Building off the momentum of 2013, the aerospace and defense M&A market remains robust with 53 transactions closing between January and August of this year. Both strategics and private equity-backed suppliers seek to capitalize on strong OEM order success and are highly acquisitive, driving strong valuations. Transaction motivations include increasing the presence on high growth aircraft platforms, expanding manufacturing capabilities, and increasing aftermarket exposure. Given ongoing consolidation trends, increased cost pressure from OEMs, and strong valuations in M&A markets, Meridian Capital believes now is an apt time for shareholders to review their growth, financing, and ownership transition objectives.
Key Industry Trends
Macroeconomic Factors Drive Long-Term Growth Forecast
At the Farnborough Airshow in July, OEMs received orders worth an estimated $115.5 billion. Boeing has amassed 941 year-to-date aircraft orders through August, while Airbus orders for the year have reached 722. Today, the combined backlog for Boeing and Airbus exceeds 11,430 aircraft, representing more than eight years of production. Notable orders include Emirates Airlines’ purchase of 150 777X and Air Canada’s order for 61 737 MAX.
Despite near record backlog levels and continued order momentum, recently cancelled orders by airlines such as Emirates, Lion Air, and Transaero have led some industry participants to be cautious of an order bubble. However, OEMs and a majority of analysts appear confident that healthy macroeconomic factors will continue to drive long-term aircraft demand. Driving factors include rising global air traffic metrics and accelerating aircraft retirement rates.
Fuel Efficiency and Reliability Improvements Drive Aircraft Retirements
As advancements in composite and engine technologies allow aircraft to fly longer distances and burn less fuel, airlines are seeking to accelerate the retirement of older aircraft. With fuel representing approximately 35% of airlines’ operating costs and aircraft such as the Boeing 737 MAX offering 14% more fuel efficiency compared to previous
platforms, airlines are upgrading fleets as a necessity to improve profitability and remain competitive.
Reliability improvements in next generation aircraft also offer the opportunity to reduce maintenance costs and aircraft downtime, minimizing delays that cost airlines over $8 billion annually. These fundamentals have led the retirement age of aircraft to drop from 26.6 years in 2011 to 23.2 years in 2012. As a result, Boeing estimates that 15,500 new aircraft will need to enter the market over the next 20 years to simply maintain the capacity of the existing global fleet.
Significant Air Traffic Growth in Asia Pacific
Rising income levels and a growing middle class is projected to increase air travel in the Asia Pacific by 6.3% annually through 2033, leading to an estimated 100 million new passengers added each year. Over the same period, Boeing forecasts 13,460 airplanes will be delivered to the region, representing 37% of the global market. To accommodate the increased demand for air travel, many airlines in the region are expanding fleets. In June, China’s second largest airliner, China Eastern Airlines, confirmed it would buy 80 737 jets including 60 737 MAX. The purchase is incremental to the airline’s previous order for 70 A320neo in February. The combined order is worth an estimated $13.8 billion.
In addition to orders from established airlines, newly launched airlines are expected to drive demand. Since 2013, India’s Tata Group launched two new airlines through partnerships with AirAsia and Singapore Airlines.
Boeing and Airbus are well-positioned to serve the demand for aircraft in the Asia Pacific, as the aerospace supply chain in the region remains underdeveloped and analysts anticipate delays for COMAC’s introduction of its single-aisle.
Popularity of New Aircraft Models Drives Increased Platform Concentration
With airlines seeking to upgrade to more fuel efficient aircraft, the demand for next generation aircraft including the 737, 787, A320, and A350 continues to rise. As of August, these four platforms represented 85% of all commercial backlog. To meet demand, Boeing and Airbus continue to execute initiatives to increase productions rates.
Influenced by the majority of commercial aerospace growth coming from the 737, 787, A320, and A350, strategic and private equity investors have been seeking to build a stronger presence on these platforms both through internal initiatives and acquisitions. For suppliers, an established presence and ongoing bid opportunities on leading platforms is critical to driving long term revenue growth.
As a result of the U.S. defense forces’ aging aircraft inventory and advancements in stealth technologies, the demand for modern defense aircraft such as the F-35 is growing. With an average age of over 20 years, the U.S. Air Force’s fleet of F-15s and F-16s is becoming outdated. In total, U.S. defense forces are expected to be upgraded with 2,400 F-35s over the next two-to-three decades, creating bidding opportunities for defense contractors and component manufacturers. An additional 700 orders are anticipated to come from international buyers over the same period. Suppliers with significant part packages on these high growth platforms are attracting significant interest from investors.
Increased Airline Profitability To Drive Aftermarket Spending
Strong global airline profitability and higher aircraft utilization rates has led to increased spending on aftermarket services and preventive maintenance programs in 2014. Analysts estimate airline profits will increase 33% this year, reaching $18.7B. As a result, airlines are more aggressively investing in maintenance and repair projects. A recent MRO survey by Canaccord Genuity projects narrowbody MRO shop visits to increase 9% in 2014, and forecasts the strongest growth for engine repair shops since 2011. Lisi Aerospace’s acquisition of Manoir Aerospace, a producer of precision forged engine blades and aerostructure components depicts a trend of increased desire to gain exposure to the engine overhaul market.
Increased Cost Pressures from OEMs
Over the past 18 months, Boeing’s “Partnering for Success” program has driven cost pressure at all levels of the aerospace supply chain. The program’s impact on profitability margins has led many suppliers to pursue acquisitions to gain scale, expand complex manufacturing and assembly capabilities, and provide more value-add services. Suppliers with proprietary manufacturing or design capabilities are achieving strong valuations due to a perceived ability to better maintain margins as a result of high switching costs for OEMs. Moreover, with aircraft build cycles extending 5-10 years, suppliers of designed-in products have greater leverage during contract negotiations. Suppliers with proprietary program capabilities remain attractive acquisition candidates for large strategics and private equity firms. In March, TransDigm continued to expand its portfolio of patented products, with its acquisition of EME, a manufacturer of highly engineered aerospace electromechanical actuators and components that receives 80% of its revenue from the sale of sole source products.
Private Equity Activity Remains Strong
The aerospace industry’s strong revenue visibility and positive macroeconomic drivers continue to generae interest from private equity investors. Through August, private equity firms have invested in 14 aerospace companies. In addition to making new platform investments, financial investors completed several add-on acquisitions to expand manufacturing and engineering capabilities of existing aerospace investments and gain access to high growth platforms.
Recent private equity add-on acquisitions include Liberty Hall Capital-backed Accurus Aerospace’s acquisition of McCann Aerospace Machining, a supplier of complex monolithic machined structural parts and assemblies with exposure to the 787 and F-35. In addition, Sorenson Capital-backed Roberts Tool’s acquired Excel Manufacturing, a manufacturer of high-wear, flight critical components. Furthermore, Blue Point Capital-backed Selmet acquired Onamac Industries, a manufacturer and supplier of complex machined components and assemblies.
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Meridian Capital Overview
Founded in 1995, Meridian is a leading middle market investment bank focused on providing M&A and corporate finance advisory services to private companies. Meridian employs fifteen investment professionals with aggregate transaction experience in excess of $20 billion in deal value. Its senior advisors and managing directors have broad industry experience in a wide range of sectors, including aerospace, transportation and logistics, niche manufacturing, technology services and consumer products. The firm focuses on middle market companies with revenues between $10 million and $250 million. Meridian is differentiated through its multidisciplinary transaction teams, industry expertise and unrivaled middle market access to international markets through the firm’s partnership with Global M&A Partners.
Meridian Capital Aerospace Team
Meridian offers a unique set of transaction and operational experience to aerospace shareholders considering transaction alternatives. The firm’s Aerospace Team has successfully completed numerous aerospace transactions and is currently engaged in several active engagements. As a result, Meridian has deep, relevant relationships with private equity and strategic buyers throughout the sector. As aerospace consolidation and industry trends evolve, Meridian has the resources and experience to evaluate your strategic opportunities. Please contact a member of Meridian’s Aerospace Industry Team with questions or requests for additional information.
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