16 July 2009
Guy Anderson, editor and lead analyst, Jane's Information Group
With this year's DSEi exhibition fast approaching, Chris Shaw speaks to the presenter of two seminars, Guy Anderson, editor and lead analyst, Jane's Information Group.
CS: In your opinion, what does the future hold for the UK defence industrial base and what is its place in the global market?
GA: The UK defence industry is one of the global success stories. It is the second largest exporter on earth and has proved adept at cracking other major markets. The mass ownership of United States defence companies by UK firms speaks volumes.
CS: What are the key differences between the UK and US defence markets?
GA: The first difference is scale. It is well known that the US market is vast: the US Department of Defense spends a dollar for every dollar spent by every other country on earth. The UK is, of course, the second biggest market.
The other issue is one of openness. The UK market is one of the most open in the world, in terms of foreign procurement and the willingness to accept foreign investment. Open access in European markets is distinctly variable. Defence is one of the few areas in which the open market principles of the European Union do not (at present) apply.
CS: While looking into the defence acquisitions in the wake of the economic downfall, did you uncover any unprecedented trends?
GA: There were a number of surprises. That M&A activity (in terms of the number of deals and dollar values) dipped sharply was completely expected. Looking further into the figures, however, it was interesting how the profile of buyers changed drastically: Deal activity in 2006 and 2007 was largely led by private equity firms and smaller defence organisations. Both PE and SMEs were shaken out by the financial crisis, whereas the top tier companies (the Lockheed Martin / Northrop Grumman / BAE level firms) continued buying just as before (helped by a combination of cash rich balance sheets from the boom years and continued appetite for their debt).
The second point is that M&A activity offers a great insight into market expectations of future defence spending (it's not so much a case of what companies are saying, but what they are buying). The expectation (particularly in the United States) was of a fundamental shift in spending priorities: the emphasis is on the intelligence, surveillance and reconnaissance fields (largely a result of lessons learnt in Iraq and Afghanistan). In short, buyers were looking for companies with technologies that were not lashed to particular programmes or platforms.
Finally, it was clear that defence companies (and private equity firms to a lesser extent) were looking to break into adjacent markets such as government IT programmes and homeland security. The boundaries between core defence and security are blurring.
CS: Which sectors have fared best throughout the downfall – and why do you think this is?
GA: The short answer is defence as a whole. It has proved – so far – to be a safe haven. As in previous years, the long lead times of contracts and the visibility offered have kept the sector buoyant.
It is interesting to contrast defence with the automotive sectors. The 2008 downturn caused demand for cars (and therefore auto components) to fall through the floor. A lot of companies produce components for both the automotive and defence /aerospace sectors: they have looked to defence to sustain them through the current crisis. We have also noticed that a number of automotive engineering firms have looked to leap into the defence sector (particularly firms with experience in the production of precision engineered parts for the top end of the auto sector).
CS: Will the defence sector emerge from the downfall as a different beast?
GA: Very interesting question: the 1990s downturn (caused by a combination of the post Cold War peace dividend and wider economic issues) led to massive top level consolidation. That is not going to happen again (there is no room for that sort of rationalisation at the top without obliterating competition).
We do, however, see rationalisation further down the supply chain: less successful / poorly position companies will either fold or be consumed by the successful.
We have also seen the development of supply chain contingency plans: a number of the top level players have realised that there is a risk of critical gaps forming in their supply chains. Options have ranged from advance payments to equity stakes and soft loans.
Overall, we expect the defence sector to emerge with less defined edges. We are already seeing the industry looking to take their current skills and capabilities into adjacent markets (civil government security, large scale IT projects, etc). The boundaries between defence and related areas have been blurring for a number of years, and that is likely to continue.
Author
Chris Shaw
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