The Federal Aviation Administration (“FAA”) announced on Friday that it will launch a review of Boeing’s 787 Dreamliner that will focus on the aircraft’s electrical system and manufacturing process quality controls.  The review is prompted by a battery fire aboard a Japan Airlines 787 on the ground in Boston on Monday, an issue that was just one in a string of technical difficulties with the plane over the past week.  All Nippon Airlines reported that cracks appeared on the outermost layer of a cockpit window on Friday, and an oil leak was discovered on a different flight that same day.  Earlier in the week, All Nippon cancelled a 787 flight after a computer malfunction erroneously showed problems with the aircraft’s brakes.  On Tuesday, United Continental found a wiring problem with one of its Dreamliner’s auxiliary power systems.  FAA Administrator Michael Huerta noted that the FAA is confident the aircraft is safe overall, but the review was necessary to understand the recent pattern of malfunctions and help prevent them from occurring again in the future.

In other news, on Thursday Deputy Defense Secretary Ashton Carter issued guidance authorizing preparatory spending reductions at DoD so as to better prepare for sequestration, if it were to occur.  Authorized actions include freezing civilian hiring, terminating temporary hires, curtailing administrative expenses, cancelling 3^rd and 4^th quarter ship and ground-depot aviation maintenance, and delaying R&D and production contracts and modifications that obligate more than $500 million.  The authorization memorandum instructs that all such actions must be reversible at a later date in the event Congress acts to avoid automatic spending cuts.

Big Movers

GeoEye (Up 12.2%) – Shares were up for the week after the Company announced on Wednesday that the Department of Justice gave DigitalGlobe antitrust approval on its acquisition of GeoEye, announced in July.

Innovative Solutions & Support (Up 8.9%) – Shares were up for the week following the Company’s announcement that it has been assigned a patent for a “method and system for reducing runway incursion at airports.”

Relevant Transactions

Greenwich AeroGroup to acquire Aero Precision Industries, a provider of OEM spares, repairs, upgrades, and modifications for military fighter, transport, and rotary aircraft, for an undisclosed amount.  The transaction enables Greenwich AeroGroup to expand its capabilities in the international military and government markets.

Vistronix acquired Technology Associates International, a provider of specialized geospatial and data visualization tools that serves the DoD, U.S. Strategic Command, and the Department of Health and Human Services, for an undisclosed amount.  The acquisition expands Vistronix’s solutions portfolio, helping the Company to position itself as a mid-tier prime contractor addressing the government’s security challenges.

ManTech International acquired ALTA Systems, a provider of IT and professional services with applications in Health IT and capital planning, for an undisclosed amount.  The transaction expands ManTech’s presence in the Federal HIT market, and enables the Company to deliver services through prime positions on the $4 billion Centers for Medicare and Medicaid Cervices Enterprise Systems Development contract vehicle.

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Last weekend President Obama nominated Senator John Kerry (D-Mass.) for the position of Secretary of State in the Administration’s second term.  Mr. Kerry has served as chairman of the Foreign Relations Committee since 2009, and has worked in Pakistan helping to calm concerns after the raid that killed Osama bin Laden, and in Afghanistan helping to build the electoral process. 

During the press conference, the President highlighted the increasingly close relationship between the State Department and the DoD, pointing to the coming transition in Afghanistan, which Obama noted will require an increased role for the Department of State.

Despite downward pressure in the last weeks due to ongoing fiscal cliff concerns, the market has had a relatively strong 2012, with the S&P 500 returning 9.8% for the year.  Aerospace shares have outperformed, returning 15.2%, bolstered by a positive commercial aerospace delivery outlook and healthier expectations for aftermarket suppliers.  Defense Primes, while trailing the broader market, have still returned 8.6% for the year, driven in large part by strong earnings reports and operational adjustments to the uncertain contracting environment experienced throughout the year.

Big Movers

Magellan Aerospace (Up 6.2%) – Shares were up for the week following the company’s announcement that it has amended its operating credit agreement with its existing lenders and has extended its subordinated loan financing with Edco Capital Corporation.

Relevant Transactions

Woodward to acquire GE Hydraulic TRAS Business, a manufacturer of hydraulic thrust reverser actuation systems for commercial aerospace platforms, for $200 million.  The acquisition, which will be integrated into the Aerospace business segment, expands Woodward’s motion control technologies and platforms.

General Dynamics acquired Applied Physical Sciences Corp., a provider of engineering and prototyping services in the fields of signal processing, marine hydrodynamics, and electromagnetics, for an undisclosed amount.  The acquisition enhances the GD Electric Boat business’ rapid-prototyping capabilities.

Cessna, a Textron Company, to acquire Jet Aviation Management’s Dusseldorf and Zurich MRO Operations, providers of MRO, refurbishment, customization, and line maintenance services for commercial aircraft, for an undisclosed amount.  The acquisition expands Cessna’s service presence in Europe, particularly in Germany and Switzerland where a majority of the Company’s Citation aircraft in the region are based.

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The healthy aerospace market in 2012 has proved an opportune time for many financial sponsors to realize successful investments.  Cyclical commercial aerospace firms have bounced back from the downturn, and despite global macroeconomic concerns, are benefiting from positive industry dynamics such as traffic growth (29 straight months of growing passenger traffic and capacity) and record backlogs at OEMs (~7 years at Boeing and Airbus).  Strong financial performance at commercial aerospace businesses has propelled stock price gains (up 10.4%⁽¹⁾ in 2012 through December 14^th), and long-term confidence and accessible capital markets have helped fuel M&A.

Portfolio company exits in the aerospace industry have taken off since the market trough, with five in 2010, 16 in 2011, and 22 in 2012 through December 14^th.  Investors have been rewarded with solid returns, including the more than three times return on Vance Street Capital’s sale of Klune Industries to Precision Castparts in a hold period of just two years.  Precision Castparts also announced the acquisition of another private equity portfolio company, Synchronous Aerospace Group, in November to continue their aerostructures expansion.  Other high-profile exits include Warburg Pincus’ $675 million sale of CAMP Systems and Platte River’s sale of roll-up PRV Aerospace to Court Square.

With recently released 20-year forecasts from Boeing and Airbus pointing towards high-rates of production for the foreseeable future, long-term prospects appear sound.  Despite the occasional turbulence, the skies ahead look clear, with continued opportunities for successful investments in the aerospace market in 2013 and beyond.

As Congress and the Administration continue to negotiate a budget deal, on December 4 the Senate passed a bill authorizing the Pentagon to spend $650 billion in GFY13, which includes $525.3 billion in baseline funding with an additional $88.5 in OCO funding.  While the bill does not address the impending cuts under sequestration, it provides insight into the makeup of spending for weapons systems in the event a compromise is reached.

The bill largely supports the weapons systems plans set forth in the Administration’s request, including $5.9 billion for the F-35 fighter program, $60 billion for the Navy’s F-18 fighter program, $1.3 billion  for the Army to buy UH-60 Black Hawk helicopters, $639.9 million to develop the Army’s Ground Combat Vehicle, and various other authorizations. 

However, the bill also scales back some of the Administration’s proposals, including placing restrictions on the development of modules for the Navy’s Littoral Combat Ship Fleet and “fencing” funds for a second Ford-class aircraft carrier pending the delivery of additional data from the Navy.  The bill will now move through a House-Senate conference committee before advancing to the President’s desk.

In other news, TransDigm’s agreement to acquire the Goodrich Pump and Engine Control Systems business, announced on October 25^th, has been terminated after the Department of Justice objected to the deal.  Under a consent agreement between Goodrich owner United Technologies and the DoJ, the transaction required the Department’s approval, and the decision was in the DoJ’s sole discretion.

Big Movers

EADS (Up 14.5%) – Shares were up for the week following the company’s announcement of a proposed new shareholder agreement that caps sovereign ownership of the firm by France, Germany, and Spain at 12%, 12%, and 4%, respectively.  The firm also announced plans for a set of governance rules that seek to limit the influence these governments will have over the company’s decisions.

Relevant Transactions

LMI Aerospace to acquire Valent Aerostructures, a manufacturer of complex structural components, major sub-assemblies, and machined parts for OEM and Tier 1 airframe manufacturers, for $246.7 million, which LMI has indicated represents an EV/EBITDA multiple of ~8.6x, adjusted for tax benefits from the transaction.  The acquisition expands LMI’s capabilities on key platforms, including the “highly-desirable” Boeing 737 platform, and will enable the Company to compete for larger and more complex projects.  According to its filings, LMI is expected to generate over $480 million in revenue and over $80 million in EBITDA in 2013P on a combined basis.

Insight Equity acquired Micross Components, a manufacturer of specialty semiconductor products for UAV guidance systems and other defense and industrial applications, from Vance Street Capital for an undisclosed amount.  The acquisition represents an investment in an “important and growing industry niche” and will enable Micross to expand its product offerings.

SRA International to acquire MorganFranklin National Security Business, a provider of C4ISR, cybersecurity, and continuity of operations services, for an undisclosed amount.  The transaction expands SRA’s capabilities in a number of specialized technical and functional domains.

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Over the past week, the Obama administration noted it would be willing to keep roughly 10,000 U.S. troops in Afghanistan post formal combat in 2014.  Earlier this month, Gen. John Allen, commander of U.S. and international forces in Afghanistan as well as commander of International Security Assistance Force (“ISAF”) nominee, Marine Gen. Joseph Dunford Jr., recommended keeping troops in Afghanistan post the administration’s December 2014 deadline.  Specifically, Gen. Allen recommended maintaining a force between 6,000 and 15,000 U.S. troops to conduct training and counterterrorism operations.  The size of the training, advisory, and counterterrorism force is currently under negotiations with Afghan President Hamid Karzai.  Many consulting firms argue that a residual force of at least 30,000 troops would be needed to be effective.

Honeywell claimed it is readying itself for the bulk of sequestration cuts to occur, planning for 80% of the Jan. 2^nd cuts to take place.  “We recognize these cuts are going to happen,” said Mike Madsen, president of Honeywell’s defense and space unit. “We’re not really fighting these—they need to occur.”  The company has even gone so far as incorporating sequestration in its public planning.

Big Movers

Bombardier Inc. (Up 13.8%) – Shares were up this week after the company announced it made the biggest sale of business aircraft in its history worth potentially up to $7.8 billion.  VistaJet, a private European company that provides luxury chartered flights, has placed firm orders for 56 Bombardier Global jets valued at $3.1 billion and acquired options for a further 86 Global jets.  Steve Ridolfi, the president of Bombardier Business Aircraft, says this is a historic order for Bombardier.

Select Relevant Transactions

KEYW Corporation acquired Rsignia, Inc., a provider of advanced cybersecurity solutions to industry and government customers, in an asset purchase.  The acquisition enhances KEYW’s Cyber Awareness and Response platform, “Project G” by providing the company with a scalable solution for monitoring and mitigating malicious internet packet activity, network monitoring and analysis, and forensics analysis.  Terms of the deal were not disclosed.

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