Merger and acquisition activity in the aerospace and defense sector increased significantly during the first three months of 2011, and is expected to continue its upward trend due to competition in commercial aerospace, budget headwinds in defense spending and availability of capital, a new report says.

The pace of merger and acquisition (M&A) activity in the aerospace and defense (A&D) sector picked up significantly in both volume and value during the first quarter of 2011 compared to 2009 and 2010 levels, according to a recent report from PricewaterhouseCoopers (PwC). In fact, the total number of A&D deals, regardless of value, exceeded quarterly totals dating back to the beginning of 1981.

In the first quarter of 2011, deals with value greater than $50 million amounted to $9.5 billion with 17 deals total, up from 10 deals and $5.7 billion in the same period last year, PwC’s Mission Control: Q1 2011 report says. This represents an increase of approximately 67 percent in deal value and 70 percent in deal volume over the same period in 2010.

“The total number of deals announced in the first three months of this year, regardless of whether a value was disclosed, is the highest first-quarter total for the global A&D sector in at least 30 years, contributing to our positive outlook for M&A in 2011,” Scott Thompson, U.S. aerospace and defense leader at PwC, said in an announcement of the report.

An uptick in mega- and large deals was a primary contributor to the first quarter’s value. There were six transactions valued over $250 million in the first three months of the year, which helped drive the increase in average deal value to $558 million — surpassing the average deal value of $357 million for all of 2010. Two mega-deals, the Rolls-Royce and Daimler joint venture bid for Tognum AG and the Northrop Grumman spin-off of the Huntington Ingalls shipbuilding business, drove most of the increase in deal value.

The impact of dealmakers outside the United States played a key role in the strength of the first quarter’s activity, according to PwC’s latest quarterly analysis. When excluding transactions involving U.S. targets and/or acquirers, the value of deals totaled $5.7 billion, or approximately 60 percent of the first quarter’s total value, and over half of the quarter’s volume. According to PwC, the relative participation of U.S. entities is likely to return closer to the levels of the previous two years, when U.S. entities were involved in the majority of deals in both volume and value.

“The overall improvement in deal activity will likely continue,” the PwC report says. “Evolving competition in commercial aerospace and budget headwinds in defense spending, coupled with greater availability of capital, should contribute to more (and incrementally larger) transactions by sector constituents.”

Moving forward, PwC’s analysis cites several factors likely to drive A&D deal totals higher in upcoming quarters.

For one, large defense contractors will likely look for consolidation opportunities as defense budgets decline. While consolidation among the large prime contractors is unlikely because of competitive and security reasons, there is opportunity for the defense primes to shift their portfolios toward growth segments such as unmanned vehicles and cyber-security.

Moreover, small and midsized aerospace companies, including those that are part of diversified industrial companies, may seek to boost shareholder value by capitalizing on the growing aerospace market and strong multiples.

Finally, private equity investors will likely remain interested in acquiring and turning around the lower-growth businesses that strategic players divest, and are likely to compete for targets with higher-growth technological capabilities. The combination of these factors supports our bullish outlook for aerospace and defense transactions for the balance of 2011.

“The substantial pick-up in [global] deal activity is being motivated by a range of factors and a variety of deal strategies, especially when it comes to the larger transactions in the quarter,” Thompson said. “We expect this increased pace to continue and to be largely driven by portfolio reshaping among defense contractors and a robust commercial aerospace market, supported by strong liquidity and improving capital markets.”

In a separate study earlier this year, PwC reported that total deal value in the A&D sector nearly doubled year-over-year in 2010, while deal volume rose 4 percent over 2009.

Resources

Mission Control: Q1 2011 (free registration required)
PricewaterhouseCoopers LLC, May 2011

Global Aerospace & Defense Deal Value and Volume Jump in the First Quarter of 2011…
PricewaterhouseCoopers LLC, May 5, 2011

Rolls-Royce and Daimler Announce Joint Venture Company…
Rolls-Royce plc, March 9, 2011

Northrop Grumman Board Approves Spin-Off of Huntington Ingalls Industries, Inc.
Huntington Ingalls Industries, March 15, 2011

Mission Control: 2010 Annual and Q4 Review (free registration required)
PricewaterhouseCoopers LLC, February 2011

Global Aerospace and Defence Sector M&A Deal Value Nearly Doubles in 2010…
PricewaterhouseCoopers LLC, Feb. 22, 2011