Feeling the strain from shrinking defence budgets in the United States and Europe, weapons makers from Britain's BAE Systems to U.S. group Raytheon are eyeing companies with innovative technology or a strong position in a specialist market, ex ec utives at the Farnborough Airshow said.
"Cyber and IRS (intelligence, surveillance and reconnaissance) are the only real growth areas in the defence sector at the moment and the big players are looking to move into those spaces more and more," said David Baxt, the global head of aerospace and defence investment banking at Jefferies., Reuters reports.
Companies with a large exposure to defence markets have already started acquiring smaller groups that can take them into a more commercial space.
British aero and defence group Cobham's recent 275-million-pound ($426 million) acquisition of Danish satellite and radio equipment maker Thrane & Thrane took it into the communications market, while BAE's acquisition of Norkom earlier this year moved it into financial services and fraud protection.
William Swanson, chief executive of U.S. arms maker Raytheon, said his company had not slowed its acquisition plans due to the uncertainty surrounding the U.S. defence budget, but that it was focusing on buying up smaller specialist firms.
"We're buying four or five companies a year. They're small, but they're niche for us and it hasn't slowed our activity," Swanson told Reuters at the air show.
"Cyber has been a good one for us and our business has been growing, and it's really growing because of cyber."
Raytheon acquired three cyber companies in 2011.
SMALL DEALS FOR NOW
One problem holding deals back, however, is the unrealistic expectations many companies have about their valuations.
"People still have beachfront property prices, mentally, and eventually prices will have to somewhat stabilize. Not every property is worth what people think it's worth," said Swanson.
Industry experts do not see a wave of huge deals happening, as seen in the 1990s, because the defence sector has already shrunk to be dominated by a handful of groups.
That calculus could change, they say, if the U.S. Congress does not avert an additional $500 billion in military spending cuts due to take effect in January under a process known as "sequestration."
Those cuts would be in addition to $487 billion in reductions already planned in the United States, which remains the world's largest market for weapons.
One London-based defence sector fund manager said mid-market deals worth up to the $2 billion mark were possible, with companies such as UK aero electrics specialist Ultra Electronics having "attracted admiring glances from some of the bigger players" in recent months.
Britain is cutting 8 percent in real terms over four years from its 34 billion pound defence budget.
Marwan Lahoud, chief strategy officer of Europe's biggest aerospace company EADS, said acquisitions were necessary as it would be impossible to offset the downturn in government defence spending through new export markets alone.
"You need to change the perimeter, you can always grow through acquisitions. If we look at anything it would be spin-offs or niche. It would not be anything substantial," he said.
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