Market acceptance of composites fueling mergers and acquisitions activity
Advancements in composite technologies have been driving change for years in the aerospace and defense industry. The basic benefits offered by composites, namely high strength and light weight, have made them a natural substitute for multiple structures and components on aircraft, missiles, ordnance, and naval and land systems. This explosion in the number of composites applications, coupled with more technological advancements than ever estimated, has fueled industry growth. In fact, the general consensus among analysts is that the market for composite aerostructures is projected to grow at 11.2 percent annually over the next five years compared to only 4.7 percent for aerostructures as a whole.
The manufacturing base, which is primarily located in North America and Europe, remains fragmented — the number of manufacturers with annual revenues in the $10 million (USD) or less range far exceeds the number of very large and vertically integrated companies. The $24 billion (USD) market for composite aerostructures is nearly evenly split between the independent players and the prime contractors. Spirit Aerosystems (Wichita, Kan.), formerly a division of The Boeing Co. (Seattle, Wash.), Vought Aircraft Industries (Dallas, Texas) and Goodrich (Charlotte, N.C.) are believed to be the three largest independent players, which together control 26 percent of the market among independents, in terms of revenue. The three largest prime contractors, Airbus, Boeing and Bombardier, control 43 percent of the market among prime contractors, in terms of revenue.
Investors and capital providers alike have taken notice of the fragmentation, the importance of the prime contractor's platforms and the attractive growth prospects. As a result, they are eagerly making moves to participate in the upside. Buyers backed by pension funds and other institutional investors (private equity buyers) have flowed into the sector and currently own two key independent market leaders: Spirit Aerosystems is now controlled by Onex Corp. (Toronto, Ontario, Canada), while Vought is controlled by long-time aerospace and defense investor, The Carlyle Group (Washington, D.C.).
Another category of buyer, those with existing and long-time composite businesses in North America and Europe, are actively working to take inefficiencies out of the supply chain via consolidation. These strategic buyers are targeting acquisitions that make their companies more vertically integrated and, therefore, able to offer prime contractors complete assemblies rather than components only. This is a key attribute to prime contractors, who are repositioning themselves as systems integrators. They see great value in subcontractors that can combine numerous components into a single subassembly. The key benefits for the primes include not only a reduction in the time and expense required to assemble a smaller number of subassemblies, but also a sharing of the manufacturing risk. Today, there are an unprecedented number of new platforms, ranging from commercial and military aircraft to land and naval systems — all with increased composite structure content. For example, the Boeing 787 aircraft is estimated to have nearly 50 percent of its weight comprised of composite structures compared to only about 5 percent for the 747-400. The new platforms offer multiple opportunities to implement this strategy.
In the general sense, merger and acquisition activity in the broader aerospace and defense industry remains exceptionally strong. This has been driven, in part, by borrower-friendly debt and equity capital markets, growing defense budgets, new platform introductions and "operations in theater" (e.g., the Afghanistan and Iraq conflicts). When attractive industry dynamics couple with easily accessible capital markets, one side effect is that many subsectors see company valuations increase significantly — some to all-time highs.
The exuberance for mergers and acquisitions we see in the overall aerospace/defense market has clearly spilled over into the composites subsector. The latter is characterized by high fragmentation and a projected five-year growth rate double the aerospace/defense sector average, not to mention a ton of crowding in other aerospace and defense subsectors. It's no surprise, then, that investors have composite plays on their radar screens. In addition to all the attractive attributes already mentioned, composite company valuations are quite attractive, comparatively speaking. Market valuations for composites companies depend on many things, ranging from the programs for which they supply structures to the quality of the fixed assets and level of automation in the manufacturing process. Although composites company valuations have increased 20 to 30 percent since 2000, the overall aerospace/defense market is still valuing composites companies at a discount compared to adjacent sectors, such as defense electronics or communications. As a result, composites companies seem like a relative bargain right now to investors who aim to gain access to such a dynamic and attractive aerospace and defense industry.
Since valuations are expected to increase, it appears that every type of consolidator, from private equity buyers to domestic and international strategic buyers, will continue to make immediate moves for acquisitions. Beyond the classic consolidation plays, additional activity will be seen from others who are trying to become highly specialized in a specific niche, such as ablative applications.
Perhaps the biggest challenge for strategic buyers playing at the composite-component level will be competing for acquisitions with the private equity buyers. Many private equity buyers have crossed into a grey area in which their investments are now so meaningful to the sector that the line has become somewhat blurred between who is truly a strategic versus a private equity buyer. This phenomenon may make it more difficult for the smaller companies with existing composites businesses to compete for acquisitions, since nearly all deals are hotly contested and can rapidly escalate in value. Of course, the other side to this is it may be the ideal time for that smaller company to consider a sale or divestiture.