C4ISR – July 2021

C4ISR M&A Reaches Historic High, Bolstered by National Defense Strategy, JADC2

As the C4ISR industry continues to offer paramount technology solutions for the Defense market, we expect a continued acceleration in M&A activity, with purchase multiples driven up by competitive and consolidating market dynamics.

Tess Oxenstierna Managing Director, Capstone Partners

Merger and acquisition (M&A) activity in the C4ISR (Command, Control, Communication, Computers, Intelligence, Surveillance, and Reconnaissance) industry is projected to outperform its 2020 high as the industry’s stability, the nascent Space sector (buoyed by the Space Force and commercial interest), and U.S. military initiatives to implement advanced communication systems have energized deal activity.

C4ISR deals increased 35% year-over-year (YOY) through year-to-date (YTD) and are poised to reach the highest annual figure since Capstone began tracking the industry in 2012.  Buyers have also paid a premium for quality C4ISR companies, with an average deal multiple of 12.3x EV/EBITDA YTD compared to 10.4x across the broader Aerospace, Defense, Government, and Security (ADGS) industry. Prime contractors and leading public companies have helped to drive up valuation multiples as they utilized M&A to gain new technology solutions to meet the swiftly changing needs of the Department of Defense (DOD), while private equity firms have sought to deploy capital into the robust and expanding addressable market. The global C4ISR market is projected to see a compound annual growth rate (CAGR) of 4.6% to reach $161.4 billion by 2027, with North America claiming the highest revenue share, according to Emergen Research.¹ Within C4ISR, Defense Intelligence, including advanced communication, reconnaissance, and surveillance solutions, is forecasted to experience the fastest growth at 7.8% CAGR through 2027.

National Defense Strategy, JADC2 Drives M&A

The U.S. military's 2018 National Defense Strategy's (NDS) pivot from preparing for non-state actors to warfighting readiness in the Indo-Pacific region is a key driver of deal inflection as high-technology enhancements and Research, Development, Test and Evaluation (RDT&E) have gained a growing share of the defense budget. While the $715 billion Fiscal Year (FY) 2022 Defense Budget request saw only a 1.6% increase in spending, C4ISR & IT (information technology) Systems funding increased 7.8% for a total of $34.8 billion, as noted by government market analytics platform Govini.² Additionally, the defense budget included a 5.1% increase in RDT&E for a record-high total of $112 billion. While the spending has expanded in key strategic areas, the dynamic threat of Russia and China will also necessitate significant overhauls to modernize and upgrade current military fleets cost-effectively, further driving demand for technology solutions.

Mission-critical technology for gathering data and interoperable information sharing has recently gained heightened attention due to the DOD's 2021 Joint All-Domain Command and Control (JADC2) initiative. At its core, JADC2 aims to remove communication stove pipes that exist due to each military branch operating on its own tactical network. JADC2 would create a connected, cloud-like communication environment where data could be gathered from planes in the air, ships at sea, and troops on the ground and, once further refined via artificial intelligence (AI) algorithms, would decrease mission response time and optimize efficiency through increased cross-branch visibility.³

Several recent M&A transactions have shown buyer rationale to be heavily influenced by these growing trends and key defense initiatives, including:

Huntington Ingalls to Acquire Alion Science and Technology

On July 6, America's largest military ship builder, Huntington Ingalls Industries (NYSE:HII), announced that it would acquire Alion Science and Technology from Veritas Capital for $1.65 billion in cash, representing an enterprise value of ~12.2x expected 2022 adjusted EBITDA, according to the 8-K filing.⁴ Alion provides engineering and R&D for the DOD and intelligence community. Already this year, Alion has been awarded more than $2 billion in government contracts to provide RDT&E and support on programs across the Navy, Air Force, and Army.

The acquisition will enhance Huntington's national security solutions portfolio including: strengthening its position in mission-critical security solutions such as AI, electronic warfare, and C4ISR; providing solutions for multi-domain operations and supporting the Navy and DOD's modernization and readiness initiatives; and accelerating its annual Technical Solutions revenue. The deal is expected to be significantly accretive to 2022 free cash flow and 2023 EPS.

Veritas & Evergreen Coast Capital Acquire Cubic 

In another recent defense deal involving Veritas Capital, Veritas and Evergreen Coast Capital (affiliate of Elliot Investment Management) acquired leading defense technology company Cubic Corporation (NYSE:CUB) for an all-cash value of ~$3.0 billion including debt assumption, at 2.3x revenue and a robust 14.7x EV/EBITDA. The take-private transaction closed in May following a bidding war with Singapore Technologies Engineering which drove Veritas and Evergreen's offer price up ~7% from its initial offer of $2.8 billion (including debt) in February. Cubic creates and integrates solutions for C4ISR customers worldwide operating through three segments: Cubic Transportation Systems (CTS), Cubic Mission Solutions (CMS), and Cubic Global Defense (CGD) Systems.

LinQuest Acquires TMC Design

In January, LinQuest Corporation, backed by Madison Dearborn Partners, acquired TMC Design Corporation for an undisclosed sum. TMC offers advanced engineering, with expertise in electromagnetics, digital signal processing, radio frequency communication, electronic warfare, satellite communication (SATCOM), and space situational tools. The company is an AS9100 D/ISO9001 certified supplier and boasts more than 325 prime contracts.

In March—in partnership with the National Security Innovation Network (NSIN), Navy, and Marine Corps—LinQuest completed a successful demonstration of the Omnispace 5G satellite. As the military seeks to implement JADC2, commercial 5G could significantly support transmitting large data sets quickly and creating connectivity across air, land, sea, and space. As contracts become available to improve defense strategies, LinQuest's acquisition will augment its position as a technical solution provider to U.S. government and commercial end-markets.

"This combination will create a compelling suite of solutions to provide all of our customers with mission-essential capabilities addressing many of our country's most challenging national security threats," LinQuest CEO Tim Dills stated in their press release.⁵

Public Companies, Financial Buyers Claim Growing Share of Deals  

Public companies continue to utilize M&A to absorb new innovative solutions, strengthening their positioning for government contracts and subsequently enhancing shareholder value. Capstone's C4ISR Index has recorded a nearly two turn increase in public company trading multiples from an average of 11.9x EV/EBITDA in 2020 to 13.8x in 2021. Collectively, these stocks are trading at 87% of their 52-week highs as of July 19.

While public companies, such as CACI International (NYSE:CACI), have noted that government processing deployment orders and task orders have been delayed due to the pandemic, the organizations continue to benefit from strong contract backlogs that provide stability and forward looking transparency. Additionally, these backlogs have largely been bolstered compared to the prior year, with Viasat's (NASDAQ:VSAT) backlog increasing 23%, Leidos' (NYSE:LDOS) +15%, and AECOM's (NYSE:ACM) +13%, according to quarterly company presentations.^6,7,8

Public entities and financial buyers have claimed a growing share of targets following the pandemic, with 76% of deals to-date in 2021 driven by a public or financial buyer compared to 57% in 2017.

As the C4ISR industry continues to offer paramount technology solutions for the Defense market, we expect a continued acceleration in M&A activity, with purchase multiples driven up by competitive and consolidating market dynamics.

Capstone remains a highly active advisor to C4ISR companies seeking a liquidity event and, with more than 15 current mandates in the ADGS industry, continuously stays abreast of the industry through market data, conversations with business owners, strategics, and private equity firms. To gain more insight into current industry trends or to learn more about optimal timing and preparation for an exit, please contact us.

Endnotes

1. Emergen Research, "C4ISR Systems Market By Application…," https://www.emergenresearch.com/request-sample/195, accessed July 19, 2021.

2. Govini, "The 2021 Federal Scorecard," https://govini.com/wp-content/uploads/2021/07/2021-Federal-Scorecard.pdf, accessed July 19, 2021.

3. Congressional Research Service, "Joint All-Doman Command and Control: Background and Issues for Congress," https://crsreports.congress.gov/product/pdf/R/R46725/, accessed July 14, 2021.

4. S. Securities and Exchange Commission, "Form 8-K Huntington Ingalls Industries, Inc.," https://sec.report/Document/0001193125-21-208167/  accessed July 19, 2021.

5. LinQuest, " 05 January 2021 - LinQuest Corporation announced the acquisition of TMC Design Corporation," https://www.linquest.com/working-with-linquest/articles/LinQuest-Completes-Acquisition-of-TMC-Design, accessed July 19, 2021.

6. Viasat, " Viasat Shareholder Letter: Q4 & Fiscal Year 2021 Financial Results," https://investors.viasat.com/events-and-presentations, accessed July 14, 2021.

7. Leidos, "Leidos Q1 2021 Presentation," https://investors.leidos.com/investor-relations/default.aspx, accessed July 14, 2021.

8. AECOM, "Q2 Earnings Presentation Slides (PDF)," https://investors.aecom.com/events-and-presentations/presentations, accessed July 14, 2021.