Services and IP protect margins, drive consolidation in logistics support space
By
Nick Wakeman
While the large defense companies may be fleeing most parts of the services market, new research from Govini shows that contractor logistics support remains a desirable niche because it lets the defense contractors own their weapons platforms from head to tail.
In recent years, I’ve heard a lot about the value of intellectual property and how if you have technology wrapped around a service, you can command market share and mitigate the scourge of lowest price contracting.
A new research report from Govini illustrates that wisdom by analyzing the contractor logistics support market the recent merger and acquisition activity in that sector.
A Govini analyst said that they were drawn to this segment of the market because little counter intuition was going on. The large aerospace and defense companies have been keen to shed their service businesses but not in contractor logistics support, which supports the weapons platforms these companies make.
Instead, there has been a consolidation in this area, most recently Lockheed Martin’s acquisition of Sikorsky. Lockheed isn’t just picking up the manufacturing of helicopters but also the long tail of support to maintain those helicopters.
“This isn’t by chance,” said Eric Gillespie, Govini founder and CEO. “The ownership of intellectual property around the supply chain allows them to circumvent the pressures of LPTA they felt during sequestration and the tight budget years.”
The logistics functions Govini looked at included things such as engineering support, identifying requirements for spares and repair parts, facilities, equipment and personnel.
It’s a big market. Govini pegged the non-classified spend by the Defense Department at $27 billion between 2010 and 2014.
Supporting this part of the lifecycle also ties the platform companies closer to the platforms they make, said Arun Sankaran, managing director of Govini.
“It is a way for the integrators to remain relevant to the platform,” Sankaran said.
Lockheed’s acquisition of Sikorsky also vaulted the company to the top of the food chain in the contractor logistics support market. Lockheed had been number three behind Northrop Grumman at No. 1 and Sikorsky at No. 2. With the acquisition, they’ve catapulted to No. 1 with nearly $7 billion in revenue between 2010 and 2014. Northrop is now No. 2 with just over $4 billion.
As Govini says in one of its conclusions, the Lockheed-Sikorsky deal is much broader than building helicopters.
The contractor logistics support market is dominated by platform companies except for the Army, where L-3 Communications is the dominant player along with ManTech International. L-3 has been supporting aircraft and other systems for the Army and ManTech does a large business supporting ground vehicles.
Their position is under pressure as the market continues to consolidate, the Govini report states.
The report also threw a spotlight on two other companies that will likely be takeover targets.
“The remaining plays for consolidation are in the unmanned systems space with General Atomics and AeroVironment,” Gillespie said. “They stand out as likely acquisition targets for someone looking to fortify their position in the space.”
Both companies make unmanned aerial vehicles. General Atomics makes the Predator family of drones and affiliated systems. AeroVironment makes smaller handheld drones such as the Puma and Switchblade.
While the consolidation may work well for industry, allowing it to take advantage of economies of scale and gain access to new markets and customers, there is a risk to the government.
“If the integrators own the platforms and all the intellectual property involved, then the government might find itself with limited bargaining power when it comes to prices,” Sankaran said.
While companies such as Lockheed and Northrop have been forced to divest their systems engineering businesses because of organizational conflicts of interest, those kinds of concerns have not been applied to the long tail associated with maintaining weapons platforms.
But after the Lockheed-Sikorsky deal, Frank Kendall, the Defense Department’s top acquisition official, raised concerns about too much power being consolidated in the defense industry.
While he was talking about the purchasing and building of weapons, it isn’t too much of a stretch to see the same concerns being applied to the logistics side of the equation.
But I think until Congress or DOD steps in, we’ll continue to see consolidation in this space because it broadens market position and protects margins.