C4ISR Market M&A Update – September 2022

C4ISR M&A Activity Remains Consistent Among Influx of Defense Spending on Sensor Technology Improvement

Consistent spending on innovative military technology has fueled healthy performance in the Command, Control, Communication, Computers, Intelligence, Surveillance, and Reconnaissance (C4ISR) market. Defense spending is slated to increase by 8.7% year-over-year (YOY) to $850 billion in fiscal year (FY) 2023, according to the Senate Committee on Appropriations.¹ Three hundred and eighty-three million dollars will be allocated specifically for the procurement of advanced sensor systems and components, according to the exploratory statement for the Fiscal Year 2023 Defense Funding Bill.² Specifically, the Pentagon’s continued prioritization of its Joint All-Domain Command and Control (JADC2) strategy, which seeks to connect sensors and data across military branches, is expected to materialize in robust demand for defense contracts and is projected to drive healthy merger and acquisition (M&A) activity for companies that provide military grade sensors and navigation equipment.

In March, the U.S. Department of Defense (DOD) released its JADC2 Implementation Plan highlighting sensor technology as an area of focus for the program’s continued development. The plan outlines a strategy for improving Command and Control (C2) capabilities by enabling joint force commanders to “sense,” “make sense,” and “act” on information across the battle space. The “sense” component of the strategy involves the improvement, construction, and application of advanced remote sensing methods (i.e., remote satellites) to feed the various intelligence sensing and information sharing networks with federated data fabrics used by Joint Force Commanders and their mission partners, according to the strategy report.³ Investment in improved sensor technology for these “data fabrics” is critical to the success of this strategy. “Command and Control in an increasingly information-focused warfighting environment have never been more critical,” Deputy Secretary of Defense (DSD) Dr. Kathleen Hicks, said in the report press release.⁴ “JADC2 will enable the DOD to act at the speed of relevance to improve U.S. national security. JADC2 is delivering capabilities beginning now, and it will continue to be funded in the coming years.” As evidenced by the March implementation plan, the DOD is committed to prioritizing the funding of sensor technology in order to make sure the vast array of information being gathered across all military branches is connected under the JADC2 banner.

Public Strategics Bolster Revenue Growth with JADC2 and Modernization Efforts

Leading players in the C4ISR sector have seen robust revenue growth, benefitting from the DOD’s push to modernize military technology and increase the pace of JADC2 adoption. Notably, the U.S. Airforce has awarded spots to 27 sector players in a $950 million contract to develop the Advanced Battle Management System (ABMS) component of the JADC2 project. Contract winners included, advanced sensor systems and equipment manufacturer SciTec, and global communication provider AT&T (NYSE:T), who launched a joint venture with defense contractor Northrop Grumman (NYSE:NOC).

Booze Allen Hamilton (NYSE:BAH), provider of intelligence, engineering, and cybersecurity, has also benefited from military modernization, achieving 13.1% YOY revenue growth in Q2 2022, according to its investor presentation.⁵ The company attributed its recent success to a series of U.S. Navy contracts this summer aimed at updating their information technology (IT) services. These included a five-year $171.8 million contract in July 2022 with the U.S. Navy’s aviation organization, and a $99 million contract in June 2022 for naval cybersecurity infrastructure improvement.^{6, 7} Booz Allen has continued to bolster its military technology through strategic acquisitions, evidenced by its purchase of data science and surveillance company EverWatch, (March 2022, undisclosed).

C4ISR M&A Activity Slightly Below 2021 Numbers, Poised for Strong Year End

Year-to-date (YTD) 2022 C4ISR M&A activity has nearly matched the elevated deal volume in 2021 with 49 transactions announced or completed. Private equity (PE) has maintained a strong investment focus in the space, as sector players have continued to consolidate through strategic acquisitions in order to improve product offerings for military consumers. The buyer profile for C4ISR transactions in YTD 2022 was split closely between strategics and financials, at 49% and 51%, respectively. Public and private strategic buyers each accounted for 24.5% of transactions, while PE platform investments accounted for 16.3% of all transactions. PE add-on transactions comprised the largest percentage of YTD transaction volume at 34.7%, a notable increase from YTD 2021. Add-on transactions accounted for 17% of the deal flow YTD 2021, and 20% for the full year.

M&A transaction multiples in the C4ISR sector have averaged 16.9x EV/EBITDA over the past three years, outpacing the broader Aerospace, Defense, Government & Security (ADGS) industry average of 11.9x EV/EBITDA. The healthy average EV/EBITDA multiple highlights a high level of competition for quality companies among buyers. The significant value being placed on C4ISR players demonstrates a promising outlook for sector growth among public and private strategic buyers who are willing to pay premiums for target companies that create synergies and improve business operations. PE buyers also see strong investment value in the sector with PE acquisitions averaging 13.4x EV/EBITDA over the past three years.

Strategics Leverage Inorganic Growth Strategies To Bolster Sensor Technology Capabilities

Public Aerospace & Defense companies have been acquiring independent manufacturers of sensors and advanced sensor systems through YTD 2022 in order to improve product lines for potential military contract wins. This highlights the continued demand for high value companies that can integrate with the JADC2 program and other sensor-focused military projects. Select recent transactions are outlined below.

• HEICO's Electronic Technologies Group Acquires Sensor Systems (August 2022, Undisclosed) - Electronic Technologies Group, a subsidiary of HEICO Corporation (NYSE:HEI), acquired Sensor Systems for an undisclosed sum in August consisting of cash and 575,000 HEICO Class A Common Shares. Founded in 1961, Sensor Systems is a family-owned designer and manufacturer of airborne antennas for military and commercial use. The company provides digitally tuned very high frequency (VHF)/ultra-high frequency (UHF) antennas for ARC-210 and ARC-231 military aircraft radios, according to the company's website.⁸ Sensor Systems also manufactures a line of custom and commercial-off-the-shelf (COTS) antenna products that can be installed on military aircraft including MQ-1 Predators, V-22 Ospreys, F-15 and F-16 Eagles, as well as C-17 Globemasters.

HEICO expects the acquisition of Sensor and its Aircraft Direction Finding (ADF), Altimeter, Glideslope, Global Positioning System (GPS), satellite communications, and Total Collision Avoidance Systems (TCAS) products to be accretive to earnings in 2023. In addition, Electronic Technologies will have immediate access to Sensor Systems' 50,000 square foot, multi-building facility in Chatsworth, California. The acquisition aligns with Electronic Technologies Group's portfolio of companies that design, manufacture, and sell mission critical and high-reliability subcomponents for defense, aviation, electronics, telecommunications, and medical applications. Electronic Technologies currently owns and operates three subsidiaries, VPT (May 2009, undisclosed), dB Control (February 2010, undisclosed), and Ramona Research (March 2012, undisclosed), which supply critical components used in the principal Unmanned Aircraft Systems (UAS) used by the U.S. military, as well as components for air-to-ground data link applications.

• EMCORE Acquires KVH Industries' Fiber Optic Gyroscope & Inertial Navigation Systems Business (August 2022, $55 Million) - Leading independent inertial navigation provider EMCORE Corporation (Nasdaq:EMKR), acquired the Fiber Optic Gyroscope (FOG) and Inertial Navigation Systems (INS) business of KVH Industries (Nasdaq:KVHI) in August, for an enterprise value of $55 million in an all-cash transaction. Following the acquisition, EMCORE will control FOG & INS business' 100,384 square foot production facility based in Tinley Park, Illinois. FOG and INS are expected to generate more than $30 million in annual revenue and is anticipated to be EBITDA-positive with significant synergies over the next two years, according to a press release.⁹ The deal also gives EMCORE access to an established customer base in the U.S. Army, as well as a product line of high-performance gyros and inertial sensors that deliver highly accurate navigation and control to a wide variety of manned, unmanned, and autonomous systems.

"We are very excited to add not only a strong and growing business with KVH's inertial navigations team, but also best-in-class manufacturing capabilities, low-cost technology development, and an exemplary sales team. When we combine these with EMCORE's closed loop and transceiver technologies, we see substantial opportunities for both businesses across revenue, gross margins, and net income. The addition of the KVH inertial navigation product line further expands our reach into the Tactical Grade segment of the market and solidifies EMCORE's position as one of the largest independent inertial navigation providers in the industry," said Jeff Rittichier, President and CEO of EMCORE, in the transaction press release.¹⁰

• Rafael Advanced Defense Systems Acquires PVP Advanced EO Systems (June 2022, Confidential) - Capstone Partners advised Rafael Advanced Defense Systems Ltd.—a designer, developer, and manufacturer of advanced defense systems—on its acquisition of PVP Advanced EO Systems, Inc. (PVP AEO) in June. Terms of the deal are confidential. Headquartered in Tustin, California, PVP Advanced EO Systems (PVP AEO) develops and manufactures electro-optic (EO) systems for air, land, sea, and critical homeland security applications including Integrated Fixed Towers (IFT) and Mobile Video Surveillance Systems (MVSS) for Customs and Border Patrol on the U.S. Southern border.

The acquisition of PVP AEO continues a significant growth period for the company that included; the creation of Rafael System Global Sustainment (RSGS), an all-American subsidiary that operates out of Bethesda, Maryland; the expansion of its C⁴ATS manufacturing subsidiary; and the launch of a joint manufacturing and testing venture with Raytheon Technologies, known as R²S. See below for more information on the deal and company strategy in an exclusive interview with Gideon Weiss, Vice President of International Business Development at Rafael.

Finding the right target, whose engineering skills and manufacturing team complemented Rafael’s technology offerings was important. We were honored to have achieved a strategic objective for Rafael—their partnership and trust in us were the basis of a successful collaboration.

Tess OxenstiernaManaging Director, Capstone Partners

Client Q&A: Rafael Advanced Defense Systems

Following Capstone's advised acquisition of PVP Advanced EO Systems by Rafael Advanced Defense Systems in June, the firm interviewed Gideon Weiss, Vice President of International Business Development, to discuss the acquisition, the role of Rafael in Israel's national security, and trends in the C4ISR sector.

Gideon Weiss, Vice President of International Business Development

Mr. Weiss has almost 30 years of experience in the Aerospace & Defense industry and began working with Rafael in 1993, where he has served in a variety of roles including Subject-Matter Expert & Instructor, Business Development & Marketing Manager, and Deputy General-Manager for Business Development, Marketing & Strategy.

During Mr. Weiss' tenure, Rafael has continued to grow its international portfolio through several joint ventures with U.S., European, African, and East Asian companies including German company Eurospike GmbH in 2019, and Australian defense contractor The Varley Group in 2018. Prior to Rafael, Gideon served as a Commanding Officer and Pilot in the Israeli Air Force for 10 years.

Can you share some of the history of Rafael and how it has differentiated itself in the market?

Rafael was founded in 1948 with the formation of the State of Israel, as the engineering core of the Israeli Defense Forces (IDF). In 1958, it transformed to become the “Armament Development Authority” of the Israeli Ministry of Defense (IMoD). As such, its core business was to be the national defense lab, developing technologies and building blocks for defense solutions. In fact, in-house serial manufacturing only started during the 60’s, while the bulk of production previously to this time, went to other Israeli industries. Certain products and unique production lines, such as naval EW, countermeasures and air-to-air missiles necessitated the construction of the first serial production lines at Rafael during the 60’s.

The dramatic national-level events of the Six-Day War of 1967, the proceeding Attrition War of 1967-1970 and the Yom Kippur War of 1973, propelled new thinking in multiple areas of defense, which formed many of the technological foundations which formed modern Rafael. The 70’s offered initial international and export business for Rafael and the Peace Treaty with Egypt in 1979, gave new perspectives to Rafael’s strategic national defense role and its relationship with the U.S. market. The proceeding conflicts, Peace of Galilee of 1982, the continuous war against terror from southern Lebanon, Gaza and Samaria, the Gulf-War of 1991 and other low-intensity conflicts, boosted advanced warfare requirements, new technologies and bolstered Rafael’s international collaborations. Indeed, the 90’s and the turn of the Millennium were characterized by multiple international teaming agreements. In the U.S., Rafael formed teaming agreements, most of which still hold today with the leading Tier-1 prime-contractors, such as Lockheed Martin, General Dynamics, BAE Systems, Northrop Grumman, Raytheon and many others.

In 2001, Rafael was transformed into a Government-Owned Company, with 100% of its shares held by the Ministry of Finance. The company has a typical business structure, with board of directors comprised of both defense-oriented and public-sector members, for a balanced oversight. Since that time, the company has shown a steady growth, with dividends paid to the Government each year, indicating positive profits. In 1993, Rafael USA, Inc. was established, first at an office in NW District of Colombia and in 2007, was moved to Bethesda MD, where it still resides. Rafael’s M&A track-record started in 2004, with the procurement of Dynamit Nobel Defence GmbH, out of Burbach Germany.

Over the years, Rafael was able to differentiate itself, first as the “National Lab” of Israel and since 2001, as the high-tech jewel of defense, specializing in state-of-the-art technologies and solutions, with international business and partnerships. Uniquely, Rafael’s modern-age mission statement sets it apart from any other defense company, reading: To be a significant pillar in the defense of Israel; As a global, growing, innovative and profitable company; Developing, manufacturing, fielding and sustaining defense systems at the forefront of technology and operational requirements.

Rafael is world renowned for the IRON DOME Missile defense system, and recently tested a new system call the Iron Beam. Can you tell us about this technology?

The Iron Dome system was developed by Rafael under a national program from 2008 until 2010, under IMoD funding. The precipice which led to its development was the 2006 Second Lebanon War, with over 4,500 rockets shot at Israel from Lebanon while Israel had no active protection. Coupled with the growing threat of Palestinian rockets, which proliferated into the Gaza Strip at that same time, the Israeli leadership made a historic decision to quickly harness resources and form a national program. At a full and open competition, Rafael presented the most capable and lowest cost solution, resulting in an undisputable award.

Fielded in early 2011, after only three years of development and testing, the system had its first operational interception on April 7^th, 2011. Since then, it has evolved into a highly-capable system, with numerous changes and modifications applied over the years, mostly through software and systems-level integration. The U.S. administration and Congress started bolstering funding for interceptor-missile manufacturing since FY-2012. The system has shown an unprecedented performance growth, which during operation Protective Edge of 2014 was measured at 92% and through 2022, improved to a staggering 97%. Unclassified public numbers of operational interceptions as of August of 2022, exceed 6,000.

The Iron-Beam directed-energy LASER system has been a risk-reduction program in the last few years, using IRAD and limited S&T funding from the IMoD. Earlier in 2022, the system matured through a series of successful tests, which led the IMoD to transform the program to Full-Scale Development. The system will be fielded in the coming years, augmenting its counter-rockets and mortars (C-RAM), as well as its counter-UAS and counter-drone capabilities, into the multi-layered defense system Israel has fielded.

Description: An IRON DOME missile defense system in the Negev region of Israel.

What key trends are you seeing in C4ISR and how have they impacted your business strategy?

Rafael utilizes all disciplines within the C4ISR realm in its systems. Hence, global changes in this market have a significant effect on Rafael. However, given Rafael’s technological superiority in this realm and its global customer-base and fielded systems, the most significant trend it not the technologies and market demands, but the requirement for localization and sovereignty by the receiving nations. This led Rafael to realizing that with ISR and EO/IR technologies being the common denominator for many of its systems in the U.S., acquiring a U.S. company in this field is a strategic goal.

Did COVID affect your operations? What did you do to resolve those challenges?

During 2020, COVID affected Rafael in the same way it did on most Defense industries, paralyzing some of its operation at the early stages of the pandemic, resulting in 90% performance overall for that year. Rafael applied multiple procedures and flexible work regimes to enable a safe, yet effective work. Shifts, remote and hybrid work, skype meetings and more were some of the solutions applied. On-sight PCR and Antigen testing, as well as corporate-led contraction investigations helped reduce the spread of the disease within workers. There were no layoffs and individual negative impact on workers was limited to compulsory utilization of paid-vacation days, at the height of the closures, when remote work was still not possible.

Given that the Capstone Aerospace & Defense Group led the buyside process for Rafael, how pleased were you with the ultimate acquisition of PVP AEO? What made PVP AEO an ideal acquisition target?

This had been the second time Rafael attempted to acquire a company in the U.S., but the first with a professional guidance. The previous was a decade ago. Tess Oxenstierna was the designated lead for the Rafael team. The overall experience of working with Tess, her team and the support from Capstone Headwaters which later evolved to Capstone Partners was superb. The entire process helped Rafael to get a better understanding of the marketplace and adjust expectations. The selection of PVP was the end result of several cycles of search, with two other primary candidates.

What made PVP the ultimate target for Rafael were the following: (a) a good-enough, viable company, with a sound customer-base, on a growth path, good reputation and an identifiable growth potential. (b) a company with good-enough capabilities in engineering and manufacturing of EO/IR systems. (c) a company with no active classified program, knowing that the FOCI and CFIUS authorization processes will be easier. (d) a privately-owned company, without ties to stock-exchange procedures and regulation during acquisition.

The support we received from Tess, until the very last moment, including the negotiations and interaction with CFIUS [Committee on Foreign Investment in the United States]—was everything we may recommend a team representing the buyside should have: professional, engaging, patient and with full picture for guidance at every stage, down to the last detail during negotiation.

How did Capstone’s knowledge of defense-related EO/IR companies and valuation insights help target companies that aligned well with Rafael’s strategic objectives? What synergies do you expect to gain from the acquisition?

Defining the immediate and long-term strategy to Capstone was at the heart of our planning, prior to addressing the formation of a targets list. The process did require some adjustments at times, but that was enabled by Capstone’s (Tess’) vast knowledge of the market and alignment of expectations. Once relevant targets were identified, Capstone’s ability to provide data about them, was key to enable Rafael’s team to evaluate and screen those targets properly. At the final stages, Capstone’s guidance was critical to enable valuation and come in at the right price range for LOI [Letter of Intent] and negotiations.

Rafael expects to gain several synergies with PVP as the PMI is underway: the first, after ensuring that the company continues to perform as planned, is to flow one to three new products into PVP to start manufacturing Stateside of Rafael-originated products. Within years two to three post-close, Rafael expects to enable a more significant growth, through flowing more projects into PVP, boosting recruitment of engineers, technicians, PM’s and operations personnel. Long-term, Rafael expects to flow complex products and technologies into PVP, such as advanced EO/IR systems and subsystems, as well as EO/IR missile seekers, such as the SPICE, SPIKE, Iron-Dome and others.

Capstone is committed to being client-focused and providing consistent high touch engagement throughout the M&A process. Was this true for you and, if so, what were some examples of this throughout the deal?

This was very true for Rafael. The outstanding examples were manifested in two significant phases: (a) the initial screening and valuation of targets; (b) the formation of the LOI and support during negotiations.

Capstone’s (Tess’) focus was not only on Rafael’s objectives, but more importantly, on the understanding of Rafael’s history, culture and the role of Rafael in Israel and in the U.S. Capstone’s team was tuned to listen well and understand Rafael’s way of thinking, decision-making process and leadership oversight, which are very different from a standard U.S. defense contractor.

What is the next growth stage for Rafael?

The year 2021 was very successful for Rafael allover. However, despite meticulous planning, 2022 had a rapid and unexpected turn of events, after February 24^th. The war in Ukraine changed and still changes so many things globally, but especially in Europe, the EU and NATO. Therefore, the next growth for Rafael could be in many directions, both Stateside, as well as in Europe, but for sure—it will be to support our overarching strategy of collaboration, localization and sovereignty for our customers and partners.

Any advice for a company that may be considering a buy-side process?

Be crystal-clear what their short and long-term goals are and what their main strategy is. Once those are clear and the investment bank is tuned-in, M&A becomes a fun and productive journey.

To discuss sector M&A activity, provide an update on your business, or learn about Capstone's wide range of advisory services and C4ISR sector knowledge, please contact Managing Director Tess Oxenstierna. 

Endnotes

1. Senate Committee on Appropriations, "Chairman Leahy Releases Fiscal Year 2023 Senate Appropriations Bill," https://www.appropriations.senate.gov/news/majority/breaking-chairman-leahy-releases-fiscal-year-2023-senate-appropriations-bills, accessed August 30, 2022.

2. Senate Committee on Appropriations, "Exploratory Statement for the Department of Defense Appropriations Bill, 2023," https://www.appropriations.senate.gov/imo/media/doc/DEFFY23RPT.pdf, accessed September 2, 2022.

3. U.S. Department of Defense, "Summary of the Joint All-Domain Command & Control (JADC2) Strategy," https://media.defense.gov/2022/Mar/17/2002958406/-1/-1/1/SUMMARY-OF-THE-JOINT-ALL-DOMAIN-COMMAND-AND-CONTROL-STRATEGY.PDF, accessed August 29, 2022.

4. U.S. Department of Defense. “DoD Announces Release of JADC2 Implementation Plan,” https://www.defense.gov/News/Releases/Release/Article/2970094/dod-announces-release-of-jadc2-implementation-plan/, accessed August 29, 2022.

5. Booz Allen Hamilton, "August Investor Presentation Deck,” https://investors.boozallen.com/static-files/d3be3a45-0f7c-4deb-b9c4-3d8c8962a761, accessed August 25, 2022.

6. GovConWire, "Booz Allen Wins $172M IDIQ Award to Support Navy's Aviation Enterprise," https://www.govconwire.com/2022/07/booz-allen-wins-172m-idiq-award-to-support-navys-aviation-enterprise/ accessed August 30, 2022.

7. GovConWire, "Booz Allen Wins Potential $99M IDIQ Contract for Navy Infrastructure, Cyber Support Services," https://www.govconwire.com/2022/06/navy-selects-booz-allen-for-99m-infrastructure-cybersecurity-support-contract/ accessed August 30, 2022.

8. Sensor Systems, "Company Industries," https://www.sensorantennas.com/about-sensor-system/aircraft-antenna-industries/#military, accessed August, 25, 2022.

9. Unmanned Systems Technology, "EMCORE Acquires the KVH FOG & Inertial Systems Business," https://www.unmannedsystemstechnology.com/2022/08/emcore-acquires-the-kvh-fog-inertial-navigation-systems-business/, accessed August 17, 2022.

10. Unmanned Systems Technology, "EMCORE Acquires the KVH FOG & Inertial Systems Business," https://www.unmannedsystemstechnology.com/2022/08/emcore-acquires-the-kvh-fog-inertial-navigation-systems-business/, accessed August 17, 2022.