M&A activity moves to small-, mid-market sectors

Aerospace & Defense (A&D) mergers and acquisitions (M&A) are now focused on small- to mid-market sectors such as unmanned aerial vehicles (drones), hypersonic flight, cybersecurity, autonomy, and space. That’s the conclusion in PwC’s Aerospace and Defense midyear Deals Outlook, which notes dealmaking has stabilized, dropping to rates consistent with the first half of 2022, after slightly increasing in the second half of 2022.

For years, mergers concentrated on mega-deals among major defense industry suppliers, but that activity has cooled, in part due to U.S. Department of Defense opposition to further large-scale consolidation. Now, the activity’s centered on integrating and aligning with market opportunities, with companies seeking opportunities that fit their existing capabilities and customers in selective acquisitions.

PwC Deals Partner Michelle Ritchie, who’s specialized in advising clients on acquisition and divestiture activities for more than 20 years, explains key themes from the report.

“The industry is focusing on portfolio optimization, driving focused acquisitions to build-out capabilities and divest non-core assets,” Ritchie says. “In the defense sub-sector, we expect deal activity levels to remain stable for the remainder of 2023. For the commercial aerospace subsector, we expect the landscape to continue at a consistent level, with activity heavily tilted toward maintenance, repair, and overhaul (MRO) and supply chain transactions.”

The report notes the A&D labor shortage, with up to 3.5 million vacancies expected in the sector by 2026, 60% of which could remain unfilled.

“Generally, the vacancies are impacting companies across the sector,” Ritchie explains. “Digital investment and performance efficiency will be key areas to assist in remedying these challenges.”

According to the report, employee turnover across the A&D industry rose to 7.1% in 2022 from 5.7% the prior year. Mid-2023, Ritchie says, “Turnover across the market appears to be returning to a more historical level, but it’s too early to tell how sustainable that may be.”

The pandemic and workforce shortages reduced defense industry production and revenue, but the situation’s improving. Ritchie notes, “Despite supply chain disruptions, global defense is increasing in 2023 and is expected to increase. Defense budgets have doubled in several countries. Expect production to continue to level out as the world resets post-pandemic.”

There was an expectation at the beginning of the year that a recession was coming soon, adding urgency to potential deal-making. But inflation has moderated (it’s 5% now vs. 9% a year ago), prompting some to foresee a recession delayed from Q2 to Q3 2023.

“The expectancy of a recession continues to stay top of mind for A&D leaders,” Ritchie cautions. “Geopolitical developments and the associated government budget priorities impact the industry, and A&D dealmakers continue to consider these influences.”

According to PwC, higher interest rates, inflationary pressures, and near-term economic uncertainty will require companies to be more purposeful in how they allocate capital to deals. – Eric