acadian Composites Carbide Technology helicopter skid shoe Interstar Technologies Hexcel EMT Material Logicon Westinghouse ESD Inter-National Research Sperry Marine SAI Technology Sterling Software Federal Systems Navia Aviation Comptek Research California Microwave ISD DPC Technologies Ryan Aeronautical Commercial Aerostructures to Carlyle Group Electron Devices & Displays to L-3 Newport News Shipbuilding Litton Industries Mannesmann Dematic Postal Network Six Aerojet EIS TRW XonTech Fibersense Technology Federal Data Corp Ferretec Teledyne Electronic Systems Fibercom Raytheon Microwave & PowerTube Precision Products to AlliedSignal ITEK to Hughes Hughes Inertial Systems SPS Magnetics to Audax Group Wyman-Gordon Titanium Castings to Ladish VEAM/TEC to ITT SciTec to mgmt Poly-Scientific to Moog Kester to American Capital Automotive to Blackstone Group Life Support to Cobham Cutting Edge Optronics LSI Products to Raytheon Electronic Products to ETA Technologies Aeronautical Systems to Goodrich Lucas Fabricated Systems to MB Aerospace Lucas Varity BDM International Astro Aerospace Pierburg Luftfahrtgerate Illgen Simula Confluent RF Systems Navigation & Space Sensors Canada to L-3 Winchester Electronics to Audax Group Teldix to Rockwell Collins Airtron Microwave Products to Cobham SiC Group to II-VI Motion Controls & Sonar Canada to Wescan Northrop Litton IndustriesTRW Integic Ten businesses Defense/Armaments to General Dynamics OAO Orincon Comsat Mobile to Telenor Electro Mechanical Systems to DRS LM Aerospace Electronic Systems to BAE Systems LM Control Systems to BAE Systems World Systems CDTI to Intelsat Comsat General to Intelsat Comsat General to Intelsat Comsat to World Data Unisys Defense Systems IBM Federal Systems LTV Missiles General Dynamics Space Systems Martin Marietta Lockheed Loral Defense Electronics Loral Space & Communications GE Engine Fabrica Militar de Aviones ACS Federal Commercial Solutions to ACS SYTEX Group Coherent Technologies INSYS Group STASYS SippicanAstrolink Loral Martin Marietta Lockheed GE Aerospace General Dynamics Fort Worth COMSAT Celerity Systems to Aeroflex Spar Aerospace Coleman Research Raytheon Flight Training EnvisoNet AlliedSignal Space & Navigation Interstate Electronics Aydin Microdyne ILEX Systems Satellite Transmissions System L-3 Communications SPD Technologies EER Systems KDI Precision Products Raytheon Aircraft Integration Aeromet PerkinElmer Detection SY Technology Emergent Government Services Bulova Defense MPRI Honeywell TCAS TrexCom LNR/EMP Electrodynamics Storm Control Center ESSCO Network Security to Symantec Hycor to Sippican Com-Cept TMA Westwood International Microwave Wescam Ship Analytics Northrop Grumman electron devices & displays AlliedSignal Ocean Systems Goodrich Avionics Systems Vertex Aerospace Nova Engineering TRL Electronics Nautronix Defence Crestview Aerospace SSG Precision Optronics CyTerra Advanced System Architectures SAM Electronics Sonoma Design Group Mobile-Vision InfraredVision Technology Ipicom Ipitek OYO Klein Associates EOTech Titan Joseph Sheairs Associates Applied Signal and Image Technology BAI Aerosystems General Dynamics Propulsion Systems Boeing Electron Dynamic Devices Pyramid Vision Video Security D.P.Associates Avisys Brashear Beamhit Northrop Grumman Navigation and Space Sensors Canada Cincinnati Electronics Raytheon Commercial Infrared Bombardier Military Aviation Services CAE Marine Controls JcAIR Test Systems to Aeroflex Avionics Systems to L-3 Engine Electrical Systems to Unison Hughey & Phillips Airport Lighting Marine Bearings to Duramax TRW Aeronautical Systems Sensors Unlimited Hella Aerospace Dana Glacier Bearings Air Science Engineering Humphrey REMEC Autoliv OEA Aerospace Raytheon Optical Systems Corning EO Sensors Advanced Creations IBP Aerospace EDO Barnes Boeing ACES II Ejection Seats ITHACO Space Systems Coltec AMMI Rohr Gulton Mark IV Lucas De-Icing Sheldahl Hoskins Aviation Lighting Technology Integration Weed Aerospace Emerson Rosemount Aerospace GE Specialty Heating & Avionics Power Abex ClevelandPneumatic Atlantic Instruments ATIS Carbine Universal Propulsion Goodrich neering bham EADS/ nologies ystems stake s Grimes Aerospace Banner Aerospace Operations Normalair/Garrett Tristar Aerospace Communications to Raytheon Ocean Systems to L-3 Trimble Air Transport Systems Mora Aerospace Chadwick-Helmuth Baker Electronics Silent Witness Quantum Laser AlliedSignal Honeywell Hermetic Aircraft to AAR TCAS to L-3 DASA Airport Systems Hughey & Phillips Smiths FOG Space & Navigation to L-3 Aerospatiale Canada to Thales DuPont Lanxide Composites GKN Hermetic Aircraft LORI Heat Exchange Northrop Grumman Precision Products ELAC-Nautik to AlliedSignal Advanced Circuits to TTM Advanced Composites to GE ADS Australia to Raytheon First Technology Safety & Analysis to HG Capital Indalex Aluminum Solutions to Sun Capital Partners Hymatic Group HoneywellAllied-Signal Aerospace & Defense to Boeing Rockwell Collins Teldix IP Unwired Anzus Evans & Sutherland simulation NLX Airshow Communication Solutions Kaiser Fluid Technologies to Tactair Fluid Controls Rockwell Scientific to Teledyne Kaiser Aerospace & Electronics Sony Trans Com Intertrade Flight Dynamics Hughes-Avicom Rockwell Automation Rockwell International United Technologies Microelectronics Center Snecma Grumman SMA stake Gear Systems to Triumph Vickers Defence Systems to Alvis Vickers Turbine Components to RBS Group Bristol Aerospace to Megellan Aerospace Rolls-Royce SAIC Data Systems & Solutions stake VT Controls INTERING BMW Rolls-Royce stake Vickers LucasVarity Geared Systems Allison Engine FAvS National Airmotive Opto-Electronics ALSTOM Gears David Brown Group Cessna Aircraft Edwards & Associates Drop Dies and Forgings UEF Aerospace Schlosser Casting Pittler Wyman-Gordon Marconi OTE Marconi Strategic Communications Telespazio AMS Italian facilities GKN AgustaWestland stake Forezio Aermacchi stake Houston Associates SVS TDA Armament stake Airbus stake Dynamic Process Solutions Get Electronique Les Ulis naval and ground to Safran Pacific Architects and Engineers Savi Technology ISXMagnet-Motor SafeView TCS Design and Management Services Raytheon ThalesGeneral DynamicsBoeing EADS Northrop GrummanLockheed Martin Precision Castparts Safran TextronFinmeccanica L-3 CommunicationsGoodrich Honeywell Rockwell Collins Rolls-Royce Precision Castparts anica A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 4 of 18 The 13 firms in the sample, and a detail from CRA’s A&D restructuring chart.
  5. 5. Martin (LMT), Northrop Grumman (NOC), General Dynamics (GD).The median performer over the long haul was ITT (ITT), as it was, curiously, in each of the three shorter time spans over which I tested. As is visually evident in the chart above, shareholder returns moved in three phases: (I) From the end of the Kosovo campaign until 11 September 2001, during which all issues but ORB and RTN provided positive returns.Amongst the former, EDO and DRS provided returns of roughly 200 percent. I will relate the reasons for these two cases later. (II) From 11 September 2001 until the invasion of Iraq, during which most is- sues provides large returns quickly, but then provided negative returns in the throughout most of 2002. Initial presumptions about a huge surge in US defense spending were deflated by the routing of the Taliban from the popu- lated areas of Afghanistan.The easy victory, many assumed, would preclude a large military build-up. (III) From the invasion of Iraq until the end of the analysis period. Every single issue in the sample of thirteen provided positive returns in this period, though Cubic’s were lackluster (11 percent in total over 3.22 years), and Armor Holdings’s were particularly impressive (422 percent in the same time period). Next, I quantified the degree of serial acquisitiveness. I did this rather bluntly, by A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 5 of 18
  6. 6. measuring the value of the acquisitions, less the top three acquisitions, to the overall ending value of the enterprise. I screened out the top three to remove the big-bang effect of deals like Northrop Grumman’s acquisition of TRW: while these are important transactions, I intended to test whether acquiring a large number of smaller firms would provide better returns than a relatively unacquisitive program. I further classified the firms by their ending market capitalization in order to judge their performance by size. Using the ending value for market capitalization could be criticized, but the results indicate that the approach only biased the effect to- wards larger firms, and against the thesis articulated above. The result over the entire seven-year interval, as shown in the chart above, sug- gests that superior returns amongst US-based defense contractors, at least in the longer run, are connected with serial acquisitiveness and and small-to-mid-sized market capitalizations, which I have somewhat arbitrarily set here to mean any- thing less than $15 billion in June 2006.To test for a statistical difference between the performance of the firms that were serial acquirers, and the rest of the sam- ple, I used the Mann-Whitney-Wilcoxon test, a non-parametric evaluation as to whether two samples came from two different distributions. In this case, the test A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 6 of 18 [results]
  7. 7. result exceeds the 98 percent confidence level for differentiation.The result may not be authoritative, but it is certainly very suggestive. I then tested the re- turns performance of the firms in the sam- ple over two shorter runs, intervals (1) + (II) and (III).Testing over intervals (I) and (II) separately seemed unreason- able, as the time in- volved would not necessarily be enough in which to capture the benefits of an acquisition, much less a series of them.As shown in the chart above, over these first two intervals, the period between the end of the campaign in Kosovo and the invasion of Iraq, shareholder value did go on some wild rides. That value, however, was not so strongly connected to the acquisitiveness, whether by smaller or larger firms in this case. In this case, I need not dis- tinguish between the acquisitive mid- cap and acquisitive large-cap firms sim- ply because there were none of the latter over this time span.There were more than few strong financial performers, but several of them made rather few acquisitions, and for rather little value as a percentage of the firm’s total value.At the same time, at least one highly acquisitive firm, General Dynamics, dropped 16 percent of its A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 7 of 18
  8. 8. shareholders’ value.The company was then (as it is to a degree now) heavily in- volved in shipbuilding and armored vehicle manufacturing, but these were at the time supposedly the weapons of the Cold War. Overall, the Mann-Whitney Wil- coxon result at the 86 percent confidence level is not enough to lead us to a con- clusion about a short-run connection between acquisitiveness and shareholder value. The third interval similarly shows dis- tinct share perform- ance behavior, as noted in the chart at left. However, as shown in the lower chart, performance had even less to do with acquisitiveness in this interval: the test provides just 64 percent confidence of a connection. The same sample can also be tested, over these two time frames, for a link between shareholder value and simple ac- quisitiveness, whether by firms large of small. Over- all, as indicated in the table on the next page, the data in our admittedly limited sample suggest that superior shareholder returns correlate well to serial acquisi- tiveness over the longer term (the generally accepted 95 percent confidence limit is almost met), but particularly well to serial acquisitiveness over the long run by smaller firms. A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 8 of 18
  9. 9. Time frame for the thirteen-firm sample Test for superior re- turns and serial ac- quisitiveness Test for superior re- turns and serial ac- quisitiveness plus mid- sized market capitali- zation Kosovo to Iraq (June 1999 to March 2003) 86% reject 86% reject Iraq to Iraq +3 (March 2003 to June 2006) 47% reject 64% reject Kosovo to Iraq +3 (June 1999 to March 2006) 94.95% almost accept 98% accept With such a limited sample set, I next looked case-by-case at the five serial acquir- ers that performed best over the long run:ATK, CW, DRS, EDO, and LLL.As shown in the chart below, their shareholders experienced gains in seven years of at least 217 percent (representing a compound annual growth rate of 11.7 per- cent), and as much as 514 percent (representing a CAGR of over 26 percent). These are thus five outstanding cases of arms makers which created shareholder value, but whether this value has been increased substantially by their acquisitions, and just how those acquisitions have contributed to this growth, are yet other questions. Is the network-centric thesis viable here, in an amalgam of scope effi- A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 9 of 18 Results of the Mann- Whitney-Wilcoxon tests over varying time frames and firm sizes Financial performance of the five most suc- cessful serial acquirers in the sample over the long run
  10. 10. ciencies and informational synergies, or has something more pedestrian, if just as economically valuable, been at work? To get at this, we should peer under the hood, as closely as we can at least, at the specific acquisition campaigns. In the first example,ATK bought a few select firms to reinforce growing businesses with precision, composite, and hypersonic tech- nologies.The chart below illustrates at what point the companies were purchased as ATK’s returns to its owners rose. ATK’s acquisitions were not completely homogeneous.Thiokol Propulsion diversi- fied the company’s activities into building launchers for space satellites, but Sport- ing Equipment merely brought new, civil ammunition customers to a company that already produced large quantities of similar products for military ones. Later on, the purchases of GASL, Microcraft, Mission Research, and PSI Group were in- tended to reinforce ATK’s hypersonics and space satellites businesses, but their long-term value to the company may be yet to be seen. For while it is difficult to correlate ATK’s shareholder returns to specific lines of expected customer spend- ing, the chart does indicate how ATK’s returns broadly match the rise in spending on munitions by the Pentagon in those categories in which ATK is competitive. Curtiss Wright, as the next chart illustrates, engaged in a four-year, ongoing acquisi- tion campaign to reinforce its flow control and motion control businesses. Serious serial activity started just after the September 2001 attacks, and continued until the spring of 2005.The deal team was thus busy, and particularly busy with US companies, but hardly at all in what CRA’s database classified as the computing and electronics (C&E) sector. Rather, Curtiss Wright was busy buying up companies A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 10 of 18 [cases]
  11. 11. that make systems for aircraft and ships, which one might not expect to be the dominant growth sectors in the midst of a land war in Asia. Similarly, DRS seems to have pursued acquisitions as an ongoing, periodic, corpo- rate development activity.The company purchased a wide set of companies, and considerably focused on US firms in the C&E sector.Acquisitions began earlier and ended later for DRS than for either ATK or CW. Acquisitions were also pursued not just when shareholders were doing well, but as the value of their investment was falling significantly in 2002. If nothing else, the pace indicates particular confi- dence within DRS’s senior management and deal team as to the soundness of their strategy and their judgement. A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 11 of 18
  12. 12. EDO was the most open about its objectives, noting in its 2003 annual report that its acquisition campaign was aiming at “diversifying the base of major platforms and customers”. Overall, the company was far less acquisitive in terms of the number of individual firms it bought, but it did buy rather larger entities — before it was acquired itself by ITT, another company in the sample. On its own, it is unclear what this indicates, but EDO’s example does not lend support to the network- centric hypothesis. Much of the company’s positive returns to shareholders were achieved in 2000, well before the large increases in military spending, when it won several important contracts for the supply of systems for military aircraft such as the F-35 Lightning II and the Eurofighter.The company subsequently purchased a range of firms with skills that were not obviously complementary to its own—save for Emblem Group, a British supplier of weapons release systems for military air- craft.While teasing out the effect of this purchase on the value of the company would be very difficult, the timing is graphically intriguing. Finally, LLL has been the poster child for serial acquisition campaigns, treating ac- quisition as a defining corporate competency since its formation in early 1997. In the seven years in consideration, LLL undertook 57 acquisitions for roughly $2.86 billion dollars. Of those transactions, 88% were of primarily US-domiciled firms, and 57% of them have been in the C&E sector. LLL’s approach may be the most significant anecdotal impeachment of the network-centric thesis.This is not be- cause of what companies LLL bought, but what it did with them afterwards. LLL was designed and run largely as a holding company, a financial acquirer that sought out undervalued assets in defense contracting, making its money on a better un- derstanding of the domain knowledge of armaments than was possessed in the market as a whole. For years, this seems to have worked very well, though notably, since the death of co-founder and CEO Frank Lanza, the company has completely shifted gears, acquiring very little, and making some effort to integrate its holdings into more somewhat more closely organized business units. A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 12 of 18
  13. 13. Reviewing the patterns of acquisition in aggregate, it is clear that these five firms had quite different approaches strategically. Only EDO concentrated on acquiring firms in the C&E sector, but several of these acquisitions were of firms with sig- nificant positions as subcontractors in the Navy-Marine Corps Intranet program, an interesting place to want to be, and not one deeply embedded in tactical C4ISR systems.With some of its acquisitions,ATK was buying capabilities for precision weapons that it wished to develop, but even this is a bit afield from the network- centric thesis, as it was articulated above. Regarding the common success of these varying approaches, we cannot rule out the financial explanation: the possibility that the management of firms like L-3 are simply better are recognizing underval- ued assets than the average actor in the market. Company Index of returns # of deals, less top 3 # in the C&E sector % in the C&E sector Cost in US$ B ATK 317 10 2 20% 0.39 CW 331 21 6 29% 0.37 DRS 614 17 10 59% 0.36 EDO 376 6 5 83% 0.08 LLL 331 57 32 57% 2.86 Finally, we should consider the two relatively unacquisitive mid-cap firms with dia- metrically opposed results for shareholders,Armor Holdings (AH) and Orbital A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 13 of 18
  14. 14. Sciences (ORB).The gap in performance, illustrated below, is visually striking, and neither firm was remarkably acquisitive over the period of the study. First, looking back even further in time, we may note that ORB performed poorly over the fourteen years preceding the endpoint of the study.The chart below shows ORB’s share price in US dollars, which is slightly more informative, but only because the company has never split its shares or paid a dividend. From 1992 to 1997, ORB was a dedicated acquirer, pulling in some well known names in the space industry, particularly Fairchild, Magellan, and MacDonald Dettwiler. In 1998 and 1999, the value of the company’s shares twice spiked and A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 14 of 18
  15. 15. fell precipitously. In 2000, the share price relatively collapsed, and ORB’s manage- ment resolved to overhaul its strategy, refocusing the company on its original mis- sion of building satellites and light launch rockets.Almost immediately after the announcement of the intent to divest MacDonald-Dettwiler, the largest acquisi- tion, the company’s shares began recovering. Indeed, between that point and the end of the period of the study, ORB’s shareholders experienced a ten-fold return on their investment. AH’s performance was spectacular, but only started after the campaign in Iraq got underway, and was substantially attributable to a single acquisition and burgeoning requirements for counterinsurgency kit. In particular,Armor Holdings purchased O’Gara-Hess & Eisenhardt in the middle of 2000, at a time when almost no one expected that ‘up-armored’ Humvees would be in such high demand.As shown in the chart below,Armor Holdings’ returns to its shareholders compare rather well visually with an index of the quarterly fatalities amongst US troops who were rid- ing in unarmored vehicles in Iraq.7 Only after its stock became so much more valuable did Armor Holdings begin acquiring companies and consolidating the mili- tary vehicles and armoring industries (before itself being acquired by BAE Systems in 2007).Thus, whether by particular prescience or just plain luck,AH’s returns depended not on an overall acquisition campaign, but with a single successful move. While the sample set is small and the evidence still circumstantial, these seven case studies do suggest that systematic acquisition activity can pay off in defense con- tracting, with some conditions and caveats: A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 15 of 18 7 For more detail, see James Hasik, Professional Grade:A working paper on recent fatalities in military vehicles in Iraq and Afghanistan, 31 October 2006 (revision 3.1), available at
  16. 16. ✦ The long run matters. Financial returns to acquisition that outdo those of other defense contractors only appear convincingly in the seven-year view, and not in either of the two roughly three-and-a-half year views.This suggests that for all the repetition, in lists of best practices in acquisition, that integration begin immediately, time is required for the benefits to appear. It also suggests that either the financial markets as a whole were not valuing these acquisition campaigns correctly, or that the actual value of the acquisitions simply did not appear for several years after the firms were acquired. If the latter is true, the time horizons of the financial models that strategic planners use for evaluating acquisitions may need some elongation. ✦ It’s not how many, but how much may matter. Over the seven years of the study, L-3 made 51 significant acquisitions, Curtiss Wright 21, DRS 17,Alliant Techsystems 10, and EDO just 6.All performed well financially, but the com- mon thread was the value of the transactions (less their three largest) to the ending market value of the companies.This suggests that the lumpiness of the intake was not so important as the overall substance of what was being ac- quired.Whether the skills, technologies, or access to customers being acquired arrived in one company or ten, a certain volume was beneficial. ✦ There is no single path.The difference in the approaches to acquisition of L-3 Communications and Armor Holdings is wide, and in between lie Curtiss Wright, DRS, and EDO.All were successful companies and particularly, suc- cessful acquirers. More so, and somewhat in opposition to the preceding point, Orbital Sciences’ divestitures indicates that the right scope of activities is not necessarily ever-wider. It is notable that Orbital’s success only came after con- siderable disappointment to its shareholders, and in the end, produced less than a five percent return in fourteen years.All the same, its strategy was just as much a conscious effort at portfolio shaping as that of Alliant Techsystems or EDO. ✦ Management is a heterodox and limited resource.That is, several of the com- panies in the study concentrated their acquisition activities in a few industrial sectors that were particularly complementary to their own existing skills. L-3 Communications stands out as the singular firm that performed well while diversifying into a wide range of business segments, but its management team was specifically assembled for the purpose.As noted above, while Frank Lanza was in charge, the company relatively limited the integration of its acquisitions to horizontal efforts at shared services and common technological develop- ment.As he said at the 2001 Paris Air Show,“we don't want to be a systems integrator; there are enough of those in the world... we’re the Sears catalog.”8 While L-3 performed very well extending itself into a wide range of compo- A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 16 of 18 8 John Morris,‘On the Record with Frank Lanza, Chairman and CEO, L3 Com- munications: Contrarian L3 Specializes in Specialization,’ Aviation Now, 20 June 2001. [observations]
  17. 17. nent businesses, Orbital only thrived by returning to the knitting with its highly integrated products: satellites and their launchers. Moreover, it is notable that the larger companies in the original sample of thirteen — General Dynamics, Lockheed Martin, Northrop Grumman, and Raytheon — all underperformed the smaller firms.Whether the problem is one of scale or scope, it does pose an uncomfortable question about the limits of managerial attention in such large defense contractors. So much for the observations.As did the earlier iteration of this study (as pre- sented in September 2007), this work does present some questions for further study: ✦ Can the benefits of systematic acquisition activity be sustained over the even longer run? This study favorably compares performance over seven years to that over three, and through several dissimilar secular political-military cycles. That said, it is unclear how long any particular strategy should be sustained, and I have not tested the ability of individual management teams to sustain the success of even adaptive strategies over time.This would be a methodologi- cally challenging question to pursue. ✦ Is acquisition necessarily a better strategy? While the emphasis of this briefing is on acquisition, the example of Orbital Sciences shows its limits. Portfolio shaping, after all, runs in both directions. Indeed, the most successful effort at portfolio management in defense contracting was probably that of General Dynamics’ great sell-off in 1993. Shares of GD returned 53 percent (including dividends) between 1 January and 31 December of that year, all while the company was divesting six significant divisions, including its missiles, electron- ics, and fighter aircraft operations.This is significant because at some point, large firms can become overburdened by the breadth of their activities. ✦ How do margins change as smaller firms are consolidated? Indeed, briefings at this and other conferences have observed that smaller defense contractors tend to achieve higher margins on sales than larger contractors. Since the ef- fect seems widespread, one may wonder whether this is attributable to some scale or scope diseconomy in defense contracting. Ceteris paribus, higher mar- gins lead to higher valuations, so we should be asking whether the margins of smaller acquired entities survive the acquisition process. Since the public re- porting of their financial data is lost in the acquisition, this would also be a methodologically challenging question. ✦ Is M&A really the new IR&D? Spending by defense contractors listed in the US on independent research & redevelopment (IR&D) remains historically low. Still, innovation continues, funded partly by customers and partly by entrepre- neurs.Acquiring innovative, entrepreneurial firms, then, can be both an ex ante and an ex post form of technological investment.The acquired organizations may obtain easier access to financing internally than in the capital markets, and future waves of entrepreneurs see acquisition as the liquidity events that spur A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 17 of 18 [questions]
  18. 18. their efforts.We might examine, then, which large contractors are doing this most effectively, and with which strategies. ✦ What are the organizational strategies that maximize the financial perform- ance of acquisitions in defense contracting? This view of the industry tests firms’ financial performance, but it does little to examine the reasons that one company’s acquisition strategy outperforms another’s over the long haul.As the preceding question regarding IR&D asks, acquisition may be spurring finan- cial success by providing access to important new technologies, but it may not always be the best approach for gaining this access. This last question, of course, is the subject of a much longer study that I have al- ready completed, and that will be published this August. James Hasik is a consulting business economist. He is Senior Defense Consultant to CRA International, and a member of the Council on Emerging National Security Affairs (CENSA). He holds an MBA (1997) in finance and applied economics from the University of Chicago, and is the author of the forthcoming Arms & Innovation: Entrepreneurship & Alliances in the 21st Century Defense Industry (University of Chicago Press,August 2008) A retrospective on M&A performance in defense: some further results JAMES HASIK • • page 18 of 18