What’s Happening in the ADG Markets?
Dr. Meslin is Senior Managing Director and a founder of CSP Associates, Inc., the leading global provider of commercial diligence advisory services to private equity sponsors active in the aerospace, defence, and government services sectors. He speaks with Lawyer Monthly about how CSP is different from other commercial diligence advisers and all about the current M&A volume in the ADG market.
What is different about the markets CSP serves, compared with those addressed by other commercial diligence advisers?
Unlike other large sectors of the economy such as retail, general manufacturing, media, or technology, the ~$1.5 trillion aerospace, defence and government (ADG) market is driven by ‘programmes’, often large and long-term activities such as those to develop and field a new type of commercial aircraft or weapon system, manage a government information technology architecture, or support military forces deployed overseas. An ADG commercial diligence adviser such as CSP must therefore have quite specialised domain knowledge in areas such as: foreign policy, national security, government budgets, mission requirements, and procurement practices, aerospace technology, and of course, the specific programs with which a target company is involved.
What is the overall M&A volume in the ADG market, and how many private equity sponsors are active?
Over the past 15 years approximately 350 private equity sponsors have been active in the ADG market. An estimated 500-600 transactions are completed each year in CSP’s served markets, although most involve smaller companies with enterprise values of $25 million or less, acquired by trade buyers. CSP estimates that private equity investors are bidders in more than 100 transactions each year. Since 2000, ten PE sponsors have completed more than 10 ADG deals, while a further 26 have acquired between five and nine companies in these sectors.
What is the level of M&A activity that CSP see, and what are some specific examples of the industry segments in which CSP are active?
CSP are typically engaged in 40-50 ADG transactions each year involving target companies and prospective acquirers in the United States, Canada, the UK and Western Europe, and the Middle East. While the US market remains by far the largest in terms of cumulative annual transaction volume and value, aerospace, defence and government services are inherently global markets and CSP are active in a diverse range of industry sub-segments. These include counter-terrorism, cyber-security, aviation component manufacturing, satellite and space launch system production and operations, overseas military logistical support, satellite and wireless telecom networks, defense hardware development and sustainment, aircraft repair and overhaul, and business jet services, to name a few.
What role do CSP perform in providing commercial diligence advice to buyers or sellers of ADG properties?
Simply put, CSP’s role is to translate the often arcane vocabulary of ADG programmes, customers, competitive and market dynamics into terms that a private equity sponsor – and importantly, its lenders – can understand in order to value, negotiate, and finance a transaction; in other words to substantiate or refute the value creation opportunity that has drawn a client to engage us. In this respect, our perspective is somewhat different from that of other professional advisers. Legal, accounting, tax or environmental diligence advisers tend to focus on the target company as it stands today, evaluating known or contingent risks and liabilities, reviewing customer and supplier contracts, opining on the quality of earnings, etc. Commercial diligence is inherently forward-looking, and is concerned mainly with validating a target company’s forecast financial performance to enable a client to properly value the business.
CSP focuses on assisting our clients to validate the investment thesis underlying a particular target company. A CSP commercial diligence assessment addresses an inter-related set of market, competitive, programme, contract, customer, management, and financial variables, in order to develop a holistic view of a target company and its outlook. Depending on the programmes the company supports, this often includes considering rather weighty (and sometimes inherently unknowable) political and national security-related questions such as: how long and in what numbers will US and NATO forces be deployed in Iraq, Syria or Afghanistan; what level of ballistic missile defences might the US and its allies procure in order to address the threat from North Korea; how might an aviation-related terrorism incident or global recession affect the production rate of Boeing or Airbus airplanes; or, what level of future defence spending might be agreed between the US Congress and the Trump Administration? As a result, clients tend to particularly value advisers such as CSP, who have deep domain knowledge and a long and reliable track record of successfully bounding the risks and opportunities inherent in target company forecasts.
Can you provide examples of particularly interesting or challenging transaction engagements?
Three recent engagements come to mind: in the first, CSP were engaged to evaluate a contractor that provides security services to personnel and facilities operating in hostile or austere overseas environments. Most of the programmes supported by the contractor required security clearances. Providing our client with a bankable view of the company’s forecast financial performance – and of the risks inherent in the business – required us to assess a complex set of geopolitical, programmatic, and contractual issues, cross-checked through interviews with company management, customers and other stakeholders.
A second engagement concerned a provider of business jet services. Here, the investment thesis did not involve national security, but rather, the rate at which high net worth individuals and corporate customers were likely to increase business jet flying hours, and in which types of aircraft. This deal turned on understanding competitive business jet access models including aircraft fractional ownership, jet cards, and traditional charter; it also included variables such as, jet fuel prices, aircraft residual values, programme pricing, and new aircraft model introductions.
Finally, a third engagement focused on a manufacturer of components for military radars, missiles, and defence communications systems. In this case, while the company provided a well-defined contract waterfall and new business pipeline, CSP were required, among other issues, to determine: how many units were likely to be procured by US and allied foreign military customers, and when; whether the company’s technology was at risk of being obsoleted; and, whether new business capture probabilities driving forecast growth were based on sound assumptions.
In each case, CSP’s output to our clients resolves to a detailed three to five-year financial forecast model of revenue and EBITDA, supported by empirical analysis presented in a compelling package, that enables a PE investment committee to determine whether to underwrite the deal, and assists lenders to explain it to internal credit committees to obtain loan approval.
Finally, how has the ADG deal environment evolved and what do you see for the next several years?
CSP has been active in the market for more than 30 years, so we have witnessed a number of economic cycles, wars (and their impact on US and NATO defence spending), and a revolution in information technology (and attendant cybersecurity challenges) that has affected how government agencies operate. Taking the period since 2000, ADG transaction activity was relatively unaffected by the events of 9/11 and the recession that followed, but fell sharply during the Great Recession as credit markets contracted. US spending on defence and government services was then adversely impacted for several years by the federal budget sequestration agreement. But over the same period the commercial aviation market saw unprecedented growth in airplane orders and production which drove high levels of transaction activity, especially among private equity sponsors.
More recently, all ADG sectors have seen good deal flow, as the commercial aerospace market remains healthy, US and European defence spending is forecast to rise, and selected areas of government services remain attractive. Looking forward over the next few years, I expect ADG to become more of a ‘stock picker’s market’, where buyers will need to be more selective around the companies they pursue (as many high-quality businesses have already been acquired). This should place more of a premium on the quality of commercial diligence advice, and the track record of the adviser providing it.
Brad M. Meslin, Ph.D.
Senior Managing Director
CSP Associates, Inc.
bmeslin@cspassociates.com | Tel: +1-617-225-2828
Dr. Meslin also manages CSP Equity Partners, a portfolio of private equity co-investments in more than 100 companies active in the industries served by CSP, which has achieved consistent top-quartile returns over nearly a 20-year period. He has served on the Boards of Directors of numerous client portfolio companies, including CMC Electronics, Sentient Jet, Berkshire Manufactured Products, Primus Aerospace, and Spacehab. He has acted as chief executive of eBizJets, the predecessor company of Sentient Jet which is the largest US business jet charter operator; and co-founded Spacehab, Inc., the first privately-financed commercial space laboratory , which flew numerous missions aboard the US Space Shuttle fleet. Dr. Meslin earned graduate degrees from The Fletcher School of Law & Diplomacy in Boston, where he currently serves as a member of the Board of Advisors.
Since 1990, CSP have been engaged in nearly 1,000 transactions in their served markets on behalf of more than 200 private equity firms, corporate buyers, and institutional financing sources. Since participating in the first known leveraged buy-out of a defence contractor more than 25 years ago, CSP developed and continue to innovate the standard for conducting commercial diligence of technology-intensive government contractors and aerospace industry suppliers. The firm provides buy-side and sell-side commercial diligence advice to clients across North America, Europe, and the Middle East.
