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Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

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Page 1: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

Sam PearlsteinManaging Director

SpeedNews Aerospace & Defense Industry

Suppliers Conference 2003

July 29, 2003

Defense Consolidation

Page 2: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 2

Agenda• Investment Summary

• Historical Consolidation

• Transformation And Defense Industrial Base Issues

• Current Consolidation And M&A

– Public And Private Market Values

– Recent Capital Raising & Transactions

– Mid-Tier Consolidation

– Return On Capital

• Other Trends

• Conclusion

Page 3: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 3

Investment SummaryDefense Spending Increasing

• Defense spending growth began in FY98 after six years of decline

• Historical valuation range of defense companies is 5-10x EBITDA

• Outlay growth 8% in FY03-05 and 6% through FY03-08

• $80B FY03 supplemental has $53B for war and $4.1B for

procurement, R&D

• Homeland security is a $36 billion additional opportunity

• Iraq lessons and transformation could change types of weapons

purchased

• Outsourcing opportunities for small and mid-tier contractors

• International contracts take time

Page 4: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 4

Defense Outlays Increasing

Average Monthly Defense Investment Outlays ($B)

8.18.5 8.7

9.2 9.2

9.8

8.8

11.2

7.0

8.0

9.0

10.0

11.0

12.0

3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03

Source: US Treasury Department

Page 5: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 5

Industry Consolidation

This chart is just a sampling of defense M&A activity.Source: DoD, company data

1993 1993-1996 1997-1999 2000-2003 Today

BOEING Litton Precision Gear McDonnell Douglas Hughes Satellite Systems BOEINGRockw ell Defense & Aerospace Skybridge (Alcatel Alstrom)

LMT Armament Systems Primex TechnologyAdvanced Technology Systems Galaxy Aerospace

GENERAL Bath Iron Works Computing Devices International Santa Barbara GENERALDYNAMICS Teledyne Vehicle Systems NASSCO Motorola IISG DYNAMICS

K-C Aviation Advanced Technical Pdts. GTE Government Systems GM Defense (Canada)

Gulfstream Aerospace Veridian

General Electric - Aerospace COMSATMARTIN General Dynamics - Space Kistler Aerospace OAO LOCKHEED

MARIETTA Lockheed (1) Leigh Aerospace MARTINLoral (2) ORINCON

Logicon Comptek ResearchVought Aircraft Racal Marine Group Sterling Softw are FederalGrumman Corp. TASC (Primark) Federal Data Corp. NORTHROP

NORTHROP Teledyne Electronic Systems California Microw ave Aerojet General EIS GRUMMAN Hughes Inertial Systems DPC Technologies New port New s Shipbuilding

Westinghouse Defense Ryan Aeronautical Litton Industries (3) Avondale Industries TRW

E-Systems RAYTHEON Magnavox Electronic Systems Hughes Aircraft (GM) JPS Communications RAYTHEON

Chrysler Tech. Airborne Texas Inst. Electronic Defense SolipsysBET PLC's Rediffusion Simulation

(1) Lockheed had acquired General Dynamics - Ft. Worth (1993)(2) Loral had acquired IBM Federal Systems (1994) and Unisys Defense (1995)(3) Litton had acquired PRC (1996), Sperry Marine (1996), TASC (1997), and Avondale (1999)

Page 6: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 6

European Consolidation

Pre-1996 1996-1998 1999- Today

British Marconi (1999)

Aerospace 3 UK companies - Royal Ordnance, interests in Siemen Plessey (Germany), BAE(formed in 1977 Reflectone, and SD-Scicon (1987) Saab (Sw eden), BAeSEMA (UK), STN LMT's AES & Control Sys (2000) SYSTEMS

by merger of four (Germany), and AWADI (Australia)

UK defense cos.) Germany's Heckler & Kock (1991) Condor Pacif ic (US - 2002)

Aerospatiale and France's

DASA (Germany) Matra Haute merge (1999) EADSDASA acquires four German (2001 merger

CASA (Spain) companies: MBB, AEG, Dornier, DASA acquires Siemens' 27% stake in Finland's Patria (2001) of DASA,

and MTU (1985-1988) defense unit (1998) CASA,

Aerospatiale 25% stake in BAE's Astrium (2002) Aerospatiale(France) Matra)

Siemens unit (Germany - 2002)

GE/RCA (US - 1987) 40% stake in UK's Pilkington Racal (UK - 2000)

Optronics (1998)

Thomson - CSF Wilcox Electric (US - 1988) Stakes in Samsung defense

(France) France's Aerospatial (So. Korea), Short Missiles THALESUK's Radifon MEL, Link-Miles, and military electronics (1998) (Canada), ADI (Australia) - 2000

50% stake in Pilikington (1991)

50% stake in France's Sextant In-Flight SystemsSignaal HAS (Netherlands -1991) Sextant Avionique (1998) (US - 2000)

This chart is just a sampling of defense M&A activity.Source: SIPRI

Page 7: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 7

Current Defense Themes

Source: Jefferies & Company, Inc., Department of Defense

• Transformation

• Network-centric warfare

• Threat-based to capabilities-based

• Precision-strike

• Joint operations

• Sensor to shooter

• Preventing friendly fire- “blue on blue”

Page 8: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 8

Industrial Base Transformation• Shifting to operational effects and away from platforms

• DoD’s primary operational effects include Combat

Support, Power Projection, Precision Engagement,

Integrated Battlespace, Homeland Protection

• Will this change DoD view toward industry consolidation?

• Platforms still the significant driver of dollars in defense

budgets for contractors

• Little short term impact from efforts to involve

commercial companies by DoD, but possibly more

competition over long term

Page 9: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 9

CONSOLIDATION & M&A

Page 10: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 10

Public Defense Stock Multiples

Defense Stock Multiples Vs. DoD Appropriations

3x

4x

5x

6x

7x

8x

9x

10x19

91

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Def

ense

En

terp

rise

Val

ue-

To

-EB

ITD

A M

ult

iple

0

20

40

60

80

100

120

140

Do

D A

pp

rop

riat

ion

s($

Bill

ion

s)

Defense Multiple Appropriations

Source: Factset, Baseline, Department of Defense

Page 11: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 11

Public Vs. Private Market Value• 2001-2002 was a unique time period with public market

multiples above 10x EBITDA exceeding private multiples

• Public market multiples have fallen while strong spending

is finally emerging

• Largecap defense stocks trade at 8.6x 2004E EBITDAP,

smallcap defense stocks average 7.4x.

• Key comparison of private multiples, public multiples and

cost of capital.

• Key drivers now for M&A are programs/backlog/growth.

Page 12: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 12

M&A Factors• Continued focus on cash flow and EBITDA multiples

• Market multiples understate acquisition multiples, e.g.

Veridian acquisition at 25-30% higher than market price

reflects control premium

• Higher growth (such as IT, electronics) may command

multiples at high end of historic 5-10x EBITDA range

(Veridian was 12x)

• Lower multiples often for smaller and 3rd tier companies

• Recent 6-12x EBITDA range in multiples shows private

multiples differentiate among companies and public

multiples often do not.

Page 13: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 13

M&A Factors Continued• Number of commercial aerospace M&A follows delivery

cycle

• While low multiples during downturn, few sellers at these

prices

Page 14: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 14

Plenty Of Capital Available

Source: Jefferies & Company, Inc. estimates, company data

Recent Capital Raising In Defense/Aerospace Industry

Company Net Value ($ millions) Date 10-yr Rate (%) Type Commercial/Defense ReasonOrbital $135 Jul-03 9 8-yr High-yield Defense Refinance capital structureAviall $200 Jun-03 7 5/8 High-yield Commercial Refinance capital structureEsterline Technologies $175 Jun-03 7 3/4 High-yield Commercial Acquisitions, debt paydow nGeneral Dynamics $2,000 May-03 4 1/4 LT debt Defense AcquisitionsL-3 Communications $120 May-03 6 1/8 High-yield Defense AcquisitionsDRS Technologies $150 Dec-02 NA Equity Defense AcquisitionsGoodrich $215 Nov-02 NA Equity Commercial AcquisitionL-3 Communications $495 Jun-02 7 5/8 High-yield Defense AcquisitionsL-3 Communications $770 Jun-02 7 5/8 Equity Defense AcquisitionsEDO Corporation $140 Apr-02 5 1/4 5-yr Convertible Defense AcquisitionsIntegrated Defense Tech. $120 Feb-02 NA IPO Defense Improve capital structureUnited Defense $225 Dec-01 NA IPO Defense Improve capital structureDRS Technologies $100 Dec-01 NA Equity Defense AcquisitionsL-3 Communications $410 Q4-01 4 10-yr Convertible Defense AcquisitionsNorthrop Grumman $1,000 Nov-01 NA Equity Defense Acquisitions, debt paydow nAlliant Techsystems $250 Nov-01 NA Equity Defense AcquisitionRaytheon $1,000 Oct-01 NA Equity Defense Improve balance sheetEDO Corporation $120 Oct-01 NA Equity Defense AcquisitionsL-3 Communications $350 May-01 NA Equity Defense AcquisitionsEsterline Technologies $70 Feb-01 NA Equity Commercial/Defense AcquisitionsL-3 Communications $290 Q4-00 5 1/4 8-yr Convertible Defense Acquisitions

Largecap Total $4,000L-3 Communications Total $2,435Other Small-Midcap Total $1,700Total $8,135

Page 15: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 15

Recent Large Transactions

Source: company data, Jefferies & Company, Inc. estimates

Date Price Revenue Price/Rev EV/EBITDA Acquired/Targeted/JV Buying/JV Partner Defense/Commercial

Q3 03 1,685$ 1,724$ 1.0x NA Fiat Avio Carlyle Group/Finmeccanica Both

Q3 03 1,219$ 1,400$ 0.9x 11.8x Veridian General Dynamics Defense

Q3 03 1,200$ 300$ 4.0x 9.5x TransDigm Warburg Pincus Commercial

Jul-03 NA 350$ NA NA The Aerostructures Corporation Vought Aircraft Industries Commercial

May-03 147$ 96$ 1.5x 6.5x DeCrane Specialty Avionics Group Odyssey Investment Partners, LLC Commercial

Mar-03 950$ 2,300$ 0.4x 8.3x DynCorp Computer Sciences Corp. Defense

Mar-03 188$ 100$ 1.9x 8.0x Goodrich Avionics L-3 Communications Corp. Commercial

Dec-02 7,800$ 16,400$ 0.5x 7.7x TRW Northrop Grumman Defense

Dec-02 110$ 80$ 1.4x 8.5x Paravant DRS Technologies Defense

Nov-02 125$ 100$ 1.3x 10.9x Wescam L-3 Communications Corp. Both

Oct-02 1,500$ 1,000$ 1.5x 8.8x TRW Aeronautics Goodrich Corporation Commercial

Oct-02 130$ 140$ 0.9x 8.1x Electron Devices & Displays (Northrop) L-3 Communications Corp. Defense

Sep-02 146$ 81$ 1.8x 8.6x BAE Advanced Systems Integrated Defense Technologies Defense

Jun-02 197$ 235$ 0.8x 7.4x Advanced Technical Products General Dynamics Both

Jun-02 110$ 80$ 1.4x 11.0x Perkin Elmer Detection Systems L-3 Communications Corp. Both

Mar-02 1,149$ 910$ 1.3x 10.2x Aircraft Integration Systems (Raytheon) L-3 Communications Corp. Defense

Jan-02 2,389$ 2,150$ 1.1x 8.7x New port New s Shipbuilding Northrop Grumman Defense

Min 0.4x 6.5x

Median 1.3x 8.6x

Max 4.0x 11.8x

Page 16: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 16

Recent Mid-Size Transactions

Source: company data, Jefferies & Company, Inc. estimates

Date Price Revenue Price/Rev EV/EBITDA Acquired/Targeted/JV Buying/JV Partner Defense/Commercial

Q3 03 92$ 80$ 1.2x 8.5x Bombardier Military Aviation Services L-3 Communications Corp. Defense

Jun-03 88$ 50$ 1.8x 11.9x Weston Group (UK) Esterline Technologies Commercial

Jun-03 25$ 30$ 0.8x 7.1x Emblem Group (MBM Technologies) EDO Corporation Defense

Mar-03 29$ 40$ 0.7x 5.9x Darlington, Inc. EDO Corporation Defense

Feb-03 38$ 55$ 0.7x 5.8x Advanced Engineering & Research Associates EDO Corporation Defense

Jan-03 70$ 70$ 1.0x 8.2x Composite Optics, Inc. Alliant Techsystems Both

Dec-02 59$ NA NA NA Condor Pacif ic BAE Systems PLC Defense

Nov-02 45$ 50$ 0.9x 9.5x International Microw ave Corporation L-3 Communications Corp. Defense

Oct-02 42$ 40$ 1.1x 8.4x Science & Applied Technology Alliant Techsystems Defense

Oct-02 28$ 60$ 0.5x 5.8x Westw ood L-3 Communications Corp. Defense

Aug-02 68$ 45$ 1.5x 11.1x BAE Systems Passive Expendables Esterline Technologies Defense

Aug-02 39$ 39$ 1.0x 6.0x Burke Industries Esterline Technologies Both

Aug-02 25$ 24$ 1.0x 8.6x ComCept L-3 Communications Corp. Defense

Jul-02 96$ 90$ 1.1x 8.0x Eaton Navy Control Division DRS Technologies Defense

Jul-02 62$ 90$ 0.7x 7.0x Condor Systems EDO Corporation Defense

May-02 50$ 40$ 1.3x 7.6x Boeing Ordnance Alliant Techsystems Defense

Jan-02 59$ 55$ 1.1x 10.6x SY Technologies L-3 Communications Corp. Defense

Min 0.5x 5.8x

Median 1.0x 8.1x

Max 1.8x 11.9x

Page 17: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 17

Many Mid-Tier Consolidators• ATK, DRS, EDO, L-3, Integrated Defense, United Defense,

Esterline, Herley, Crane, others

• EPS accretion easier with low interest rates and no goodwill

amortization

• Still many defense companies available for consolidation

• Primes continue to divest small units and factories to focus on

core competencies

• Second and third tier trying to restore customer/supplier balance as

perception that consolidation left them with fewer customers and

more competition.

Page 18: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 18

Low Interest Rates Help

Source: Jefferies & Company, Inc.

Effect of Borrowing Rate on EBITDA Multiples

17.5x

14.0x11.7x

10.0x8.8x

7.8x 7.0x

17.5x

14.0x11.7x

10.0x8.8x

7.8x 7.0x

0.0x

5.0x

10.0x

15.0x

20.0x

4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0%

Borrowing Rate

Page 19: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 19

Questions For Consolidators• What will selling price/multiple of Integrated Defense

Technologies be (and who will be the buyer)? Or will it

come off the market?

• Will investors pay premium for acquisition-driven growth?

Recent trends suggest no.

• How many $50-100 million defense properties are out

there to consolidate?

• What is the exit strategy and will there be consolidation

within the mid-tier group?

• What will be the strategy for Homeland Security? Buy,

joint-venture, license, etc.?

Page 20: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 20

How To Generate Return• Objective is for ROC to be higher than cost of funds

• Typical focus is accretive acquisitions

• But to create value, need to be disciplined on price and

integrate the business

• Good examples are General Dynamics, Alliant

Techsystems, United Technologies

Page 21: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 21

Return On Capital Varies

Source: Jefferies & Company, Inc., Baseline, Factset, company data

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

GD UTX ATK BA GR EDO DRS LLL LMT NOC RTN

Trailing 5-yr Return on Invested Capital

Page 22: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 22

Other Trends• Buy American legislation pending but unlikely to pass as it

would be disruptive and costly to defense contractors

• Weak dollar potentially makes US purchases easier for

foreign entities?

• Pension expense & reimbursement impact on valuation

Page 23: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 23

Conclusion• Consolidation will continue

• Low interest rates affects pricing

• Accretion is not sufficient to create value

• Investors paying less for acquired growth

Page 24: Sam Pearlstein Managing Director SpeedNews Aerospace & Defense Industry Suppliers Conference 2003 July 29, 2003 Defense Consolidation

7/29/2003 24

Disclaimer

Additional information available upon request.

This material has been prepared by Jefferies & Company, Inc. ("Jefferies") a U.S.-registered broker-dealer, employing appropriate expertise, and in the belief that it is fair and not misleading. It is approved for distribution in the United Kingdom by Jefferies International Limited ("JIL") regulated by the Financial Services Authority ("FSA"). The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore except for any obligations under the rules of the FSA, we do not guarantee its accuracy. Additional and supporting information is available upon request. This is not an offer or solicitation of an offer to buy or sell any security or investment. Any opinion or estimates constitute our best judgment as of this date, and are subject to change without notice. Jefferies and JIL and their affiliates and their respective directors, officers and employees may buy or sell securities mentioned herein as agent or principal for their own account. This material is intended for use only by professional or institutional investors falling within articles 19 or 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001and not the general investing public. None of the investments or investment services mentioned or described herein are available to other persons in the U.K. and in particular are not available to "private customers" as defined by the rules of the FSA or to anyone in Canada who is not a "Designated Institution" as defined by the Securities Act (Ontario)."