Cross-border deals take center stage

A flurry of international deals involving European buyers of U.S. defense and civilian contractors has been under way since early 2007. Of 292 transactions by strategic buyers of U.S.-based defense companies in 2007, 50 buyers were foreign — 17 percent. So far in 2008, two of 17 deals involve foreign buyers.

Notable transactions last year included the QinetiQ Group plc's acquisition of Analex Corp., BAE Systems plc's acquisition of Armor Holdings Inc., Global Strategies Group Inc.'s acquisition of SFA Inc. and Ultra Electronics Holdings plc's acquisition of Criticom Inc. Already this year, two more significant cross-border deals have been announced: the acquisition of Sparta Inc. by Cobham plc and MTC Technologies Inc. by BAE Systems.

We also are noticing significant interest from other European and Israeli companies in U.S. defense and civilian contractors.

Two major French companies, Thales and EADS, have said 2008 will be the year they make U.S. acquisitions.

Why all this cross-border activity? First, the dollar is weak compared to the British pound and the euro. The pound has appreciated more than 40 percent against the U.S. dollar since 2002. The euro has appreciated even more rapidly. Thus, U.K. and European buyers are able to pay premium prices to win auctions of U.S. defense and civilian contractors. The foreign-exchange situation is encouraging European and U.K. buyers to undertake major strategic realignments away from the European markets in favor of the U.S. market. They are hedging currency risk and locking in good deals.

Other factors encouraging cross-border activity are continued strong U.S. defense and homeland security spending, including funding for new technologies that have commercial applications, and recent legislative and administration initiatives encouraging foreign investment by NATO countries.

The first paragraph of the recent executive order implementing the Foreign Investment and National Security Act of 2007 (FINSA) states, "International investment in the [United States] promotes economic growth, productivity, competitiveness and job creation. It is the policy of the [United States] to support unequivocally such investment, consistent with the protection of the national security."

In addition, the Senate is expected to ratify the U.K.-U.S. Defense Cooperation Treaty early this year, which will facilitate technology transfers with announced reforms of U.S. export control policies to promote synergies and efficiencies for companies in NATO countries.

Yet, European buyers face challenges in acquiring U.S. defense and civilian contractors.

FINSA reforms by the Committee on Foreign Investment in the United States added new political scrutiny to the process. It is now more rigorous, creating longer and greater due-diligence risk rationale for foreign buyers having to pay a premium. The Defense Security Service also is evaluating proposals to continue clearances following changes in ownership. Furthermore, the acquisition of a U.S. defense firm requires State Department review under the International Traffic in Arms Regulation.

Although there are regulatory hurdles, we anticipate significant foreign purchases of U.S. defense and civilian contractors, primarily by NATO firms, throughout 2008 because of the favorable exchange rates, growth of defense and homeland spending, and interest in technology transfer.