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Retrospective on M&A Performance in Defense



A retrospective on M&A performance in defense: some further (working) results. A...

A retrospective on M&A performance in defense: some further (working) results. A
briefing to the SRI Aerospace & Defense Investors Conference at the Hyatt Regency, Reston, Virginia, 19 March 2008



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Retrospective on M&A Performance in Defense Retrospective on M&A Performance in Defense Document Transcript

  • JAMES HASIK www.jameshasik.com • 512-299-1269 • jhasik@jameshasik.com 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 [introduction] prices.2 Smaller firms (those in the bottom quartile of overall market value on the New York 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, 1Matthew 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
  • A retrospective on M&A performance in defense: some further results 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 on Yugoslav forces on the bat- 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 http://www.citadel.edu/pao/addresses/pres_bush.html for the transcript. JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 2 of 18
  • A retrospective on M&A performance in defense: some further results 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- [methodology] 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. 40,000 35,000 Largest military suppliers worldwide 30,000 by 2006 military contracting revenues (US$ MM) less state- and privately-owned enterprises 25,000 less foreign companies less services specialists 20,000 less companies focused on commercial markets less recently formed companies 15,000 10,000 5,000 0 Lockheed Martin Boeing BAE Systems Northrop Grumman Raytheon General Dynamics EADS L-3 Communications Finmeccanica United Technologies Thales Kellogg Brown & Root SAIC General Electric Honeywell Rolls Royce ITT DCNS CSC Alliant Techsystems DRS Technologies SAFRAN Saab Booz Allen Mitsubishi Heavy Textron Rockwell Collins Almaz Antei EDS Rheinmetall Armor Holdings URS IAI Hindustan Aeronautics Dassault Qinetiq Goodrich Harris Elbit GKN KMW Oshkosh CACI Bechtel VT Cobham Kawasaki HI Mantech Rafael Mitsubishi Electric Nexter Diehl Washington Group ST Engineering Babcock International Batelle Indra Sistemas Bharat Electronics NEC EDO Tactical Missiles Fincantieri The Aerospace Corp. Jacobs Engineering Sukhoi Patria Irkut MiG Tenix Teledyne Cubic AAI Ultra Electronics Russia’s Helicopters Curtiss Wright Ufa Enginebuilding Ruag ARINC Korean Aerospace Severnaya Shipyard Aerospace Equipment Meggitt CAE IMI Kongsberg Alion Bearingpoint Ball Aerospace IHI Marine Fujitsu KB Instrument Design Toshiba Rotem MMPP Salyut Orbital IHI Aselsan Komatsu Admirality Shipyards 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 6 An electronic copy is available at http://www.crai.com JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 3 of 18
  • A retrospective on M&A performance in defense: some further results Defense approximate reported approx. market # of significant News 2006 defense 2006 total capitalization on transactions, rank for revenues revenues 10 June 2006 June 1999 to 2007 Company Symbol (US$ MM) (US$ MM) (US$ MM) 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 Aerospace and Defense Industry Restructuring Next, I calcu- (January 1992–December 2006) lated returns to The 13 firms in the Boeing EADS Finmeccanica General Dynamics Goodrich shareholders: Honeywell L-3 Communications Lockheed Martin Northrop Grumman Precision Castparts Raytheon Rockwell Collins Rolls-Royce Safran Textron Thales sample, and a detail Aviall maintenance to TAT Group stake Les Ulis naval and EADS Sogerma Services Airbus ground to Safran not just share Nova Engineering Pacific Architects and Engineers Virtual Technology IP Unwired EADS Les Ulis naval and ground Overwatch Systems ADI stake SVS from CRA’s A&D First Technology Safety & Winchester Electronics Special Metals Rockwell Scientific Anzus Innovative EADS/ Get Electronique Dynamic Chamberlain Mfg Crestview Aerospace TRL Electronics to Audax Group to Teledyne SAIC Data Systems Fastening Systems Thales Navigati nologies Scranton facility Analysis to HG Capital Nautronix Defence Savi Technology Survivability to Platinum Equity Shah Capital Pa Sofrelog Process SSG Precision Optronics & Solutions stake Technologies Carmen Systems Anteon Magnet-Motor price apprecia- Solutions CyTerra ISX Evans & Sutherland simulation Interstar Technologies IFR Datamat Indalex Aluminum Solutions Advanced System Architectures SafeView Houston Associates FC Business Systems to Sun Capital Partners SAM Electronics TCS Design and Management Services Dutch Space Sensors Unlimited Shur-Lok Group Arnprior facility to EOTech Applied Signal restructuring chart. Consolidated Industries Titan and Image Technology Coherent Technologies Confluent RF Systems TDA Armament stake Talon Instruments Itronix UTD SMA stake Aeroframe Services to Tadpole Computer Joseph Sheairs Sonoma Design Group US Helicopter M&O High Tech Optic Linden Street Capital BAE Systems military Associates INSYS Group Candover Inves tion, but total C4 Systems Interactive to JcAIR Test Systems Mobile-Vision Rocketdyne to United Technologies and secure comms MAYA Viz KoolConnect Technologies CAE Marine InfraredVision Technology Teldix to Teldix On Demand Wichita/Tulsa facilities to Onex to Aeroflex SYTEX Group Rockwell Collins Air Industries Sagem Snecma AMS Air Controls Mfg to RMB Nokia professional Traffic Mgmt Airborne Electronic Boeing Electron Dynamic Devices anica Products Electron Dynamic Devices to L-3 Systems to Astronics Propulsion Systems to L-3 General Dynamics Propulsion Systems mobile radio AMS Italian facilities STASYS Integic Racal Instruments Aeronautics Services Aeronautics & Transportation BAI Aerosystems Cincinnati Electronics Navigation & Space SPS Magnetics Commercial Infrared to L-3 GKN AgustaWestland stake to Wyle Labs Testing to Calspan Astrolink Sippican Sensors Canada to L-3 to Audax Group Pyramid Vision Video Security Gespac Integration returns, includ- Boeing Commercial Raytheon Commercial Infrared Comsat Electronics to BAE TriPoint Global Engineering Technology Northrop Grumman Photon Research Associates D.P. Associates General Petroleum Helicopters Acadian Composites Acoustics to Frontier Systems Navigation and Space to Intelsat JF Lehman neering Spectrum Astro Avisys Sensors Canada e-Software Brashear Kester to American Capital SPS Technologies Gear Systems Digital Cinema Hymatic Group Beamhit to Triumph Arisem to AccessIT NLX ARNAV Systems Illgen Simula ing reinvested s Steyr Spezialfahrzeug stake Vertex Aerospace RF Components to Aerial Targets to Corinth facility Silent Witness Celerity Systems to Aeroflex ACS Federal Fairchild Semiconductor Composite Engineering Digital System Resources Ipicom Ipitek Commercial SciTec to mgmt Boeing Corinth facility to Snecma Datron IMCO OYO Klein Associates Solutions to ACS VT Controls Forezio Aermacchi stake Comsat General ystems stake ADS Australia to Raytheon to Intelsat Astrium stake Veridian Bombardier Poly-Scientific to Moog Life Support to Cobham Antennas to Co Aeromet Military Honeywell ADS Australia Conquest Creative Technology Aviation Services Orincon XonTech Automotive to Blackstone Group Marconi OTE Avionics Systems to L-3 Leica Vectronix dividends. As Spokane facility to Triumph GM Defense Baker Electronics Goodrich Avionics Systems VEAM/TEC to ITT Paradigm Comms stake Ship Analytics Solipsys Carbide Technology helicopter skid shoe bham Wescam World Systems Aeronautical Space Propulsion to Aerojet Advanced Circuits to TTM International CDTI to Intelsat Fibersense Technology Vickers Defence Services to SAS Marconi Strategic Communications JPS Communications Systems to Alvis Flight Safety Boeing Training stake Eisenwerke Microwave Northrop Grumman Electron Devices & Displays to L-3 Airshow Mora Aerospace Westwood Kaiserlautern Command electron devices & displays Comsat to System TRW Aeronautical Systems Com-Cept TMA World Data TRW Motion Controls & Sonar Kaiser Fluid Ordnance to ATK Telespazio Technologies to shown in the Chadwick-Helmuth Raytheon Aircraft Aeronautical Canada to Wescan AIS to L-3 Comsat Mobile Western Australia Specialty Alloys Tactair Fluid Controls Advanced Technical Products Integration Systems to Snecma Sabena Systems Composite to Telenor Goodrich Engine Service stake Products to SY Technology Communication Experlan Nortel Cogent PerkinElmer Detection Newport News Shipbuilding Solutions Specialty Materials Global Control Sensors & Electronic Systems to DRS Advanced Composites to GE Spar Aerospace Rockwell Electro Mechanical SiC Group to II-VI Turbine Engine Motorola IISG Hella Aerospace Emergent Government Services Systems to DRS Automation Components to Utica SBS International Aerojet EIS Racal Instruments to Trimble Air Transport Systems Bulova Defense Network Teuchos Thomas Weisel/JF Lehman chart on the Santa Barbara Australian Aerospace Dana Glacier Bearings EnvisoNet OAO Six Airtron Microwave Litton Industries Rockwell Galaxy Aerospace Products to Cobham INTERING Opto-Electronics Aerospace Co. to Collins Magellan Hawker de Havilland Cogent Defense Systems Air Science Engineering KDI Precision Products Veritas Capital Saco Defense EER Systems Mannesmann Dematic Postal Drop Dies and Forgings Avimo Group St. Louis fabrication Primex Technology Humphrey REMEC Texen to Barco N.V. operations to GKN Autoliv OEA Aerospace Coleman Research LM Aerospace Electronic Optical Systems Vickers Turbine Jeppesen Sanderson Quantum Laser Cutting Edge Optronics Scaled Composites to Goodrich Construccionnes MPRI Systems to BAE Systems Components next page, those returns over the seven-year time interval can be broken into two to Burt Rutan Kaiser Aerospace Sopartech Racal Electronics Aeronauticas Raytheon Optical Systems Hermetic Aircraft to AAR Federal Data Corp to RBS Group Continental Graphics Corning EO Sensors Weather & Electronics Autometric Hughes MTU to DiamlerChrysler Raytheon Flight Training Sterling Software Federal Systems Services Advanced Creations TCAS to L-3 COMSAT Navia Aviation to Landmark UEF Aerospace Flight Training to L3 Hughes Space & Finmeccanica Comptek Research Sony Trans Com Communications DaimlerChrysler Aerospatiale Honeywell TCAS Communications Aerospace Matra IBP Aerospace BMW Rolls-Royce stake Shorts Missile Systems Tristar Aerospace LM Control Systems Commercial Aerostructures Wyman-Gordon Precision Gear to Derlan Network Security to Symantec to Carlyle Group EDO Barnes to BAE Systems categories, conveniently breaking into two equal groups at the level of 200 percent GTE Government Systems Space & Navigation to L-3 TrexCom LNR/EMP CAC Systemes Boeing ACES II Ejection Seats Wyman-Gordon FAvS National Airmotive ADI ACESII Ejection Seat to Goodrich Elekluft Elektronik Aerospatiale Canada to Thales Pierburg DPC Technologies Avondale Titanium Castings to Serco AlliedSignal Space Luftfahrtgerate to Ladish Intertrade Edwards & Associates Preston Group ITHACO Space Systems & Navigation Information Services to SAIC AlliedSignal Honeywell Ryan Aeronautical Vickers AlliedSigna Matra Hautes Coltec Interstate Electronics Aerospatial Technologies Lucas Fabricated California ALSTOM Gears Canada ARGO Systems to Condor Gulfstream Aydin Systems to Denro Flight Dynamics Microwave ISD return on investment (which is shown in the chart as an indexed return of 300). Aerospace Normalair/Garrett MB Aerospace AMMI Microdyne Lucas Varity Avco to Altech African Defense Syste Civil helicopters to RDM Associates First Capital DuPont Lanxide Composites Astro Aerospace Sextant Avionique CMS Group to Primex Universal Propulsion Electrodynamics Ground EO/FPA to DRS GKN Hermetic Aircraft TASC Airport Systems NASSCO Holdings DASA Storm Control Center ESSCO AlliedSignal David Brown Group Alcatel Military Flight Training to Honeywell Communications to Raytheon Airport Inter-National Communications Communications Hycor to Sippican SPD Technologies Indeed, the best performers, DRS and Armor Holdings (recently acquired by BAE to GECAS Systems Research Sonobuoys to Ultra Electronics Siemens Defense Sycomore Computing Devices International Fuel Systems to Electronics AlliedSignal Ocean Systems Montek Division to Moog MMIC Operations Woodward Governor Ocean Systems to L-3 Hughey & Phillips to TriQuint ILEX Systems Schlosser Casting Hughes-Avicom Avicom to Rockwell Banner Aerospace Operations Wormald Technology Lucent ATS Rohr Satellite Transmissions System Logicon Bristol Aerospace to Systems), provided their shareholders more than a four-fold return over those Hughes Aircraft to Raytheon Hughes Aircraft Engine Electrical BDM International Racal Marine Pittler Megellan Aerospace Deutsche System Lockheed Martin Systems to Unison Grimes Aerospace Defense/Armaments McDonnell Douglas SODERN Defense/Armaments to General Dynamics SAI Technology LucasVarity Geared Systems Alliant Marine Gulton Mark IV L-3 Communications Systems Ten businesses Marine Bearings Texas Instrument Hughey & Phillips to Duramax seven years. The remainder in the top half includes Alliant Techsystems (ATK), Cur- PRC AEGIS Services DSEG Textron Aerostructures Dornier Luftfahrt Airport Lighting Loral Space & to Tracor Communications Westinghouse ESD to Carlyle Group to Fairchild AE Turbine Components Sextant ATE Teledyne Vehicle Systems LORI Heat Exchange Sperry Marine Aerospace & Defense Telefunken Loral Defense Litton Itek Smiths FOG Chrysler ESI &CTAS to Boeing Rockwell Sendertechnik Electronics Aerospace & Defense to Tech-Sym Giravions Dorand Precision Products PRC to AlliedSignal ITEK to Hughes Aircraft Services FBOs United Technologies Microelectronics Center tiss Wright (CW), EDO Corporation (EDO), and L-3 Communications (LLL). The Lucas De-Icing Unisys Defense Teldix to Mercury Air Northrop Grumman GE Engine Systems Magnavox Electronic Systems Precision Products Fabrica Militar de Aviones Imo Electro Optics E-Systems Sheldahl Hoskins Aviation Lighting Bath Iron Works Inertial Systems Thorn-EMI Intevac E-OSystems to Litton Technology Integration Allison Engine Lockheed Hughes Inertial Systems bottom half, which still includes some firms with impressive financial performance, CAE Link Martin Marietta Litton Precision Gear Hexcel EMT Material Precision Gear Space Systems to Weed Aerospace General Dynamics Space Systems to Boeing Martin Marietta Rediffusion Simulation Vought Aircraft Raytheon Rediffusion Simulatio Ferretec is comprised of Cubic (CUB), Orbital Sciences (ORB), Raytheon (RTN), Lockheed to Thomson-CSF IBM Federal Systems Emerson ELAC-Nautik to AlliedSignal Rosemount General Dynamics Teledyne Electronic Systems Fort Worth Aerospace Fort Worth Grumman GE Specialty Electronic Products Electronics mfg to Lockheed Heating & to Elbit/Crossroads Avionics Power to ETA Technologies Fibercom Aeroformation GE Aerospace LTV Missiles BAe Corporate Jets Morpho Systemes Electronics to Carlyle Group Atlantic Instruments Missile operations Cessna Aircraft to Hughes to Textron Raytheon Microwave Microwave & Power Abex ClevelandPneumatic & PowerTube Tube Division to Litton Applied Remote General Technology to Raytheon Dynamics Applied Remote Technology GD Missile Ops ATIS Carbine Amber Engineering LSI Products to Raytheon TRW LSI Products de Havilland Cessna Aircraft to Bombardier General Precision Castparts Rockwell JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com Daimler-Benz Martin Litton page 4 of 18 Boeing Hughes Aerospace Aerospatiale Dynamics Goodrich Allied-Signal Honeywell Marietta Lockheed Loral TRW Northrop Industries Raytheon International Rolls-Royce Sagem Snecma Textron Thomson-CSF
  • A retrospective on M&A performance in defense: some further results 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 JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 5 of 18
  • A retrospective on M&A performance in defense: some further results 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 [results] 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 JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 6 of 18
  • A retrospective on M&A performance in defense: some further results 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 JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 7 of 18
  • A retrospective on M&A performance in defense: some further results 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. JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 8 of 18
  • A retrospective on M&A performance in defense: some further results Test for superior re- turns and serial ac- Test for superior re- quisitiveness plus mid- Time frame for the turns and serial ac- sized market capitali- thirteen-firm sample quisitiveness zation Kosovo to Iraq 86% 86% (June 1999 to March 2003) reject reject Iraq to Iraq +3 47% 64% Results of the Mann- (March 2003 to June 2006) reject reject Whitney-Wilcoxon tests over varying time Kosovo to Iraq +3 94.95% 98% frames and firm sizes (June 1999 to March 2006) almost accept 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). Financial performance of the five most suc- cessful serial acquirers in the sample over the long run 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- JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 9 of 18
  • A retrospective on M&A performance in defense: some further results ciencies and informational synergies, or has something more pedestrian, if just as economically valuable, been at work? [cases] 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 JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 10 of 18
  • A retrospective on M&A performance in defense: some further results 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. JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 11 of 18
  • A retrospective on M&A performance in defense: some further results 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 $2.86 billion dollars. Of those transactions, 88% were of primarily US-domiciled firms, and 57% of them have been in the C&E sector. LLL’s approach may be the most significant anecdotal impeachment of the network-centric thesis. This is not be- cause of what companies LLL bought, but what it did with them afterwards. LLL was designed and run largely as a holding company, a financial acquirer that sought out undervalued assets in defense contracting, making its money on a better un- derstanding of the domain knowledge of armaments than was possessed in the market as a whole. For years, this seems to have worked very well, though notably, since the death of co-founder and CEO Frank Lanza, the company has completely shifted gears, acquiring very little, and making some effort to integrate its holdings into more somewhat more closely organized business units. JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 12 of 18
  • A retrospective on M&A performance in defense: some further results Reviewing the patterns of acquisition in aggregate, it is clear that these five firms had quite different approaches strategically. Only EDO concentrated on acquiring firms in the C&E sector, but several of these acquisitions were of firms with sig- nificant positions as subcontractors in the Navy-Marine Corps Intranet program, an interesting place to want to be, and not one deeply embedded in tactical C4ISR systems. With some of its acquisitions, ATK was buying capabilities for precision weapons that it wished to develop, but even this is a bit afield from the network- centric thesis, as it was articulated above. Regarding the common success of these varying approaches, we cannot rule out the financial explanation: the possibility that the management of firms like L-3 are simply better are recognizing underval- ued assets than the average actor in the market. Index of # of deals, # in the % in the Cost in Company returns less top 3 C&E sector C&E sector US$ 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 JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 13 of 18
  • A retrospective on M&A performance in defense: some further results 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 JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 14 of 18
  • A retrospective on M&A performance in defense: some further results 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: 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 http://www.jameshasik.com JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 15 of 18
  • A retrospective on M&A performance in defense: some further results [observations] ✦ 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- 8John Morris, ‘On the Record with Frank Lanza, Chairman and CEO, L3 Com- munications: Contrarian L3 Specializes in Specialization,’ Aviation Now, 20 June 2001. JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 16 of 18
  • A retrospective on M&A performance in defense: some further results 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: [questions] ✦ 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 JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 17 of 18
  • A retrospective on M&A performance in defense: some further results 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) JAMES HASIK • jhasik@jameshasik.com • www.jameshasik.com page 18 of 18