Aerospace & Defense Update

Alphabet, Google’s parent company, announced its plans to sell Boston Dynamics, the legged-robot maker, as a result of internal disagreements and concerns about the Company’s ability to develop a marketable product within the next few years.  Alphabet acquired Boston Dynamics and six other companies in 2013, as part of an acquisition spree to develop a robotics unit dubbed Replicant.  Due to organizational conflicts, Alphabet recently dissolved Replicant and reassigned its employees to the Company’s X division, a future innovations arm that focuses on “moonshots”.  However, Alphabet executives struggled to find a proper fit for Boston Dynamics, as Boston Dynamics executives resisted Alphabet’s demands to abandon humanoid robots in order to work towards solving transportation or logistics problems.  Additionally, Boston Dynamics robots’ distinguishing feature, their ability to walk on two or four legs, is primarily useful for military applications creating further conflicts of fit as Alphabet stated it would not sell robots for military purposes.

Government officials and U.S. aerospace companies are striving to develop new cockpit-equipment standards that would eventually allow aircraft to tap into local satellite-navigation systems across the globe.  Recent efforts to draft regulations and common technical benchmarks aim to enhance airline safety by supplementing signals from U.S.-operated Global Positioning Satellites (“GPS”) with broadcasts from separate regional or ground-based technology.  Although the concept has been discussed in principle for years, many industry leaders and regulators are increasingly advocating for joint standards with the ultimate goal of enabling more precise and redundant location information worldwide, regardless of airline or aircraft type.  Industry leaders also outlined the importance of establishing signal integrity and availability requirements in order to address potential increases in intentional signal interference or hacking.

Government Technology Solutions Update

In preparing its 2015 FISMA report, the Office of Management and Budget (“OMB”) found that Federal agencies reported over 77,000 cyber incidents in 2015, an increase of ~10% from 2014.  The 2015 figure continues a decade-long trend of increasing Federal cyber incidents dating back to 2006 in which only 5,500 incidents were reported.  Despite an increase in total incidents, the OMB found 30% were unrelated to cyber-intrusion, including mishandling of sensitive information, loss of physical data records, and policy violations.  To understand if agencies’ cyber capabilities are successfully adapting to evolving threats, the 2015 Federal Inspectors General implemented an Information Security Continuous Monitoring (“ISCM”) framework to assess capabilities.  Their findings revealed 21 of the 24 CFO Act agencies implemented low-level ISCM maturity; only the General Services Administration (“GSA”) received a favorable score of 91%, exceeding the 68% average.  While there is still room for improvement, the OPM has cited significant improvement for areas targeted in last year’s cyber sprint, and is hopeful the $19 billion provision for cyber improvements in the President’s FY2017 budget request will accelerate this effort.

The GSA established its initial dedicated cloud computing effort nearly seven years ago; however, given the scale of the project, the agency continues its work of migrating to the cloud in pursuit of enhanced capabilities and reduced costs.  In order to expedite this process for the GSA and other Federal agencies, the Office of Citizen Services and Innovative Technologies (“OCSIT”) recently released a Request for Information (“RFI”) to gain a better understanding of vendors’ capabilities in the space.  The primary aim is to create a robust portfolio of cloud products, tools, platforms, and services that can support Federal agencies as they transition to the cloud.  The RFI focuses on five critical areas focused on both government experience and suggested contractor responsibilities. Primarily, the OCSIT is looking for contractors who not only understand the challenges that are inherent to government operations, but also that bring distinctive and innovative perspectives.   By encouraging creativity and calculated risk-taking on smaller projects, the OCSIT hopes to leverage any insights learned from successes or failures to improve processes on significant projects in the future.

Big Movers

Mercury Systems (Up 11.2%) – Shares were up this week after the Company announced plans to acquire certain businesses from Microsemi Corporation

Smith & Wesson (Down 9.7%) – Shares were down this week after Sportsman’s Warehouse projected a decrease in firearm sales for FY2016

Transactions

FTG Aerospace acquired Airco Industries, Inc., a provider of displays and control panels for military and commercial airborne and ground communications and navigation systems.  Terms of the deal were not disclosed.

Mercury Systems to acquire Embedded Security, RF and Microwave, and Custom Microelectronics businesses from Microsemi Corporation, a provider of high-frequency components and subsystem solutions for defense electronics, homeland security, and other government end-use applications.  The deal is worth an estimated $300 million.

Micro Focus International to acquire Serena Software, a provider of orchestrated IT solutions and application lifecycle management for Global 2000 companies and Federal customers.  The deal is worth an estimated $540 million.

Novaria Group to acquire Ferco Aerospace, a provider of high-strength and temperature resistant brackets, tube assemblies, and other exotic metal fabrications.  Terms of the deal were not disclosed.

Sirius Computer Solutions to acquire Force 3, a provider of infrastructure and security services, including next generation networking and IT support for Federal agencies.  Terms of the deal were not disclosed

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Aerospace & Defense Update

Almost five months after the Air Force awarded Northrop Grumman a contract to provide the Long Range Strike-Bomber (“LRS-B”), Air Force secretary Deborah Lee James finally disclosed seven major contractors who will join Northrop in building, what is now officially designated, the B-21.  James announced that Pratt & Whitney will build the B-21 engines at its facility in East Hartford, Connecticut.  James also noted the Air Force’s decision not to go with GE aviation on the engines reflects a departure from the legacy B-2 stealth bomber.  The other partners that will supply the airframe or mission systems include BAE Systems, GKN Aerospace, Janicki Industries, Orbital ATK, Rockwell Collins, and Spirit AeroSystems.  James did not disclose additional details about which B-21 component each contractor will build.  The Air Force’s decision to release the names of the key contractors is the first major step in the on-going effort to increase transparency and build support for the program.

Orbital ATK featured a wide range of satellite and space launch, propulsion, and logistics technologies during the Satellite 2016 conference and exhibition.  The Company highlighted their ability to design, build and deliver products to orbit for a variety of commercial and government customers around the world.  During the conference, Orbital ATK announced it is close to signing a pioneering contract with Intelsat to launch robotic space tugs to extend the life of geriatric satellites circling the Earth.  In addition to repositioning satellites, the tug would eventually fuel or repair ailing craft with robotic technology, which would permit satellites to be blasted into space with minimum fuel on board, generating substantial weight and cost savings.  The deal is expected to be announced as early as next month and would cap a lengthy struggle to turn in-orbit satellite servicing into a commercial reality.

Government Technology Solutions Update

The Department of Veteran’s Affairs (“VA”) announced the awardees to its $22.3 billion Transformation Twenty-One Total Technology Next Generation Acquisition (“T4NG”) program this week.  21 contractors won spots on the program, including 10 service-disabled veteran owned small businesses (“SDVOSB”), two small businesses, and nine large businesses, with all 21 having the ability to bid on any of the task orders (“TOs”) released under the vehicle.  The contracts have a base period of five-years and a one-year option period. The program seeks to foster private-public sector strategic cooperation in order to provide information technology (“IT”) services and solutions to support “MyVA” initiatives, including health IT, telecommunications, cybersecurity, and cloud mobility to further support and improve veteran care.

As part of the Executive Branch’s initiative to improve IT interoperability, the White House plans to release the plans for a pilot program that will call for the sharing of source code amongst Federal agencies.   The plan will call for agencies to release at least 20% of their new code as open-source in order to support improved access to the custom codes of these agencies.  Custom codes are defined as those codes developed by third parties for specific agencies.  As noted by U.S. Chief Information Officer (“CIO”) Tony Scott, “this policy is consistent with the Federal Government’s long-standing policy of technology neutrality through which we seek to ensure that Federal investments in IT are merit-based, improve the performance of our government and create value for the American people.”  To support the initiative, the Office of Management and Budget (“OMB”) will launch “Project Open Source” to aid agencies in implementing the White House’s guidance within 90 days of announcement.

Big Movers

Comtech Telecommunications (Up 7.3%) – Shares were up this week following a dividend announcement of $0.30 per share, representing a $1.20 dividend on an annualized basis and a yield of 5.57%

Finmeccanica (Up 7.3%) – Shares were up this week after the Company announced contract awards totaling around $130 million for air traffic control management systems

Transactions

Drew Marine, Inc. to acquire NAL Research Corporation, a provider of iridium satellite modem and tracking terminal services.  The terms of the deal were not disclosed.

Jet Aviation AG, a subsidiary of General Dynamics, to acquire AvJet Corporation, a provider of private jet management services.  Terms of the deal were not disclosed.

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Aerospace & Defense Update

The chairman of the Senate Armed Services Committee (“SASC”), Senator John McCain, stated he will not authorize the Long Range Strike-Bomber (“LRS-B”) if the procurement is on a cost-plus basis.  Senator McCain expressed concern of the additional costs associated with the contract structure and voiced opposition to hear the Air Force’s perspective on the matter.  Following the Senator’s remarks, the Air Force revealed the contract will be divided into two parts, cost-plus and firm fixed price.  The first phase, which consists of engineering and manufacturing development, is currently structured as a cost-plus with incentives.  The Air Force and Senator McCain are scheduled to discuss concerns surrounding the project during closed briefings with the SASC and the House Armed Services Committee in the following weeks.

According to sources familiar with the matter, Honeywell reportedly offered a merger proposal of around $105 billion, including debt, for United Technologies.  The industrial titans have a combined $95 billion in annual revenue and share an extended list of overlapping products and customers.  Following a decade of consolidation among aerospace suppliers, the two Companies are seeking to increase their leverage with their customers by demonstrating their expansive suite of products and technical expertise.  United Technologies expressed concerns around a potential transaction as the merger proposal was a source of unease from major customers and regulators on three continents.  However, Honeywell remains persistent and is continuing its pressure on United Technologies to remain engaged in merger talks.

Government Technology Solutions Update

As part of the Department of Defense’s (“DoD”) Third Offset Strategy, it is reaching out to non-defense technology companies to help increase its technological competencies and harness the benefits of recent IT advancements. The biggest challenge the DoD faces is dispelling the perception that government contracting stifles technology advancement given an arduous and time-consuming acquisition process and a limited ability for vendors to develop internal Intellectual Property (“IP”).  The Defense Innovation Unit Experimental (“DIUx”), located in Silicon Valley, was created to build and strengthen relationships with innovative companies, identify emerging technologies, and serve as a west-coast presence for the DoD.  The department recognizes it has traditionally fallen behind in these areas, and has established DIUx to bolster military capabilities in preparation for technological challenges and opportunities in the future.

The Federal Risk and Authorization Management Program (“FedRAMP”) has postponed launching its high baseline standards for cloud authorization by one to two months in an effort to reduce its existing backlog.  Initially, in 2012, FedRAMP successfully vetted cloud providers in six months; today that process takes anywhere from 12 to 18 months, according to FedRAMP Director Matt Goodrich.  Part of the slowdown has been caused by an increasing number of Cloud Service Providers (“CSPs”) and Third-Party Assessment Organizations (“3PAO”).  To more effectively manage the workload, FedRAMP is working with stakeholders to redesign the authorization process to focus primarily on actual capabilities and security, rather than documentation.  Goodrich expects the redesign to “make every authorization happen in less than six months,” and will provide a six-month FedRAMP update within the next two weeks.

Big Movers

United Technologies (Up 10.7%) – Shares were up this week following the news of a potential merger with Honeywell

Zodiac Aerospace (Down 28.4%) – Shares were down this week after the Company forecasted a recovery that will take longer than the 18 months initially planned

Transactions

CAE, Inc. to acquire Lockheed Martin Commercial Flight Training (“LMCFT”), a provider commercial aviation training products and services.  Terms of the deal were not disclosed.

General Dynamics to acquire Bluefin Robotics, a provider of unmanned undersea vehicles for customers in the defense, scientific, and commercial markets.  Terms of the deal were not disclosed.

Safariland to acquire United Uniform Company, a provider of tactical gear and uniforms for law enforcement and public safety professionals.  Terms of the deal were not disclosed.

Stirling Square Capital Partners acquired Mettis Aerospace, a provider of precision forged and machined components for aerospace and defense customers.  Terms of the deal were not disclosed.

General Atomics to acquire Ducommun Incorporated’s subsidiary, Miltec Corporation, a provider of engineering, technical, and program management services for advanced weapons systems and military defense systems.  The deal is worth an estimated $14.6 million.  KippsDeSanto & Co. acted as the exclusive financial advisor to Ducommun Incorporated.

Oracle Corporation to acquire Ravello Systems, Inc., a provider of cloud-based virtualization software applications and solutions.  The deal is worth an estimated $500.0 million.

Quantech Services, Inc. to acquire KeyW Systems Engineering and Technical Assistance business, a provider of SETA services to Defense agencies.  The deal is worth an estimated $12.0 million.

Rhone Capital to acquire a 45% minority stake in Garda World Security Corporation, a provider of business solutions and security services worldwide.  Terms of the deal were not disclosed.

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Aerospace & Defense Update

The Securities and Exchange Commission (“SEC”) has launched an investigation to determine whether Boeing properly accounted for the costs and expected sales of the 787 Dreamliner and the 747 jumbo aircraft.  The probe, prompted by a whistleblower’s complaint, concentrates on projections made by the Company about the long term profitability of two of its best known jetliners.  Both aircraft are renowned for the technological advancements they introduced into the aerospace industry.  The SEC investigation will be concentrated on Boeing’s use of program accounting, which allows the Company to average out upfront costs of manufacturing and the anticipated profits of planes over the full duration of production programs.  Though SEC officials have not determined if a case will need to be filed, Boeing’s share prices fell 6.8% on Thursday, marking the second large drop this month.

On Tuesday, the Obama administration released its $582.7 billion Government Fiscal Year (“GFY”) 2017 budget request to Congress.  The Defense Department’s request includes $71.8 billion for research and development (“R&D”), a 4% increase from the enacted $69 billion of last year.  The increase in R&D is expected to provide a foundation for the Third Offset high-tech investment portfolio, the Pentagon’s plan to restore rapidly declining U.S. military technological supremacy.  Over recent years the Pentagon’s budget requests exceeded past caps established by the Budget Control Act, also known as sequestration, however, this year’s request falls under Bipartisan Budget Act (“BBA”) providing the Pentagon with increased certainty on its funding levels.

Government Technology Solutions Update

President Barack Obama cited the Federal government’s portfolio of aging IT systems as a major focus area in his final budget request to Congress. On a combined basis, IT spending for civilian agencies, the DoD, and the intelligence community makes up approximately $90 billion of the budget request. “And I just want to say as an aside here [that] one of the biggest gaps between the public sector and the private sector is in our IT space, and it makes everybody’s information vulnerable,” Obama said.  A critical component of the budget request is for updated IT systems and infrastructure to replace archaic legacy systems.  In addition, the request highlighted the need for additional cloud adoption, the integration of interagency systems, and increased cybersecurity activities.  Currently, 26 Federal agencies are focusing on the successful migration of their IT to cloud based systems and converged agency infrastructure, as well as improving their cybersecurity practices and protocols, a trend likely to continue over the near term.

On Tuesday, the Obama administration announced a national cybersecurity action plan designed to address fundamental security challenges exacerbated by swift technological changes and the migration of Federal systems to the cloud.  The action plan focuses on three areas: (i.) substantially increasing Federal funds dedicated to cybersecurity; (ii.) the appointment of a Chief Information Security Official (“CISO”) that would report directly to Tony Scott, the Federal Chief Information Officer; and (iii.) the expansion of efforts to increase the nation’s cybersecurity workforce and public cyber-education initiatives.  To accomplish these goals, the plan proposes increasing cybersecurity funding to $19 billion, up 35% from last year’s allocation of $14 billion.  The fund would operate out of the General Services Administration, with set benchmarks the program must reach to receive further funding.   The funding will be complemented by a $62 million increase in the currently $4 billion initiative to increase the size of the nation’s cybersecurity corps reserve, as well as the creation of a Federal Privacy Council designed to monitor the progress Federal agencies are making in securing their networks.

Big Movers

Boeing (Down 11.4%) – Shares were down this week after the SEC launched an investigation on the Company’s accounting practices

American Science & Engineering (Down 30.6%) – Shares were down this week after the Company reported disappointing earnings

Transactions

Assured Enterprises has acquired Nova Defense & Aerospace International, a provider of IT and cyber security consulting to sensitive national security clients.  Terms of the deal were not disclosed.

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Aerospace & Defense Update

Boeing released its financial guidance for 2016, which included plans to deliver fewer commercial jets this year than last.  The guidance sent shares down 8.9% to end Wednesday trading at $116.58, its lowest close since October 2013.  However, Boeing achieved first flight of its 737 MAX on Friday, hoping to stay competitive against Airbus for the next decade in short-haul airliners.  The first flight comes nine days after the first delivery of the rival Airbus A320neo and begins more than a year of flight tests to achieve certification by the Federal Aviation Administration (“FAA”).  The Company plans to deliver its first jet to Southwest Airlines in the third quarter of 2017.

House Majority Leader Kevin McCarthy and Senate Armed Services Committee Chairman John McCain introduced legislation to repeal a provision that allows the unlimited purchase and use of rocket engines manufactured by the Russian company, NPO Energomash.  The two lawmakers believe NPO Energomash is controlled by friends of Russian President Vladimir Putin, and argue that U.S. purchases enrich the Putin regime and fuel Russia’s military industrial base.  The provision in question was a component of the 2016 omnibus spending legislation that allowed United Launch Alliance (“ULA”) to continue purchasing RD-180 engines from Moscow until a domestic alternative became available.  The Russian engines have powered dozens of ULA and Air Force launches over the past decade.  McCarthy and McCain believe the ban will facilitate a competitive domestic environment that provides the incentive to scale each component required to access space.

Government Technology Solutions Update

On Tuesday, Lockheed Martin officially announced that it has entered into an agreement to separate and combine its Information Systems & Global Solutions (“IS&GS”) business with Leidos.  Since the announcement, investor sentiment has been mixed.  Initially, stock prices for both companies fell considerably and while Lockheed’s share price quickly rebounded, Leidos’ share price closed the week at $46.12, or approximately 15% off of its pre-announcement price.  The $5 billion, tax-free transaction includes a $1.8 billion one-time special cash payment by Leidos to Lockheed.  In addition, Lockheed’s shareholders will receive approximately 50% of Leidos’ outstanding stock, which has an estimated value of approximately $3.2 billion.  In conjunction with the transaction, Leidos also plans to issue a  $1 billion special dividend to its existing shareholders.   To fund both payments, Leidos will rely on cash on hand, existing revolving credit facilities, and approximately $1.5 billion of new debt.  The combined company is expected to reach $10 billion in revenue with approximately $1 billion in adjusted EBITDA, and would become the largest federal IT services provider, surpassing the newly formed CSRA.  Management anticipates approximately $120 million in annual cost synergies by late 2018 and that the transaction will be accretive to adjusted EPS in the second quarter of combined operations.  While the deal is expected to create significant revenue and cost synergies, some investors are concerned about the relatively high valuation of the transaction along with integration risks associated with the mega-merger.

The U.S. Air Force announced awardees to its Platform for Engineering and Integration Tactical and Strategic Systems (“PEITSS”) contract earlier this week.  Of the ten companies that bid, six were awarded spots on the contract, which is valued at $538 million over seven years with expected completion in January 2023.  Companies will support systems within the Air Force that provide tactical and strategic command and control capabilities and battle management.  These capabilities will likely include surveillance, weapons control, and airspace management.

Big Movers

OSI Systems, Inc. (Down 30.2%) – Shares were down this week after the Company announced earnings for Q2 that fell 59% from last year

The Timken Company (Up 9.4%) – Shares were up this week after the Company announced fourth quarter earnings that beat analysts’ estimates

Transactions

Johnson Controls acquired Tyco International, a provider of security products and services, fire detection and suppression products and services, and life safety products worldwide.  The deal is worth an estimated $14.4 billion.

e2v Technologies to acquire Signal Processing Devices Sweden AB, a provider of signal processing solutions for analog-to-digital conversion.  The deal is worth an estimated $14.0 million.

Rockwell Collins to acquire the Matrix Series Projector Product Lines of Christie Digital Systems, a provider of advanced simulation and training projectors and projection systems.  The terms of the deal were not disclosed.

Leidos announced its merger with Lockheed Martin’s IS&GS Business, a provider of IT solutions and cyber security to Federal customers.  The deal is worth an estimated $5.0 billion.

PricewaterhouseCoopers acquired Praxism, a provider of identity and access management consultant services.  Terms of the deal were not disclosed.

SOS International has acquired New World Solutions, a provider of high value technical services to the Intelligence and Defense communities.  Terms of the deal were not disclosed.

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