Tier 1 Growth Is Transforming Aerospace & Defense

Airbus and Boeing
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divested of their aerostructures businesses in the early 2000s, along with other divisions that were not considered core to their strategy of becoming aircraft integrators. Airbus recently reversed this move, as it now considers aerostructures as a core airplane design and manufacturing activity. It will re-integrate its two major aerostructures assembly companies, calling it Airbus Atlantic.

The industry dynamics have changed. While the OEMs were downsizing this past decade, select tier 1 suppliers were growing. The divestitures by the OEMs provided a growth opportunity for these smaller companies, dramatically transforming the aerospace and defense industry. RTX is the prime example of this growth. In the last 10 years, it became the largest tier 1 aerospace company, growing significantly through mergers and acquisitions.

RTX, formerly known as United Technologies
UTX
Corporation, grew by acquiring Goodrich in 2012, B/E Aerospace in 2017 and Rockwell Collins
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in 2018 and then merging with Raytheon in 2020. RTX today is comprised of three business units: Collins Aerospace, Pratt & Whitney and Raytheon. For some perspective, RTX annual revenues were $67 billion in 2022, compared with Boeing’s $66.6 billion during that same period.

The trend of tier-1 growth is not new, but such large-scale growth was initially limited to primarily RTX. The newer trend is that there are more tier 1s following the growth trend that RTX started through mergers and acquisitions.

Oliver Althoff, managing director for Aviation, Aerospace and Defense at Seabury Capital Group, recently shared with me that several tier-1 aerospace and defense companies continue to reshape their portfolios with respect to changing strategic orientation. These companies, he said, may be seeking to increase margins, or they only have a certain amount of cash earmarked for capital expenditures, networking capital investments or research and development expenditures for new programs. The internal cash requests of businesses often exceed what the corporate parent can invest, creating haves and have-nots among different business units.

Althoff also noted that these publicly traded companies return cash to shareholders through share buybacks or dividends as a regularly planned use of cashflow that is generated. In those instances, business units are either struggling to achieve their business metrics or margin targets or are left void of investments. Althoff summarized his thoughts that often companies divest portions of the business to a new owner for whom such a business unit might be a better fit.

Ball
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Corporation announced on August 17 its divestiture of its aerospace business, Ball Aerospace, to BAE Systems for $5.5 billion. Ball Corporation stated that it’s continuing to execute its strategy of enabling the greater use of circular aluminum packaging on a global scale. While Ball Corporation is downsizing its portfolio and using cash proceeds for its non-aerospace business, BAE Systems will be enhancing its portfolio by adding a mission-critical space systems and defense technologies across air, land and sea domains.

While RTX has grown through the larger acquisitions stated earlier, there have also been divestitures of businesses that were not strategically aligned with the broader RTX. Examples of these divested assets were the Collins GPS Military business and the Raytheon airborne tactical radios businesses to BAE Systems in 2020.

Last month, RTX announced its latest divestiture, selling the Collins Aerospace actuation and flight controls business to Safran. On its Q2 2023 earnings call on July 25, RTX CEO Greg Hayes stated, “Of course, our transformation isn’t done. We will continue to develop initiatives to better leverage our scale and breadth and to enable operational excellence and a best-in-class cost structure.”

This $5.6 billion acquisition brings more European aerospace business locations under Safran’s control, adding more Airbus content to its already extensive portfolio. This unique opportunity allows Safran to become a global leader in critical flight control and actuation functions, per the Safran website.

John Sengenberger, director of integration and separations at Virtas Partners, shared with me that the Ball Aerospace and Collins Aerospace actuation carve-outs were notably all-cash in an elevated interest rate environment. Sengenberger further articulated that the BAE Systems deal grows its largest customer, adding Ball Aerospace’s 98% U.S. federal government sales to BAE’s 35% U.S. Department of Defense sales.

Sengenberger points to pre-synergy valuations of Ball Aerospace at 19.6x EBITDA and Collins Aerospace actuation at 14x EBITDA as indicators of strong industry demand for high-quality defense and aerospace assets.

RTX continues to re-shape its portfolio via divestitures after multiple historic acquisitions, while companies such as BAE Systems and SAFRAN are in growth mode and are opportunistically enhancing their portfolios through strategic and accretive acquisitions. It is likely we will see more M&A transactions and growth in the tier 1 segment as the aerospace and defense sector requirements change.