Aviation Week & Space Technology - 30 March-12 April 2015

18 AVIATION WEEK & SPACE TECHNOLOGY/MARCH 30-APRIL 12, 2015 AviationWeek.com/awst

ORBITAL-ATK

COMMENTARY

The reasons for this surge vary with

the motivations of the involved parties.

Dave Thompson, now Orbital-ATK’s

CEO and president, noted in a March 12

speech that discussions began more than

two years ago with ATK’s Mark DeYoung

included shared views that defense

spending would be constrained for the

foreseeable future and customers would

be more interested in afordability.

Harris’s CEO in a March 3 presenta-

tion at a JP Morgan conference seemed

to take a diferent view, that defense

markets would be rising and Exelis

brought scale and capabilities that

could help accelerate Harris’s growth.

Justification for the strategic review of

Sikorsky rested on the “fit” of this ven-

erable “platform provider” compared

to the rest of United Technologies’

aerospace businesses, which are self-

described “systems providers.”

There are two sides to every deal, and

clearly there may be some underlying

factors that are not discussed as openly.

One point of diference is on defense

market expectations. The consensus is

that the U.S. market is bottoming, but

that’s arguable. Some defense sectors

face more vibrant commercial and

non-traditional competitors and there

are companies that will have to up their

L

ast year marked a reversal from a dearth of defense-sector

restructuring, and the pace has not slowed in 2015. Orbital

Sciences Corp. and the ATK Defense Group completed their

merger. Harris is buying Exelis. Airbus and Finmeccanica have

been housecleaning by selling of parts of their defense portfolios.

SAIC announced it was buying Sitor, and most recently, United

Technologies said it was exploring options for Sikorsky while

Gencorp plans a corporate-wide restructuring to reduce costs.

The Rise of Defense

Middleweights

Competition surges at new corporate level

velopment of $324 million, which is

roughly 35-65% of the amount reported

by Boeing Defense, Lockheed Martin,

Northrop Grumman and Raytheon.

Management focus is another intan-

gible from restructuring. It is debatable

whether Huntington Ingalls, which was

spun of from Northrop Grumman in

2011 could have performed as well if

it had remained part of a diversified

heritage defense systems enterprise.

MBDA’s ownership simplification could

entail greater agility and if Sikorsky is

spun of as a free-standing public compa-

ny, its management may be able to make

decisions that had not been possible.

Industry structure should continue

to evolve in 2015-18. There may not be a

“land-grab” type of mergers-and-acqui-

sitions boom where a move by one cor-

poration or enterprise triggers rushes by

others to tie up with remaining proper-

ties. The evolution of the sector may

depend more on discrete developments

and follow a path of action-reaction.

The outlook for U.S. and European

defense budgets is one obvious devel-

opment. If the new middleweights—

Harris and Orbital-ATK (whose

Aircraft Survivability Equipment suite

is shown above) and possibly Sikorsky

prove to be more competitive, that

could force other companies to rethink

their strategies and positioning.

Major program down-selects in

2015, particularly the long-range strike

bomber program that pits Boeing and

Lockheed Martin against Northrop

Grumman, are potential trigger.s

There are still other military aero-

space opportunities, including the T-X

trainer and sixth-generation fighter

development. The Joint Light Tactical

Vehicle program for which AM Gen-

eral, Lockheed Martin and Oshkosh

are competing is another. A number

of private equity firms need to realize

value from investments in defense

services made several years ago.

Combinations of the largest defense

companies may still be of limits, particu-

larly since the architect of a policy pro-

hibiting such deals is now U.S. secretary

of defense. There may be room for more

portfolio-shaping at the primes, but the

creation of an $80-100 billion behemoth

may weigh too heavily on customer

desire for competition that keeps costs

in check and spurs innovation. c

games to stay in the running. Space

launch and satellites come to mind. More

investment may be needed to stay com-

petitive and it could weigh on margins

and free cash flow in 2015-18. For some

managements, that prospect and the

impact it could have on a stock price or

broader corporate financial expectations

might trigger a decision to divest and let

someone else do the heavy lifting.

Industry restructuring should con-

tinue, and it will reshape the competitive

landscape. While it may take until 2018

or beyond to see the full implications of

recently announced deals and actions,

they point to the emergence of more

competitive middleweight defense com-

panies. Cost synergies should be realized

in 2015-16 and appear to be the normal

ones associated with reduction of du-

plicative overhead, but at the margin to

make new companies more competitive.

The more interesting potential

synergies lie in sales opportunities,

either through new customer penetra-

tion or new program wins that were

not possible by stand-alone companies.

These may be more difcult to achieve,

but they are part of the Orbital-ATK

integration plan. Harris-Exelis, on a

pro-forma basis for 2014, reported

company-funded research and de-

Up Front

By Byron Callan

Contributing columnist

Byron Callan is a director

at Capital Alpha Partners.