sam pearlstein managing director speednews aerospace & defense industry suppliers conference...
TRANSCRIPT
Sam PearlsteinManaging 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
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 $36 billion additional opportunity
• Iraq lessons and transformation could change types of weapons
purchased
• Outsourcing opportunities for small and mid-tier contractors
• International contracts take time
7/29/2003 4
Defense Outlays Increasing
Average Monthly Defense Investment Outlays ($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
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)
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
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”
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
7/29/2003 9
CONSOLIDATION & M&A
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
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.
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.
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
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 $8,135
7/29/2003 15
Recent Large Transactions
Source: company data, Jefferies & Company, Inc. estimates
Date Price Revenue Price/Rev EV/EBITDA Acquired/Targeted/JV Buying/JV Partner Defense/Commercial
Q3 03 1,685$ 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
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
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.
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
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.?
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
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
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
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
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)."