Market Watch: U.S. market draws British firms' acquisition interest
- By Jerry Grossman
- Jun 03, 2002
Discussions with senior executives at defense companies based in the United Kingdom reveal a common objective: expanding their presence in the U.S. market.
U.K.-based defense companies have both a strong interest and the capital to step up acquisition efforts. This appetite adds more fuel to an already robust domestic defense mergers and acquisitions market.
As it relates to prospective acquisitions of U.S. defense companies, U.S. defense and intelligence officials generally take a positive view of U.K. buyers. Additional evidence of the comfort between U.S. and U.K. officials is reflected in the increased sales by U.S. defense companies to the U.K. of the same products and technology being purchased by the U.S. Department of Defense.
While U.K.-based companies have some growth opportunities in Great Britain, particularly in outsourcing, the U.S. defense market is the largest in the world, roughly equivalent to defense spending in all other allied countries combined.
As the United States executes its war on terrorism, European countries are reluctant to get involved. Spending for national defense by European governments remains a lower priority than in Great Britain and the United States.
Conversely, the common language, legal system, culture, similarity of our capitalistic market systems and our common view of the need for prioritizing defense spending provide additional impetus to U.K.-U.S. transactions. The greater size and momentum of the U.S. defense market supports the expectation that most cross-border deals will involve U.K. buyers and U.S. sellers.
An interesting aspect of the acquisition initiatives of U.K. defense companies is that, historically, U.K. companies have made investments in research and development with their own capital. The result is private ownership of military technology, so the profits produced from ongoing sales of military systems and products are retained by the companies.
In the United States, historically, defense companies have relied on government-funded technology development, resulting in a sharing of benefits from resulting products between Defense Department users and suppliers. Today, the Department of Defense is encouraging its suppliers to make greater use of commercial technology through integration of off-the-shelf products.
This emphasis fits well with many U.K. companies, wherein they, and not the government customers, retain ownership of intellectual property and technology.
The capacity of U.K. defense companies to finance acquisitions is substantial. Fifteen public U.K. companies, with aggregate sales of about $27 billion, have a total market capitalization of equity of more than $30 billion. In addition, most of these companies have additional borrowing capacity, as well as potential to raise equity through their shareholders or supplementary public offerings. Nearly all of these companies have operations, as well as strategic business development offices, in the United States.
In terms of public market valuations, the U.K. defense companies are trading at price-performance relationships that are in line with U.S. defense primes. For example, the enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization) ratios for the U.K. companies, at about 10 times, are substantially the same as their U.S. counterparts, which are trading at multiples of about 9.5 times.
The enterprise value to revenue ratios for U.K. and U.S. defense companies are roughly 1.2 times. In this valuation environment, target acquisitions would be equally as accretive to U.K. buyers as they are to U.S. defense buyers.
These circumstances suggest that, in the months ahead, several U.S.-based defense businesses may combine with U.K. buyers, expanding the coordination and cooperation between the United States and its long term ally, the British.Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va.
Jerry Grossman is managing director at Houlihan Lokey Howard and Zukin.