Dealmaking slowed down in the second half of 2022, but the year ended with a bang. John Stack, Canaccord Genuity's head of U.S. aerospace and defense investment banking at in New York, joins the podcast to share his insights.
The 5th annual Aviation Week Network’s A&D Mergers and Acquisitions conference takes place in Beverly Hills, California, on Jan. 30. Find out more and register here.
Welcome to the first Check 6 podcast of 2023. I'm Joe Anselmo, Aviation Week's editorial director and editor-in-chief of Aviation Week magazine.
When it comes to mergers and acquisitions in the aerospace and defense industry, 2022 began with a whimper and ended with a bang. Early in the year the popularity of SPACs or special purpose acquisition companies, was quickly fading. Then. the Biden administration sued to block Lockheed Martin's proposed takeover of Aerojet Rocketdyne, citing concerns about competition and consolidation.
Flash forward to mid-December, when two big deals in the space sector were announced just two days apart. Satellite builder and remote sensing specialist Maxar Technologies agreed to a private buyout worth $6.4 billion, while Aerojet Rocketdyne found a new buyer, L3Harris, which agreed to pay $4.7 billion for the stored propulsion, space and missile system supplier.
So, will that momentum carry into 2023? Will a long awaited consolidation in the commercial aviation supply chain finally begin in earnest? Who will be buying? How stiff will the competition be, and how will interest rates and inflation affect deal making?
Joining us to delve into all of this is a special guest. John Stack is a managing director and head of U.S. Aerospace & Defense Investment Banking at Canaccord Genuity in New York. John has been a major player in aerospace finance for more than two decades with extensive transaction experience and stints running business development for Textron and Cessna Aircraft.
Also here to weigh in is Michael Bruno, Aviation Week's executive editor for business and our point man for covering aerospace M&A.
John, let's start off with you. What is your outlook for aerospace M&A in 2023, and where are we going to see the most activity?
Thanks, Joe. Happy New Year. It's great to be here. As you said last year ended with a bang with a couple of very large transactions. I would say in terms of overall deal volume, the last two quarters were a bit slower than normal. I think there's certainly some pent-up demand that we have out there in the market. I think we'll start a little bit slower first quarter, and despite some of the recessionary fears and the sort of cocktail of uncertainties that we have, including interest rates, inflation, Ukraine and some of the constraints that we're experiencing, talent and supply chain, I think that we'll have a sort of measured and constructive M&A market across aerospace defense in 2023.
So John, let's get your advice for companies that are interested in buying or selling this year. What advice do you have for them?
There certainly is a flight to quality. I think in companies that are looking to be sold, I think there's an opportunity here to get in front of a variety of investors. There's certainly record dry powder amongst the private equity groups and for companies that are great fits with the strategics where there's something that's on strategy, I think there's a really interesting opportunity there.
Sort of dovetailing on some of the private companies, I think some that are maybe looking to raise growth capital in 2023 may find it to be a challenging environment. Valuations may be a bit lower, and they may be looking at saying, ‘Okay, well could maybe take capital and be maybe highly diluted.’ That may start to facilitate them to entertaining M&A conversations and saying, ‘Okay, well maybe we'd rather sell the business at maybe a lower valuation than taking capital, a [situation] where we would ultimately be diluted further than we like.’ And so I think we've seen some of that in '22 and I think we may see more of that in '23 as maybe the private markets, the lower end of the continuum, are a little bit more challenging from a fundraising standpoint.
You, Michael and I were just talking before we hit record about last year and it did start with a whimper and end with a bang. But save for those two big deals in December, you were pointing out that the deal making really did slow down in the second half of the year. Do you see that slowdown continuing into 2023 or do you see things picking up?
Yeah, the first two quarters of '22 were sort of typical sort of a hundred-ish deal volume quarters, and then the other ones, the last two were sort of in the eighties. And so it wasn't a big drop, but it was certainly off. And I expect there could be a little bit of pent-up demand and some deals that may be will slide into '23, but I think it may be a little bit of a slightly slower start to '23 that notwithstanding some major recession should hopefully continue to be constructive as I mentioned earlier.
I think there's a lot of pent-up demand amongst the strategics that have balance sheets that have been improved, that are looking to do acquisitions. I mean, we've seen some nice tuck-in acquisitions and capabilities in '22, and again, particularly across some of the technology areas where there's been a lot of investor interest: space, autonomy, hypersonic, cyber, those are areas that certainly have been invested in and folks are looking for both exits that are the VC-backed businesses and the strategics are also looking to add capabilities to their businesses.
Michael Bruno, if you go back a year, we were hearing some fairly bullish forecasts for aerospace M&A in 2022, and then we got hit with soaring inflation, higher interest rates, antitrust concerns, and a supply chain crisis. So how does all that affect the M&A landscape as we start out in 2023?
It is still a very interesting landscape. Part of that is because what you see or what you expect to see depends on where you sit. So, in the space realm, for example, particularly commercial space, we had the SPAC driven manic activity for the past couple of years going into last year, 2022. And there were expectations that SPACs were here to stay and while you might see a slight drop-off in the number of companies going that it was still a useful tool for becoming public and that there were so many commercial space startups out there that we'd continued to see the pipeline, and that just didn't happen.
At the same time, we've been waiting around for an M&A wave in the commercial aviation sector, particularly the supplier base. And that's been predicted for many years. It's actually part of a very long running ongoing consolidation wave. But there has been an expectation that it's going to pick up now that we're past the COVID pandemic and the [production]rates from the leading OEMs have been set. And so there's a better forecast, more visibility in the market and that in turn allows suppliers to better forecast what their revenue is going to be and particularly on the contracts they're either on or expect to be on. But yet we didn't see that takeoff in 2022 either and that's really interesting. But that hasn't happened yet and I'm beginning to wonder, well, we may not really see that particular wave. It's going to continue, but it may not be a big wave as we were once expecting.
Meanwhile, on the defense side of things, because of ongoing tensions with China, because of Russia's invasion of Ukraine, because of continuing stress in the relationships with Iran and North Korea, we have just seen a ramping up of interest in all things defense and that extends all the way into mergers and acquisitions. So you have companies being bought, you mentioned Maxar and Aerojet. They're absolutely both have defense and space angles to those acquisitions, if not entirely. Those deals may have happened for those companies, not necessarily with those buyers, but deals to sell them may have happened for particular reasons with each one of those companies, but they still play into this defense and space theme, which we expect to continue particularly with interest in anything space, anything hypersonics, cyber is interesting, electronic warfare is interesting, defense electronics is interesting.
The one place you're not really going to see very much action in is in aerostructures. And whether that's on the commercial or the defense side, because there's just still way too much capacity and it makes a little sense for anybody to go spend money to buy a machine shop just to build more of what's not needed yet. So definitely really interesting year ahead, I think. But it does depend on where you sit to see what you expect.
John, we just heard Michael talk about long predictions about a commercial supplier consolidation wave. I wanted to get your thoughts on that, one. And two, we really had a meltdown in supply chain last year. Airbus and Boeing couldn't get engines and the engine makers couldn't get some of their key materials or parts. How does all this affect what's going on?
In terms of the commercial recovery here, I mean going back to sort of March, 2020, there was definitely a very abrupt shift from interest in commercial aviation that had been quite frothy for some time to defense. And so that abrupt shift really hasn't come back yet. And I think there still remains a little bit of a valuation sort of discrepancy in terms of what buyers are looking to pay and what sellers are looking to garner for commercial aero assets. And a number of businesses that were in the market didn't end up trading just because of that. Valuation expectations just weren't there. And, to make things worse, companies didn't hit their performance numbers and so you start missing plan and that obviously creates a bigger evaluation gap.
So again, I think it's one where there's certainly is investor interest and opportunity, but it's going to be at the right valuation and the businesses are going to ultimately need to perform. And then relative to supply chain, this has been an issue across not just aerospace defense but just globally. I think that has become a major constraint coupled with talent that's affecting businesses worldwide.
And I would also say on the MRO side, getting mechanics is a real issue in the gating item and that's an area where even some of the demand signals are coming back and companies are having a hard time actually getting the talent to turn the wrenches and fix airplanes and do things. That's obviously been a challenge for a number of businesses.
John, I've got a question for you going a little bit deeper into that commercial aviation supply chain crisis and the rebuild from the pandemic low. You had mentioned dry powder, and I think that's worth reiterating that there's so much private equity dry powder out there still yet to be spent. Meanwhile, you do have strategics, the very large companies, tier 1s, OEMs that are more interested in bolting on, I think in particular capabilities. I'm curious if you see the potential for private equity to really step in specifically on the commercial side of things and try to build new mid-sized giants that are the new major suppliers, the tier 2s, and maybe even tier 1 of the next decade or two. Or do you think private equity is looking elsewhere in defense and space and they want to get in on that game because it's a very long term, it's got reliable growth?
I think it's a bit of both. I think certainly the priority areas have been around defense and space, autonomy and some of these key technology themes. But certainly with the $2 trillion of dry powder, private equity has an opportunity to once, if they were able to get thematically convinced about the commercial aero cycle and where things are going, there certainly is the opportunity for group or groups to build up and amalgamate, some meaningful players there. But it just comes down to conviction in driving value creation on that. And again, looking across the different investment opportunities that they have. But as the market conditions improve, as businesses improve, then I think that creates opportunities both for strategic and financial players to actually apply some of these commercial assets.
So we talked about commercial guys. Defense, obviously the big six defense primes always get headlines when they do anything. But go down beneath that there is a lot of concern about the health of the supplier base and maybe the need for some more consolidation there to create healthier suppliers. Is that a trend you guys expect to see this year?
I'll jump in there first. Definitely want to hear John's opinion on this, but I think there first of all has been a long-running concern about the health of the defense industrial base ever since the end of the Cold War. And so it's a background theme, it's a back burner issue, it's always there. It's never going away and so it can play a part I think in mergers and acquisitions, but I think for various reasons we have found that there has not necessarily been a driving motivation for M&A simply because of health of the industrial base. What is happening is strategics are reaching out the top tier, the tier 1s, primes and OEMs are reaching out and they're bolting on small shops that bring in unique exquisite capabilities that those big companies didn't have before. You'll see a company like Raytheon Technologies, a super tier 1 and a prime in many instances go out and buy Blue Canyon Space Company, for example, to try to get in a little bit more on that space growth market.
You certainly see Lockheed and the other major primes getting in on space. L3Harris buying Aerojet Rocketdyne, the big proposal at the end of December. That's a unique story in and of itself for other reasons, but you'll see these large companies go and buy smaller companies, but because of the technology to build it they're bringing in-house, not because necessarily there's a huge concern over the supplier health.
I think you will always see large companies buy suppliers that they need critically and for whom the small suppliers are about to go out of business because they're going bankrupt and the large company just can't get that part somewhere else. Yeah, they'll step in and buy that company, but I don't know that we're going to see that any more than we had seen. But I welcome John's opinion on it because he is actually got real expertise there.
I think during these times of uncertainty like this, obviously the large strategics are taking a look at their portfolio and doing strategic reviews, and I think coming out of that is there could be some portfolio shaping activities and divestitures of things and also could identify strategic acquisitions. And I think that there's been a pretty disciplined market over the last number of years. I won't say that necessarily bad deals weren't done, but I think there's been a pretty strategic focus for the various companies.
I don't necessarily expect 2023 to be a gold rush year, but again, I think it's going to be measured, I think it should be constructive year for A&D M&A and companies will execute acquisition strategy where it makes sense and whether that's vertical or horizontal, there could be some players here that could make sense.
And John, do any of those trends, we talked about inflation, currency fluctuations, interest rates, do any of those play into this landscape?
It certainly does. I mean, I would say that cocktail of uncertainties, again that I alluded to, including the constraints around talent and supply chain have certainly been a challenge in the public equity market over the last year. We saw substantially lower IPOs and follow-on offerings on the public side and everything else, but M&A, again with an aerospace defense was still pretty decent in terms of overall transaction volume.
And so again, I think just given the capability set and particularly focused around defense, but having some additional sort of green shoots in terms of M&A around some of the commercial opportunities, I think that there's probably more impetus to do good transactions just given improved aerospace defense balance sheets, record dry powder for the private equity groups. And it's also seeing an increased grouping, increased number of private equity groups that are investing in aerospace and defense, bode well for continued M&A within 2023.
Unfortunately, we're running short on time, but John, I had a final question for you. We're talking about M&A in aerospace and defense, but so many of the technologies that are going to drive the future of this industry are from outside of aerospace: automation, artificial intelligence, electrification. It's a long list. Are you seeing that mix change, that aero aerospace companies are making acquisitions outside of the traditional A&D space? Are you seeing more of that?
Yeah, and I would expect to see that accelerate, Joe. I think that particularly the strategics as they're looking to bolster capabilities from artificial intelligence, cyber, we talked about autonomy, unmanned systems, there certainly has been increased emphasis over the last year or so that I would expect to continue to accelerate and seeing some of that crossover of companies that are maybe on the commercial side and looking at other applications for those technologies. And so yeah, I would definitely expect that to continue going forward.
Okay. Well, John Stack, thank you so much for taking the time to share your insights with us. Michael Bruno, thanks to you as well. That is a wrap for this week's Check 6 Podcast. Special thanks to our producer in London, Guy Ferneyhough.
Speaking of dealmaking, Michael and I will be at Aviation Week's A&D M&A conference, which takes place on January 30th at the Beverly Wilshire Hotel in Beverly Hills, California. The one-day event is sponsored by Lazard and CSP Associates, and this year's theme is Opportunity Amidst Uncertainty. If you're interested in joining us, go to adma.aviationweek.com for more information. That's adma.aviationweek.com.
Thank you for your time and see you again next week.