As the U.S. government entered into a shut down this week, the reverberations were felt through the aerospace and defense industry.  According to the National Association of Government Contractors, 58% of government contractors said the shutdown would have a negative effect on their business.  For example, UTC announced that it would be furloughing 2,000 workers as production of Black Hawk helicopters was halted.  UTC unveiled plans to furlough an additional 3,000 workers if the shut-down were to drag on for longer than a couple weeks.  Lockheed Martin, BAE, and Boeing also have announced they may begin furloughing employees in the next week.

There were a number of mixed developments this past week with Lockheed Martin’s F-35 Joint Strike Fighter Jet Program.  On the positive side, Lockheed finalized two contracts with the Department of Defense (“DoD”) worth $7.1 billion for 71 more F-35 jets.  The order includes 47 F-35As for the Air Force, 13 F-35Bs for the Marines Corps, and 11 F-35Cs for the Navy.  Additionally, the South Korean government reopened the competition for its $7.2 billion fifth-generation fighter order.  Previously, the F-35 had been eliminated from the contest in favor of Boeing’s F-15.  However, the South Korean Defense Ministry brought the F-35 back into the competition on September 28^th after protests from a number of South Korean generals.

In the midst of these positive developments, the Pentagon Inspector General released a report on September 30^th highlighting 363 issues with the F-35 program, 147 of which were considered “major.”  A need for improved training and stricter criteria for acceptance of a plane were two of the largest highlighted issues. In response, Lockheed said that they have already addressed most of the issues mentioned in the report and are working to fix the outstanding problems.  Despite the issues, the DoD has stated that it has made great strides in its relationship with Lockheed in the past year.

Big Movers

Finmeccanica SpA (Up 15.6%) – Shares were up this week after insiders revealed that the Italian state lender Cassa Depositi & Prestiti has offered to buy 85% of Finmeccanica’s Ansaldo Energia power-plant division for 1.2 billion euros.  During the past year, the Company has been trying to raise 1 billion euros via asset sales to pay down nearly 5 billion euros of debt.

Relevant Transactions

Astronics Corporation acquired AeroSat Corporation,a provider of aircraft antenna systems for commercial transport, business jet, and military aircraft customers.  Astronics will pay $12.0 million in cash up-front with a potential earnout of $5 million to $20 million.

Curtiss-Wright Corporation acquired Parvus Corporation, a subsidiary of EuroTech SpA.,a designer and manufacturer of rugged small form factor computers and communications subsystems for the aerospace, defense, security, and industrial markets.  Curtiss-Wright will pay $38.0 million for Parvus.

LLR Partners completed a $50 million investment in Cigital, Inc., a provider of software security consulting services.  Cigital will use the investment to continue its growth in existing markets, penetrate new verticals, and expand geographically.

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This week, German airline Lufthansa announced a large order for wide-body jets.  The German flag carrier said it is ordering 34 new 777-9X jets from Boeing and 25 A350-900 jets from European rival Airbus as it updates its long-haul fleet to make it more fuel efficient and lower costs.

Rolls-Royce and United Technologies, two of the largest players in the worldwide aircraft engine industry, announced that they were abandoning plans to form a new joint venture to produce a mid-size commercial jet engine.  The companies cited the current regulatory environment as the reason for not proceeding with the partnership.

In the government space, the September 30^th deadline for Congress to pass a funding bill is rapidly approaching.  On September 20^th, the Republican-controlled House of Representatives passed a continuing resolution (“CR”) that ties discretionary spending to the defunding of the Patient Protection and Affordable Care Act (“PPACA”), which has been a politically charged issue since it was enacted in 2010.

The Democratic-controlled Senate has already declared a CR defunding PPACA as “dead on arrival,” and plans to pass a CR maintaining government funding at current levels through December 15^th.  Even if a CR is successfully passed before September 30^th, the government is on pace to reach its debt ceiling in mid-October, likely triggering another fiscal showdown in Congress.

Big Movers

The Boeing Company (Up 4.8%) – Shares were up this week after the successful maiden flight of the Company’s 787-9 aircraft on September 17^th.  The 787-9 is a slightly longer version of Boeing’s 787-8 Dreamliner.  The Company currently has unfilled orders for 388 787-9 aircraft and 548 787-8 aircraft worth a combined $217 billion at list prices.

Triumph Group (Down 7.5%) – Shares were down this week after the Company announced lowered profit expectations due to production cuts to the Boeing 747-8, an aircraft for which Triumph is a key supplier.

Relevant Transactions

Secure Communications Systems, a portfolio company of Vance Street Capital, acquired Lark Engineering Co.,a manufacturer of radio frequency filters for the commercial, industrial, and military markets.  The acquisition will expand Secure’s product offering and cross-selling opportunities.  Terms of the deal were not disclosed.

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As in 2013, Congress is not expected to pass a defense budget by the end of the government fiscal year on September 30, but instead enact a temporary continuing resolution (“CR”) to fund the entire government at spending levels comparable to the previous fiscal year.  In response, Pentagon officials are asking for flexibility in meeting Congress’ spending cap, which the Pentagon’s 2014 budget proposal currently exceeds by $52 billion.  Rather than focusing on eliminating certain programs, officials are hoping to reduce investment and increase efficiency in certain programs.  Typically under a CR, starting new programs and adjusting program investment levels are prohibited.

Last year, the Pentagon furloughed most civilian employees, decreased training, and delayed deployments to meet spending caps.  For 2014, a similar reduction in civilian work force will likely be a component in meeting spending caps.  While the need for reduction is uncertain until the enactment of the CR, officials are hopeful they will not have to resort to furloughs again in the coming fiscal year.

Big Movers

SAIC Inc. (Down 4.6%) – Shares were down this week after the Company announced second quarter earnings results below analyst estimates and subsequently decreased its fiscal 2014 outlook.

The Timken Company (Up 9.7%) – Shares were up this week after the Company announced it will spin off its specialty steel making division into a separate stand-alone company.

Relevant Transactions

Alliant Techsystems, Inc. (“ATK”) to acquire MidOcean Partners’ Bushnell Group Holdings, Inc.,a provider of branded sports optics, outdoor accessories, and performance eyewear, for $985 million in cash.  ATK will use the acquisition to expand the offerings and capabilities of its Sporting Group division as well as enter new markets.

Marshall Aerospace and Defence Group acquired Hawker Beechcraft Limited, European MRO Business Unit, a provider of maintenance, modification, paint, and upgrade services to Hawker and Beechcraft aircraft.  Marshall will use the acquisition to strengthen its civil aerospace business and increase its offerings to the business and commercial aviation marketplace.

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After two weeks of continued violence in Egypt, American military aid to the country is coming under scrutiny.  Annually, the U.S. provides $1.3 billion in military aid to Egypt in the form of tanks, helicopters, aircraft, infantry vehicles, and ammunition.  On August 22, the European Union unanimously agreed to suspend export licenses for all military technology to Egypt.  In response, the U.S. government has temporarily delayed the delivery of four F-16 jets, 10 Apache helicopters, and 125 Abrams tanks to Egypt.

Despite the current suspension of foreign military aid, analysts do not see the U.S. permanently ending its support as Egypt’s geographic location makes it a regional linchpin.  Egypt is one of the few Arab countries to have a peace treaty with Israel, a key U.S. ally, and the U.S. relies on access to Egyptian airspace for military flights and the Suez Canal for oil transportation.  U.S. officials worry that other parties will fill the void were military aid permanently suspended, as a group of Persian Gulf states have already offered $12 billion in aid if the U.S. assistance program ends.  Ultimately, analysts believe military aid will continue as U.S. strategic concerns remain the primary catalyst behind the decision.

The decision on military aid also has implications for defense contractors, as Egypt presents opportunities to provide products and assembly assistance services.  In 2011, General Dynamics won a $395 million award from the U.S. Army to provide Abrams tanks to the Egyptian military, and last year won an additional $50 million award to provide technical assistance at Egyptian tank assembly plants.  The Egyptian military has consistently shown a strong preference for U.S. defense products, and any U.S. suspension in aid would have a large impact on the U.S. defense industry.

In the government services space, NASA awarded a $1.76 billion contract to SAIC to provide biomedical, medical, and health services for NASA’s human spaceflight programs at Houston’s Johnson Space Center.  Additionally, SAIC named Samuel Gordy as the head of the Company’s National Security Sector integrated systems group.  This division will be a key part of Leidos when SAIC splits into two companies later this year.

Big Movers

Kratos Defense and Security Solutions (Up 11.8%) – Shares continued their upward climb this week after the Company announced 2Q13 earnings above analyst estimates.  Additionally, Kratos recently announced they had won a position on the Department of Homeland Security’s five year, $6 billion Continuous Diagnostics and Mitigation contract to provide government-wide cybersecurity products

Relevant Transactions

Sparton Corporation to acquire Aydin Displays, Inc.,a provider of flat panel display and touch-screen solutions with application-critical performance for military, aerospace, and civil marine customers.  Sparton will use the acquisition to expand its electromechanical capabilities and gain further penetration into the Boeing P8A Poseidon program.

Gen Cap America, Inc. acquired Renaissance Electronics Corporation, a provider of radiofrequency, microwave, and millimeter wave solutions for military and commercial applications.  Gen Cap will use the acquisition to expand its portfolio and strengthen customer relationships in the military, avionics, industrial, and consumer sectors.  Terms of the deal were not disclosed.

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This week the Senate Appropriations Defense Subcommittee approved a $594 billion defense budget for the 2014 fiscal year, further easing uncertainty about future defense spending. The Subcommittee voted in favor of a bill that provides the Pentagon with a $516.4 billion base budget and an additional $77.8 billion for Overseas Contingency Operations.  The bill calls for increased funding in multiple areas, such as restoring $3 billion to readiness accounts, adding over $320 million to Naval shipbuilding initiatives, and introducing a 1% pay increase for various personnel.  Among the components of the bill is a new spending restriction on the F-35 Joint Strike Fighter program that, although providing full funding for the purchase of 29 new aircraft in 2014, reduces advanced procurement for 2015 in order to focus on testing, design, and development of the current aircraft.  To counteract the proposed funding increases for specific programs, the bill looks to reinforce Defense Secretary Chuck Hagel’s planned pay cuts and 20% personnel reduction to create a savings of about $8 billion.  Additionally, the Subcommittee hopes to carefully reduce spending within the budget and transfer $12.6 billion of “wasteful, unnecessary, and duplicative” spending from lower to higher priority programs.

Big Movers

EADS N.V. (Up 2.2%) – Shares were up this week after EADS announced plans to restructure the Company’s business divisions and rebrand itself as Airbus, its commercial aerospace division, in 2014.

CGI Group, Inc. (Up 12.4%) – Shares were up this week after CGI Group announced its fiscal year third quarter earnings of $0.68 per share and $2.57 billion in revenue, both of which beat analyst estimates by 6.8% and 2.0%, respectively.

Relevant Transactions

Integrated Missions Solutions, LLC has agreed to acquire Michael Baker Corporation, an architecture, construction, and engineering firm.  Integrated Mission Solutions, an affiliate of DC Capital Partners, will use the acquisition to increase its global presence and expand its engineering capabilities to execute larger projects.  Michael Baker shareholders will receive $40.50 per share, valuing the transaction at $397 million.

Accenture Federal Services has agreed to acquire ASM Research, Inc.,a provider of advanced information technology and services to U.S. Defense and Federal health clients.  Accenture will use the acquisition to expand its Federal health capabilities, serve military personnel, and support its growing health business. Terms of the deal were not disclosed.⁽¹⁾

(1) KippsDeSanto & Co. served as exclusive financial advisor to ASM Research, Inc.

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