Another Wave of Defense M&A Could Be Coming
According to the National Defense Industrial Association’s Vital Signs report, the industry could be approaching further consolidation as contractors seeking to grow their portfolios use mergers as a growth tool.
M&A has been a primary tool since the end of the Cold War, and increased dramatically in the 1990s, with the number of primary contractors dropping from 50 to a mere six. While military budgets increased again following the 9/11 terrorist attacks, significant drawdowns since have meant that the number of prime contracts has dropped by nearly 20 percent since the 2011 Budget Control Act.
In 2015, then-Undersecretary of Defense for Acquisition, Technology and Logistics Frank Kendall expressed concerns that the small number of prime contractors could affect innovation and perhaps even undermine national defense.
“The trend toward fewer and larger prime contractors has the potential to affect innovation, limit the supply base, pose entry barriers to small, medium and large businesses, and ultimately reduce competition — resulting in higher prices to be paid by the American taxpayer,” he warned.
The large number of high-profile mergers in recent years suggest things may be changing, and another wave of post-COVID-19 consolidations could be just around the corner. Analysts are forecasting a range of scenarios in the new political climate—ranging from a best case of a flat budget to the worst case of a significant decline. New programs may be declined if the latter comes to fruition.
Downturns have historically brought about big consolidations in the industry. Several other factors also point to a bonanza in mergers and acquisitions:
- Intense competition for fewer contracts.
- The potential re-emergence of lowest-price technically acceptable contracts.
- The increased drive to innovate in spite of budget constraints.
- Liquidity challenges and distressed assets that may give rise to a buyer’s market.
It’s important to note that M&A isn’t an option only for the most powerful companies. Smaller contractors may purchase units from other companies to become more agile. While traditional economic theory suggests a wave of mergers could drive prices higher and reduce competition, many primes push back on this idea, saying that mergers offer greater efficiency while promoting innovation.
Companies that hope to get in on the consolidation wave have little time to waste. Regulatory scrutiny of mergers can slow things down, and requires significant planning. The largest players have the most support to manage the process, so smaller companies should begin movement now to get ahead of the curve.