Jen Grant

Q3 2019 Aerospace MA Newsletter What We’re Discussing with Clients The aerospace and defense (A&D) market remains secure and robust. Strong tailwinds, excellent demand drivers, and favorable macroeconomic factors propel the industry at the moment. Still high commercial aircraft orders, systems and platforms modernization, rising prominence on cabin interiors, and increased government defense spending are driving factors for sustained growth in the industry as well. However, international trade wars and tariffs have led to protectionist actions by governments in aluminum and steel producing nations. These activities prompt worries of harmful impacts on the defense industrial base. In light of these concerns, supplier relationship management is more crucial now than ever, like collaboration, cross-planning, and shared objectives drive the necessary process improvements and innovations while keeping costs affordable, that the A&D industry is realizing. The following are three critical topics we are regularly discussing with our clients: Modernization and Upgrades of Platforms & Hardware The global commercial aircraft market remains strong by driving order intake across the entire value chain. A primary driver is the need for modernizing and upgrading existing hardware, systems, and platforms. As governments anticipate stronger, more hostile external threats, there is a political consensus on fasttracked modernization and upgrade and replacements. The industry as a whole corroborates these statements through technological developments. Efforts focus on improving legacy systems using the Size, Weight, Power, and Cost (SWaP-C) concept, which focuses on measuring the bottom line. Companies with the ability to upgrade weapons systems and military aircraft and ships benefit the most. Significant growth and business opportunities are on the horizon for companies with ready, off-the-shelf replacement solutions or technologies that can deliver next-generation capabilities at affordable costs. Pursuing Tariff Exemptions The tariff dispute remains a threat risk for A&D companies and suppliers, especially with imported aluminum and specialty alloys (frequently used in weapons systems and aircraft) and steel (commonly used in carriers, ships, and light armored vehicles). Organizations representing U.S. aerospace and defense interests have concerns that aspects of the tariffs may have adverse effects on the industry. The commercial aerospace industry “requires” foreign steel and aluminum, and the tariffs negatively impact the chain by increasing costs on industrial products. In turn, this impacts revenue with which to invest while remaining competitive on the defense side of their business. Processes are in place that allow companies to secure exclusions from tariffs on imported aluminum and steel if they can demonstrate that it’s not possible to purchase the products in the United States from American suppliers. Filing for and ultimately receiving an exemption can be a long and complicated process, but worth the time and effort to potentially recoup meaningful spend on materials. Applications inundate the U.S. Department of Commerce with requests for exemptions. Tens of thousands still await rulings. Even so, it’s never too late to start the process. Successful Supplier Relationship Management With the increasing complexity and potential risks of an integrated supply chain, supplier relationship management is a critical aspect and is no longer exclusively about execution, cost, and delivery. A focused partnership and communication strategy can determine which buyers and suppliers remain competitive and realize improved supply chain management, enhanced productivity and quality, and added value. Supply relationship management helps with managing exposure and risk, as well. Apply it in particular to suppliers with the highest values, quantities, or importance on the mission-critical side. Suppliers must cultivate this type of relationship over time and may include a significant resource commitment. However, it can pay off in spades in terms of increased customer loyalty, reduced market anxiety, and improved communications. A proactive approach and defined relationship mutually benefit all parties involved, but the company must give careful consideration when choosing that relationship and ensuring it aligns with the goals of the business. YTD 2019 Market Summary & Outlook Overall, market activity is lower in recent years, but it’s still an attractive investment. Overall M&A deal volume increased in the first half of 2019 to 110 transactions from a Q4 2018 low of 94. These increased volumes still remain slightly low when compared to the 10-year average. Additionally, total deal value for YTD 2019 of $64.4 billion is 2.7 times higher when compared to YTD 2018 total deal value. Notably, the YTD deal volume is consistent with 2018 and 5 percent higher than the 10-year average.General market dynamics support middle-market transactions which continue to drive deal volume and value. Strategic buyers continue to dominate the space. PMCF Perspectives: Increasing Focus on Cabin Interiors •The aircraft cabin interiors market has a projected growth from $27 billion by 2025 at a CAGR of 5.87 percent. The increasing number of new aircraft orders, additional component retrofitting, and the rising demand for achieving an enhanced passenger experience, such as in-flight entertainment and connectivity options, is currently driving this growth. Suppliers are working more closely with airlines in developing cabin interiors that can generate other sources of revenue including onboard shopping, wireless internet, and advertising. Virtual reality (VR) is another option that airlines are exploring as a premium-service and source of comfort for nervous flyers. Potential advertising opportunities may exist within VR as well. Companies with well-equipped manufacturing facilities and secure distribution networks stand to benefit the most. Macroeconomic Trends and Signals The aerospace and defense market in 2019 should experience robust growth, with increases in overall defense spending and weapons development, and steady growth in the commercial aviation market. The U.S. Department of Defense Budget (2015 – 2023P) The U.S. Department of Defense (DoD) is increasing spending to deter and counter North Korea, Iran, and global terrorism. This strategy can sustain U.S. influence and ensure favorable regional balances of power. They are also strategically responding to growing political, economic, military, and information competitions. Air Traffic Passenger Traffic Growth (2013 – 2019P) Air traffic passenger traffic growth continues to experience a significant boom as economic conditions remain stable. Postive global dynamics and the spread of global airlines accelerates growth year-overyear. Pentagon Hypersonic Spending by Armed Forces Branch (2020 – 2024P). The Pentagon continues to develop its hypersonic weapons portfolio amid rising global tensions and the ever-pressing demand to position itself as the leader in advanced systems. Advanced development of scramjet-powered cruise missiles and air-launched boost-glide systems continue to drive supply chain demand and boost DoD spend. Raw Materials (Q1 2018 – YTD 2019) Manufacturers and suppliers are contending with high price levels of steel, aluminum, titanium, copper, resins, and plastics. Although there has been some recent price moderation, the persistence of elevated prices underscores the need for companies to optimize efficiency and cost savings. As tariff exemption waivers begin flowing through the network and supply chain, they somewhat diminish the criticality of potential surcharges. The risk of high costs associated with resulting tariffs remains a concern as a whole. Key Deal Highlights Hanwha Aerospace Acquires EDAC Technologies On June 10, 2019, the South Korean aviation company Hanwha Aerospace it is acquiring EDAC Technologies from Greenbriar Equity Group for $297.2 million USD. The acquisition is going through by the end of 2019. Hanwha is absorbing the entire stake of EDAC following the merger alongside a special purpose company. EDAC is headquartered in Connecticut and founded in 1946. The company’s past clients include GE and Rolls-Royce. Hanwha is formerly known as Samsung Techwin and was acquired by Hanwha in 2014. Additionally, Hanwha’s revenues nearly doubled over the last four years making the jump from 2.6 trillion won in 2015 to 4.5 in 2018. ManTech Acquires Kforce Government Solutions On March 1, 2019, ManTech International Corporation announced the acquisition of Kforce Government Solutions, Inc. for $115 million cash transaction. Kforce is headquartered in Fairfax, VA and provides technology solution, data management, and analytics during federal health and defense missions. The acquisition incorporates an additional 500 employees to the ManTech team. It’s worth noting that Kforce generated nearly $100 million in revenue during the 2018 fiscal year. The merger allows the ManTech to deliver services in transformative ways that directly impact information technology programs. ManTech funded the acquisition using cash-on-hand as well as additional lines of credit. The company anticipates a slight rise in earnings per share during 2019 due to the merger. Strategic Planning For Sale Planning for a Sale and Unlocking the Value in a Business Before a company’s potential sale, shareholders and management should assess certain internal strategic risks in advance of a transaction to best position the company for a successful outcome. The following key factors should be reviewed and addressed before going to market: Customer Concentration Significant customer concentration points to a key concern. The concern is that companies may lose a substantial portion of revenues upon change in ownership. Mitigating this risk requires business owners to demonstrate the strength and tenure of its customer relationships and its ability to backfill lost revenue with new customer revenue. In some instances, a company’s ability to demonstrate growth in wallet share within key accounts underscores customer reliance and can be viewed favorably by investors. Workforce Stability Unemployment rates hovering around 3.7 percent fuel a robust and competitive labor market, especially within the A&D space. High turnover often results in lost productivity and increased expenses related to overtime or temporary labor. Business owners can avoid unusually high turnover by tying compensation and promotions to a defined performance matrix. Additionally, formalizing training programs specific to each employee’s operational area while building stronger ties to community networking initiatives can facilitate succession planning and mitigate short-term hiring issues. Scalability of Infrastructure Potential buyers may view an acquisition unfavorably if a company’s infrastructure isn’t optimized to support forecast growth. Ensuring all existing equipment is maintained correctly can help a company avoid superfluous capital investment before a sale. Business owners must carefully consider additional investments by focusing on higher-ROI equipment pieces that are necessary to support growth. Financial Stability Stability of cash flows is a crucial component to understanding valuation and an optimal purchase price. While cyclicality or seasonality may be inherent to individual A&D companies, outlier fluctuations in revenue and profitability can be mitigated by gaining greater visibility from customers and keeping sales representatives apprised of actions needed to fuel growth or replace revenue from lost accounts. Growth Prospects A company’s ability to support its estimated growth with a concrete strategy helps investors gain confidence in the forecast, which ultimately assists in maximizing shareholder value. High-level strategies should be supplemented by granular analysis to give more credence to a three to five year growth plan. _____________________________________________________________________________________ References/Sources: • https://www.aero-mag.com/five-trends-that-will-shape-the-ad-industry-in-2019/ • https://www.thomasnet.com/insights/supplier-relationshipmanagement/?utm_content=featuredstory&position=3&linktype=title&channel=email&campaign _type=thomas_industry_update&campaign_name=tiu190827&utm_campaign=tiu190827&utm_ medium=email&utm_source=thomas_industry_update&tinid=- • https://www.defensedaily.com/trump-places-tariffs-aluminum-steel-imports-ad-industry-seespotential-harm/business-financial/ • https://www.cnn.com/travel/article/airline-cabin-interiors-of-the-future/index.html • https://www.pwc.com/us/en/industries/industrial-products/library/aerospace-defense-quarterlydeals-insights.html • http://www.theinvestor.co.kr/view.php?ud=- • https://investor.mantech.com/press-releases/press-release-details/mantech-acquire-kforcegovernment-solutions