Aerospace and Defence

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Aerospace & Defence2011 year in reviewand 2012 forecast

We look at how aerospace

and defence companies

perform todayand

what challenges and

opportunities they

will face tomorrow.

www.pwc.com/aerospaceanddefence


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Aerospace and defence industry delivers asecond consecutive year of record revenues and prots 1

Commercial aerospace leads the way 3Defence 12

Mergers and acquisitions 21

In summary 23

Contents


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PwCiv

Our data is based on the scal 2011results for the largest 100 aerospaceand defence companies, by revenue,

with publicly available nancialreports. Our cut-off for publication

was March 31, 2012. Accordingly,a few companies were omitted

because they had not reportedresults by the cut-off.

A&D companies include those thatgenerate the majority of revenue fromaerospace and defence activities,or for diversied companies, thosereportable segments that derive a

majority of revenue from aerospaceand defence activities. The resultsare reported in U.S. dollars. Foreigncurrencies were translated at averageexchange rates for the years endedDecember 31, 2011 and 2010,respectively.

Our report also expresses PwCspoint of view on topics affecting theindustry. Our viewpoints have beendeveloped based on our interactions

with our clients and other industryleaders and analysts.

Methodology


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A&D 2011 year in review and 2012 forecast 1

Aerospace and defence industrydelivers a second consecutiveyear of record revenues andprots

Our research indicates that theaerospace and defence (A&D)industry reported its best year everin 2011 in terms of revenue andprot on the strength of a surgingcommercial aviation market thatmore than offset a soft defence

performance. The industry hadto overcome a nearly $5 billiondecline in the operating prot ofFinmeccanica to achieve the recordprot results. For 2011 the top100 A&D companies reported$677 billion in revenue and$60.0 billion in operating prot,setting records. Revenue was higherby 5% compared with 2010, whileoperating prot was up 2% over2010. Operating margin dropped

27 basis points to 8.86%.

The mood in commercial aerospaceis described by industry leadersas optimistic. Air trafc is strongand steady, driving the lucrativeaftermarket business; the industrydelivered a record number of largeaircraft and the orders continue,driving record backlogmore thaneight yearsat current produc-tion rates. Times are so good,some people are asking whether

theres a bubble. While there arerisks, particularly the availabilityof aircraft nancing, we believeit isreal. Recent volatility in oilprices threatens to derail near-term economic growth; however,forecasted demand is based onreasonable assumptions aboutlong-term economic growth anddemographics. More importantly,backlogs provide a signicantcushion between demand and

current production rates that couldabsorb any reasonably anticipatedsoftening in demand.

Summary table

US$ billions 2011 2010 Change

Revenue $677 $648 5%

Operating profit $60.0 $59.1 2%

Operating margin 8.86% 9.13% -27 bps

Source: PwC


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The mood in defence might bedescribed as pensive due largely tothe uncertainty over the prospect ofsequestration in the United States.While the industry is prepared toabsorb projected U.S. budget cutsof about $500 billion over the nextdecade, the situation could becomesignicantly more challenging ifsequestration is not averted, which

would trigger automatic cuts todefence spending. While manybelieve such cuts could result inunacceptable risks to national

Triumph Groupincreased 26 spots

from #69 to #43

Oshkosh Defensedropped 14 spotsfrom #19 to #33

Largest increase in revenue (dollars) EADS $7,729M

Largest increase in revenue (percentage) Triumph Group 124%

Largest increase in profit (dollars) Thales $1,282M

Largest increase in profit (percentage) Thales 471%

Highest operating margin Transdigm 40.4%

Largest decrease in revenue (dollars) Oshkosh Defense -$2,797M

Largest decrease in revenue (percentage) Oshkosh Defense -39%

Largest decrease in profit (dollars) Finmeccanica -4,949M

Largest decrease in profit (percentage) Finmeccanica -303%

security, it is difcult to predict howthe political process will evolve,especially in a presidentialelection year.

Defence companies face morepressure than ever to improveproductivity, increase transparency,respond to increasingly complexgovernment regulations andoversight, tighter schedules, andgenerally higher expectations.Persistent security threats, theIranian nuclear threat, and

geopolitical instability, as witnessedrecently in the Middle East,underscore the need for globalsecurity and could rapidly changedefence priorities.

During the past decade, the A&Dindustry has demonstrated a moredisciplined management approachthrough economic cycles, whichhas resulted in steady revenue andearnings growth and culminatedin back-to-back record years ofrevenues and prot.

Largestincrease intop 100 list

Largestdecrease intop 100 list

Aerospace and defence industry delivers a second consecutive year of revenues and prots

Source: PwC


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Commercial aerospaceleads the way

Record deliveries and backlog, new aircraftlaunches, and rst ights

Boeing was, again, the industryslargest company, reporting$68.7 billion in revenue, a 7%increase, on the strength ofcommercial aircraft deliveries.EADS increased revenue from45.8 billion to 49.1 billion, also7% (13% when translated into U.S.dollars). EADS reported the largestrevenue growth, $7.7 billion, nearlygrabbing the top spot on our list,nishing narrowly behind Boeing byonly $407 million. Predominantlycommercial aerospace companiesgenerally reported strong revenuegrowth. United Technologies, GE

Aviation, and Honeywell Aerospacealso reported 7% growth. Compa-nies reporting double-digit growthinclude Safran, Goodrich, PrecisionCastparts, Harris, and Spirit Aerosys-tems. Triumph Group reported thelargest revenue percentage increase,

124%, on the strength of its acquisi-tion of Vought. Triumph also madethe largest upward movement onthe list, advancing 26 spots to #43.Oshkosh Defense reported the largestdrop in revenue and prot as a resultof lower M-ATV production due tothe decreasing tempo of operations inIraq and Afghanistan.

0

500

1,000

1,500

2,000

2,500

3,000

Airliner market viewNew orders

2001(626Total)

386 405 357 435

1,430 1,3301,683

1,159

475

309

1,104

2,111

367

149

505

967

537433

167139112

240

2002(517Total)

2003(496Total)

2004(602Total)

2005(1967Total)

2006(1763Total)

2007(2650Total)

2008(1664Total)

2009(624Total)

2010(1413Total)

2011(2478Total)

Widebody Jet Narrowbody Jet

Number

ofaircraft

Year ending

Source: ACAS (February 2011)


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Boeing was also the industrys most protable company, with $5.844 billionin operating prot, an increase of 18%. Thales reported the largest protpercentage increase, 471%, due to the absence of large programme chargesrecognised in 2010 for Meltem Marine Patrol and A400M. Industry oper-ating margin decreased 27 basis points to 8.86%. Despite the record results,the industry as a whole continues to nd double-digit operating marginelusive. The industrys best operating margin belongs to Transdigm, at40.4%, down slightly from 43.8% the prior year.

Globalisation

The A&D industry continues to globalise. Companies are reporting increasedforeign direct investment, with the rate approximately doubling from adecade ago. For investments in manufacturing, China and India have beenthe top targets. The United States is third, on the strength of its marketsize and capabilities. Fourth on the list is Mexico, which has developedan aerospace manufacturing niche. India was the top target for R&Dinvestments, while China came in seventh, presumably because of concernsover intellectual property protection. The United States was the second mostpopular target for aerospace and defence R&D investments.

Commercial aerospace leads the way

Investments by Top 50 Global A&D companies in international markets

02468

101214161820222426283032

201120102009200820072006200520042003200220012000

M an ufac turin g R&D

2

7

2

59

6

3

2

36

6

7 7

13

18

4

12

21

9

6

9

7

3

1

Source: Company Reports


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2012 forecast and risks

For 2012, we expect more of the same based on the trends revealed by thedata. We expect continued growth in commercial aerospace, resulting fromstrong and steady demand for global aviation and increased commercialaircraft production. In the early part of 2012, economic indicators aregenerally positive. However, geopolitical risk with Iran is driving upoil prices, which could threaten the fragile economic recovery. Also,programme management risk is always present, in particular supply chainrisk. PwCs analysis indicates that total aircraft production will grow at10% compounded annual growth through 2016, placing signicant strain

on the supply chain. A recent PwC study found that 21% of the supplybase demonstrates signicant capacity and/or nancial risk. Furthermore,the Japanese tsunami has caused companies to take a closer look atgeographical risk and sole source arrangements. While revenue is expectedto rise, there is a signicant risk that return on sales could drop due to supplychain inefciencies. During prior periods of growth, raw material and supplyshortages have resulted in late deliveries, rush shipments, out-of-sequence

work, and overtime, which have prevented the benets of higher volumefrom dropping to the bottom line.

Defence revenues should, again, be modestly lower. However, recent cost-cutting actions in the United States and Europe should mitigate the impact

to the bottom line. There are also some risks that are difcult to forecast,such as the effect of destabilisation of the geopolitical environment in theMiddle East on defence spending. Overall, the industry should report anotherstrong year in 2012 and quite possibly another record, on the strength ofcommercial aerospace.

Commercial aerospace leads the way

0

500

1,000

1,500

2,000

2,500

3,000

Regional Jet

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2011

Widebody Narrowbody

Historical net orders

Source: Airline Monitor, Company Reports


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Aircraft backlog Boeing Airbus Total

Backlog at December 31, 2010 3,443 3,552 6,995

Net orders 805 1,419 2,224

Deliveries 477 534 1,011

Backlog at December 31, 2011 3,771 4,437 8,208

Commercial aerospace

Record deliveries and backlog, new aircraft launches,and rst ights

The industry delivered a record number of large aircraft, exceeding the1,000 mark for the rst time; Boeing and Airbus each launched newnarrowbody aircraft with unprecedented efciency improvements;the second-best year for orders pushed backlog to new highs; and the787 made its rst revenue ight.

Boeing and Airbus delivered, in aggregate, 1,011 aircraft in 2011. Airbus

delivered 421 single-aisle aircraft, or 35 per month, while Boeing delivered372 single-aisle aircraft, or 31 per month. Both companies have announcedfuture production rate increases. In addition, Airbus recognised a record

year of 1,419 net orders, while the industry recorded 2,224 net ordersfor large commercial aircraft, the second-best year in aviation history,after 2007, pushing backlog to a new record of 8,208 aircraft, more thaneight years at current production rates. Boeings backlog is at a record$293 billion and Airbus backlog is at a record $679 billion (at list price),a 41% increase.

Backlog (US$ billions) 12/31/11 12/31/10 12/31/09 12/31/08

Boeing $293 $256 $250 $279

Airbus* $679 $480 $459 $471

* at list price

Source: Boeing annual report; EADS annual report


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For 2011, the International Air Transportation

Association (IATA) reported revenue passenger

growth of 5.9%. This level of demand bodes wellfor the 20-year forecast of approximately 33,000

new planes at a value greater than $4 trillion.

Airline protability is projected to be about

$7 billion globally in 2011. However, rising oil

prices continue to threaten protability into 2012.

IATA statistics 2011 2010

Revenue passenger miles +5.9% +8.2%

Load 78.1% 78.4%

Cargo freight ton miles -0.7% +20.6%

Load 45.9% 53.8%

Source: IATA



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0

10

20

3040

50

60

70

80

90

100

1950 1960 1970 1980 1990 2000 2010

49%

82%

Engine fuelconsumption

707120

Comet 4

747100

A380

A380

777300ER

777300ER

777200

777200

787

787

Aircraft fuel

burn per seat

747400

DC863

Fuel efficiency gains since the early jet age

%o

fb

ase(Comet4)

Year of model introduction

Order activity was driven in large part by the launch of two new single-aisle aircraft, the A320NEO and 737MAX. Both offerings are re-engined

versions of the existing models, promising at least 15% efciencyimprovement. To put this in perspective, aircraft engines have achieved49% efciency improvement in more than ve decades of the jet era, orabout 1% per year. But the gains were greater in the early years and theindustry has averaged only about 0.5% improvement per year in the past

three decades. So, a 15% improvement in one generation is a signicantadvance in efciency.


Source: Air Transport Action Group


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Commercial aerospace2012 forecast: fair skies

but risks loom

For 2012, both Boeing and Airbusare each expected to deliver near600 aircraft, a 15% to 20% increaseover 2011. The increase is moresignicant for Boeing, drivenprimarily by production ramp-upin 787 and 747. This is a signicantincrease for an industry which,arguably, has the most complexand longest lead time supply chain.The challenge will be avoiding priorissues in raising production rates.Previous years have witnessed rawmaterials shortages, late deliveries,out-of-sequence work, overtime,and rush shipments throughout thesupply chain, all of which erodethe benets of higher volume fromdropping to the bottom line. Theindustry will face these challengesnot only in 2012 but in the longerterm as capacity constraints bumpup against eight years of backlog.

Original equipment manufacturers(OEMs) and suppliers are encour-aged to perform thorough suppliercapacity and readiness assessments.

While it is difcult to predict orders,it is unlikely that orders will keep thepace of 2011. Already 2012 is off toa great start. At the Singapore AirShow, Lion Air announced an orderfor 230 Boeing aircraft valuedat $22.4 billion. Thats the largest

single order in aviation history.Separately, Norwegian Air Shuttleplaced orders for 222 narrowbodyaircraft, split between Boeing and

Airbus. Boeing is expected to bookabout 1,000 net orders in 2012 andindustry executives anticipate ordersto be around 1,600 to 1,800, pushingbacklog to another new high by theend of 2012.

For the past three decades, leasedand nanced aircraft have steadilygrown to represent about half of the

commercial airline eet. Leasingcompanies have about 16% of thecurrent backlog, a historic high.

Aircraft lessors will become evenmore important as their morestable business models, diversiedportfolios, and comparativelyhigher grade ratings ease theiraccess to the capital markets.

The European Sovereign debt crisis,ongoing uncertainty in the nancial

markets, and, in particular, theretreat of the French banks (whohave historically played a dominantrole in the European aviationnancing market) are causingongoing tensions in the fundingmarket. These tensions have beenheightened by the implications forthe banking system that Basel III,requiring improvement in capitalratios and tightening of creditconditions, may result in moreexpensive debt where it is available.


A savior of aircraft nancing overthe last few years has been ExportCredit Agency (ECA) nancing.Traditionally a backstop, this hasnow become the funding source ofchoice for many airlines. However,going forward the new AircraftSector Understanding (ASU) whichgoverns pricing of ECA nancing

will come into force in 2013 andwill result in considerable premiumincreases for this nancing stream.

Another risk in 2012 is that the

Export Import Bank (EXIM) is closeto its funding limit of $100 billion.Without further U.S. governmentsupport, a lack of EXIM nancingcould threaten both current yeardeliveries and future orders.Furthermore, U.S. airlines areprotesting EXIM on the basis thatit provides advantages to foreignairlines that are not available todomestic airlines.

Space

2012 is scheduled to be a big yearfor space. Both SpaceX and OrbitalSciences are scheduled to dockspacecraft with the InternationalSpace Station under the CommercialOrbital Transportation Services(COTS) programme. In addition,research and development continuesunder the Commercial CrewDevelopment (CCDev) programme.Companies receiving funding from

NASA for CCDev include Boeing,SpaceX, United Launch Alliance, BlueOrigin, and Sierra Nevada (NASApress releases, www.nasa.gov).


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0%

25%

50%

75%

100%

Large Twin aisle Single aisle Regional jets

Source: Boeing

2010

Airplanes19,410

2030

Airplanes39,530

Share of fleet Delivery units

Market value: $4,060 billion

2011 to 2030

New airplanes33,500

70%

22%

2%

6%

Growth in business jets

The business jet rebound continuesto be elusive and slower than wasexpected at the beginning of the

year. Positive signs in the rst halfof the year were eroded by weak-ness in the back half of the year,and overall cycles for the year wereonly modestly higher, leaving thebusiness jet industry still more than10% below the 2007 peak.

Companies are reporting thatbusiness jet backlogs have beencut approximately in half since thestart of the recession. The recoveryin business jets is expected to trackthe overall Western economicrecovery, which continues to beslow. Therefore, business jetsshould see another year of modestimprovement. The medium tolong term for business jets shouldsee signicant growth, driven byeconomic growth and adaptingregulations in Asia and the Middle

East, particularly in China. Theselonger routes favour the largersegment of the business jet market.

Long-term forecast

The long-term forecast for commercial OEM aircraft is more than30,000 deliveries in the next 20 years at a value of around $4 trillion.While some have raised questions about whether these forecastsare optimistic, they are based on solid assumptions about globaleconomic growth and the rate of aircraft replacement. In fact, thesignicant efciency improvements of new aircraft may acceleratethe demand for replacement aircraft. With long-term demand atmore than 1,500 aircraft per year and current production rates at1,000 per year, the industry has both a lot of future growth and alot of cushion to absorb any softening in demand. Perhaps a keycompetitive advantage in the future will go to the company that caneffectively raise production rates fastest to shorten delivery times.

At the same time, new competitors have emerged to try to takeadvantage of the growing market. Commercial Aircraft Corporationof China (COMAC) has launched its C919 aircraft with rst scheduleddeliveries in 2016. COMAC is projecting to sell more than 2,000planes, or about 7% market share. In addition, Irkut of Russia haslaunched a narrowbody aircraft and Bombardier is marketing itsCSeries. Embraer has elected to stay in its regional niche and notenter the increasingly crowded narrowbody market.



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Defence

The top six U.S. defence companiesreported revenues down about1% and prots up about 1%.1Thisis not surprising since the U.S.defence budget was essentially at.The only thing certain about thefuture defence budget is that it willbe lower, but it s anyones guesshow much. The presidents budgetproposes a modest 1% decrease inthe scal 2013 budget and approxi-mately $500 billion in cuts overthe next decade, or approximately10%. However, many members of

Congress strongly oppose this levelof cuts. Furthermore, the budgetbattle is taking place against abackdrop of a presidential electionand an impending sequestration,

which could require even deepercuts. The future defence budget willlikely be signicantly shaped by the2012 elections.

During 2012 European defenceministries started to deal with

the detailed consequences ofbudgetary reductions by cuttingand re-proling programmes andreducing platform numbers. Thisprocess has yet to fully unwind,leading to considerable uncertaintyin the supply base as companiesstruggle to manage both the impactof known reductions and the risk ofuncertain future reductions. Initia-tives to preserve capability at thesame or lower cost have burgeoned(in Germany, Sweden, Norway, and

the UK, for example) and there has

U.S. defence contractors have a at year,while European colleagues fared a littleworse

1 Annual earnings reports: Boeing, LockheedMartin, General Dynamics, Northrop Grumman,

Raytheon, and L-3


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been a growing appetite for capability and cost-sharing between nations.The NATO Secretary-Generals Smart Defence initiative seeks to achievethis for the Alliance, and bilateral arrangements such as the Anglo-FrenchDefence Co-Operation Treaty seek collaboration in a range of activity frommilitary operations to acquisition. NATOs operations in Libya highlightedthe importance of being able to respond to unforeseen eventsthe returnto contingencyand of a strong blend of European capabilities able tobe deployed at short notice. Though the Libyan operation was relativelyshort-lived, it suggested capability gaps that European nations will nddifcult to plug while under the current nancial pressures.

Just as European defence companies come to terms with decline in theirtraditional markets, so they are simultaneously pursuing opportunitiesin growth markets; the Middle East, Brazil, South East Asia, and India all

offer growth, although there is strong competition and in-country barriersto entry can be challenging.

Backlog (US$ billions) 12/31/11 12/31/10

Lockheed Martin $81 $78

EADS Defence $73 $83

Finmeccanica $64 $70

BAE Systems $58 $63

Boeing Defense, Space & Security $46 $48

Thales $43 $34

General Dynamics (exc. Gulfstream) $40 $42

Northrop Grumman $40 $64

Raytheon $35 $36

L-3 $11 $11

Total $491 $511

Defence

Source: Company reports


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One bright area of opportunityfor defence contractors has beenexports. The annual volume of U.S.defence export sales agreementshas more than doubled from 2006through 2010 (the most recent

year of available data). Much ofthe growth during this period hasbeen in Asia due to concerns overChinas growing military power andtensions between North Korea andSouth Korea, and in the Middle Eastdue to concern over Irans militaryambitions. Some highlights from2011 include:

Saudi Arabia will buy 84 F-15sand upgrades to 70 others,

worth $30 billion (Bloomberg)

India selects Dassault Rafaleghters worth $10 billion (BBC)

Japan selects F-35 for next

generation ghter, in a dealworth approximately $8 billion(Washington Post)

Taiwan to upgrade F-16 eetworth $6 billion (Business Week)

The United Arab Emiratesbuys THAAD missiles worth$3.5 billion (Bloomberg)

India buys 10 C-17s worth$2 billion (India Times)

Future export opportunitiesinclude:

Turkey afrms plans to buy 100F-35s worth $16 billion (Reuters)

South Korea gears up for a jetghter competition (DefenseIndustry Daily)

Exports

The growth of defence export deals has led to a record backlog of

$327 billion at mid-year 2011. We have in excess of 13,000 active

cases with more than 165 countries and institutions, adding up to

about $327 billion, said Vice Admiral Bill Landay at a Pentagon news

brieng ahead of the Paris Air Show. (Source: Bloomberg)

Defence

Direct commercial sales authorizations Foreign military sales (FMS) agreements

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

USDb

il

U.S. foreign military sales (FMS) agreements and

direct commercial sales authorizations

0

40

80

120

160

200

47 55 52 53 62 67

52

6789

107123

154

11 11 12 12 13 13 18 18 29 24309

Source: US Department of Defense, US Department of State


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Defence forecast

as defence ministries workthrough the rounds of budgetcuts instigated two years ago.There is little likelihood of anybudgetary increases until 2015 andit may be necessary to pare somedefence budgets still further if theEurozones austerity measureshave to be tightened. The UK willannounce a balanced defenceprogramme (London Times) forthe rst time in a generation, which

will provide clarity for OEMs aftersome years of uncertainty. At thesame time, accelerated transitionin Afghanistan will start to manifestitself in rationalizing in-theaterequipment and logistic support andan increase in logistic movement asmilitary materiel is redeployed. Thenext few years will see an enhancedtempo of equipment refurbishmentas a result, though the extent of

this, and its effect on industry, hasyet to be quantied.

European nations will continuetheir various transformationprogrammes aimed at preservingcapability at lower cost and willimport many of the ideas andconcepts pioneered in the UK a few

years ago; we will see an increasein availability contracting for land,sea, and air platforms, plus an

The current focus remains onaffordability. The U.S. DefenseDepartment now lists affordabilityamong its procurement criteria onits website. Contractors need to stayfocused on improving productivity.We are entering a period of fewernew platforms. But at the sametime, there is a need to recapitaliseequipment. So, the focus will shiftfrom new platforms to platformupgrades and sustainment. Itsnearly impossible to predict theoverall health of the defenceindustry beyond a few yearsdown the road. The uncertaintyof sequestration, the presidentialelection, the U.S. militarys role in

world affairs, a tightening Pentagonbudget, the growing threat of Iransnuclear weapons programme,continued threats of terrorism, thepossible fall of governments in the

Middle East, and other factors willinuence the long-term picture.The scal 2012 U.S. defence budgetis roughly at, and the proposed2013 budget reects only a modestdecrease, so we expect another yearof at performance for the defenceindustry in 2012.

During 2012 we will start tosee some stability return tothe European defence markets

Defence

increasing appetite for industry-ledsolutions in the provision oftraining, infrastructure, and backofce shared services. We will alsosee programmes for industry takeon more complex and broaderrolesthe UKs Materiel Strategymay prove to be a pioneeringapproach. The drive for exports

will also continue and will remainercely competitive as globaldefence industry competes in thegrowth markets.

So while the traditional, platform,and equipment-based defencemarkets in Europe remain underintense pressure, opportunities existfor industry more broadly to deliverservice-based capabilities in manycountries. In the UK, the wholeof the defence support servicesmarket is projected to be worth an

estimated 16 billion per year by2020, or approximately 75% of totalMoD spend with industry; thesetrends will accelerate in Europe(PwC assessment based on publicdomain sources, 2012).


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Defence

Here are three challenges the industry might consider to thrive in

the future:

InnovationInvestment in innovation during a period of tight budgets will be criticalto the health of the defence industrial base and global security. Historically,innovation in defence research and development leads to myriadcommercial applications, such as the Internet, GPS, and commercial satellitecommunications. Once the F-35 Joint Strike Fighter completes development,there will be no military ghter aircraft in development for the rst timesince the innovation of ight. In addition, the United States needs to rapidlycrystallise its exploration strategy, where many new technologies are born.

The threat environment is also unpredictable. For example, while thecapabilities of Chinas J-20 fth-generation ghter are still unknown, thethreat is years ahead of prediction. The United States should considerpreserving its specialised aircraft engineering talent to develop thesixth-generation ghter.


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Defence

Improving the speed and effective-ness of programme developmentusually produces the biggest gainsin affordability. Schedule delays arethe biggest factor in budget over-runs. While contractors take pridein their programme managementabilities, the industry must seekcontinuous improvement, includingunbiased, independent assessmentsand benchmarking.

The defence supply chain hasbecome extremely complex. It iscommon that 50% to 80% or moreof the total value of production liesin a technically complex, multi-tiersupply chain. Defence contrac-tors can no longer accept that longlead times and marginal supplierperformance are the industrynorm. The industry must challengeitself to get much closer to just in

time delivery. The industry mightconsider adopting leading-edge riskmanagement practices to regain

visibility into the supply chain thathas been lost through outsourcing.

Companies that embrace the

affordability challenge and

execute on these critical areas

will create greater value for the

war ghters, taxpayers, and

shareholders.

Information technology repre-sents one of the biggest areas fordiscretionary spending at mostcompanies, including defence rms.Many A&D companies have investedmillions in systems implementa-tions but havent yet realised thefull capabilities and productivityenhancements that these systemsenable. Many IT organisations arestill spending most of their timein legacy system maintenance andenhancements. Companies needto unlock the full capabilities oftheir IT platforms, become leaner,and migrate the IT organisationaway from costly maintenancetoward strategic initiatives andcompetitive advantage.

Finally, improved knowledgemanagement will become morecritical. The industry was alreadyfacing a talent drain because ofdemographics. Now that talentdrain has been accelerated byearly retirements and workforcereductions. Companies needto identify the key people andknowledge in their organisationsand capture that information usingsearchable technology tools. Butthey also need to create a knowledgemanagement culture that promotesand rewards the effective capture anduse of knowledge.


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Defence

The regulatory environmentThe current regulatory environment is certainly a key factor on thedefence industry.

Several reforms may help improve the environment for A&D companies.

Acquisition reform

Attempts to improve the current defence acquisition process have not yetmet the desired outcomes. One reason is that reforms have sought to placeever increasing regulations on the contractors. Acquisition reform mightbenet from addressing how Congress funds long-term programmes ona short-term basis and the manner in which the customer initially denesrequirements and the impact of subsequent modications. Our recommen-dations include:

Addressing the denition and stability of requirements

Establishing realistic budgets and funding based on the inherent risks ofdeveloping advanced technologies

Promoting exibility and innovation in the bid and proposal process

Using contract structures appropriate to risk

Promoting international cooperation and cost sharing


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Defence

The Defense Contract Audit Agency

The purpose of the Defense Contract Audit Agency (DCAA) is to protect thegovernment and taxpayers from fraud and abuse. The following reformscould improve the effectiveness and efciency of DCAA audits:

Audit approach Benchmark the audit approach against commercialpractices such as those regulations established under the AmericanInstitute of Certied Public Accountants (AICPA) and Public Company

Accounting Oversight Board (PCAOB).

Materiality Establish materiality standards. Materiality is not dened

for government contracting exceptions. It is widely accepted in commer-cial practice that it is impractical and cost prohibitive to build a controlsystem to catch minor errors.

Third-party reliance The DCAAs resources are limited. While DCAAstandards allow for reliance on third parties, it is seldom done. TheDCAA could consider establishing standards for third-party reliance thatpromote such use where the third party is objective and competent toimprove the speed and efciency of the regulatory process.

Export control reform

Many people believe that current export control regulations are outdated

and present a competitive disadvantage to the U.S. defence industrialbase. Many technologies that are broadly used in commercial applicationare still subject to export control restrictions. A good example is satellites.U.S. companies still face export control restrictions on products that aresold commercially. President Obama is a supporter of export reform.3Lawmakers should expedite export control reform to promote U.S. exportsand preserve key skills in the industrial base.

3 www.whitehouse.gov, Fact Sheet on the Presidents Export Control Reform Initiative, 2010.


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Mergers and acquisitions

Spinoffs and divestitures mean new activity

Aerospace M&A pushes dealtotals to record levels4

2011 was a record year for aerospaceand defence transactions. The 341deals and $43.7 billion of deal valueannounced during 2011 beat theprevious highs: 332 deals in 2010and $42.0 billion of value in 2007.The $16 billion United Technologiesacquisition of Goodrich Corpora-

tion was the primary value driver.Volume drivers were more broad-based, with higher numbers forsmall deals (less than $50 million)and mega deals (above $1 billion)alike. Although mega deals werenot as common in 2011 as they

were in 2007, these transactionshave continued their recovery fromthe recent low of only two suchannouncements in 2009 up to sixin 2011. This led to an increase

in average deal sizes, even whenremoving the impact of the Goodrichdeal. The Goodrich transactionboosted U.S. total deal value abovehistoric norms despite a drop in thenumber of U.S. deals. There was alsoa big increase in deals for aerospacetargets in 2011, measured on both a

volume and value basis. This, whenconsidered alongside the highersales multiples awarded to aerospacecompared with defence targets,reects the more favourable

outlook for this part of the sector.

4 PwC, Mission control, fourth quarter 2011


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Mergers and acquisitions

for North American targets, boostingthe number of cross-border deals forU.S. targets. There was also impor-tant activity for non-U.S. companiesthat have signicant U.S. revenues,as a means of increasing exposureto the largest defence market in the

world. One rationale for these typesof deals is that, in some cases, theymay be easier to close. Transactionsinvolving Asian acquirers declined

year on year.

Deal volumes likely to grow

in 2012With OEM backlogs contributingto higher overall sector growthprospects, aerospace M&A is likelyto continue to lead the A&D dealmarket in 2012. The outlook fordefence is somewhat less certain.Defence M&A will likely remainoriented toward large spin-offs oflower-growth units and smalleracquisitions in growth areas, such ascyber security. However, the further

defence budgets fall, the more likelythere could be calls for larger-scaleconsolidation, which could outweighantitrust concerns, in order to main-tain a strong defence industrial base.Strategic investors have signicantcash positions and appear well-positioned to drive a high volumeof deals in 2012, both large andsmall. Deal volume, if not deal value,could be set to break another newrecord in 2012. In particular, EADS

is looking to grow its U.S. presencethrough acquisitions. The companygets less than 3% of its revenue fromU.S. subsidiaries and has stated itsintention to grow its U.S. revenuefrom $1.8 billion today to about$10 billion.

Defence divestitures andprivate equity exits boost

large deal volume

Divestiture of slower-growth defencebusinesses and private equity exitsdominate the list of largest deals.Two headline divestitures, theNorthrop Grumman shipbuildingspin-off and the break-up of ITT,ranked among the top ve deals this

year. In addition, four of the top 10deals were sales by private equitycompanies to strategic investors. Onthe buy side, only one private equitypurchase made the list: the Provi-dence Equity Partners acquisition ofSRA International. The 2011 largestdeal targets were much more variedthan in 2007, when the focus wasmainly on aerospace targets. Also,more big deals predominated in theearlier record year; eight of the 10largest deals in 2007 were for valuesat or above $1.8 billion, compared

with just four such deals in 2011.Private equity exits played a role in

each year. Activist investors had apart to play in some of the large 2011divestitures but nancial investorinvolvement was most evident in thesmaller deals.

Europe and the United Statesdrive global activity as Asiatakes a step back

European acquirers played amuch more signicant role in the2011 aerospace and defence deal

market compared with 2010. Thepace of market consolidationhastened within Europe andoutbound deals also increased. Thefocus was rmly trans-Atlantic; allEuropean outbound deals above the$50 million threshold in 2011 were

However, we also believe furtherconsolidation is likely. The U.S.Defense Department has indicatedthat it will oppose any deals thatcreate a sole source supplier. There-fore, it is unlikely we will see anyconsolidation among the top 10players, but there remains ampleopportunity for other companies inthe A&D arena. We see C4ISR as apocket of growth in an otherwiseat market. Also, given the reducedtempo of operations in Iraq and

Afghanistan, it may be time for

further consolidation of landsystems providers.

Looking ahead, we point to fourthemes that are likely to affect M&Aactivity in the coming years:

Increasing consolidation ascompanies respond to costpressures

Further re-evaluation of supplychains by big manufacturers, in

both civil and military segments,as they seek to gain better controlof their large programmepipelines

Continuing growth in thesecurity, surveillance, andhomeland security sector

Greater investment in andcompetition from fast-growingmarkets, most notably China

We believe these trends will provide

the context for continued growth indeal volume, although deal value isunlikely to keep pace with the record

year of 2011.


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RevenueUS$ millions

Operating ProfitUS$ millions

# Company 2011 2010 Change 2011 2010 Change51 Kawasaki Aerospace 2,472 2,150 15% 38 19 94%

52 GKN Aerospace 2,377 2,243 6% 266 250 7%53 Meggitt 2,335 1,796 30% 578 469 23%54 MOOG 2,331 2,114 10% 246 216 14%55 BBA Aviation 2,137 1,834 17% 181 156 16%56 ThyssenKrupp Marine Systems 2,076 1,600 30% 296 192 54%57 Curtiss-Wright 2,054 1,893 9% 205 180 14%58 RUAG 2,003 1,727 16% 124 94 32%

59Allegheny Technologies High PerformanceMetals

1,956 1,410 39% 365 258 41%

60 Teledyne Technologies 1,942 1,644 18% 227 179 27%61 Parker Hannifin Aerospace 1,922 1,744 10% 247 208 19%62 AAR 1,776 1,316 35% 139 94 48%63 Esterline Technologies 1,718 1,527 13% 198 188 5%

64 Eaton Aerospace 1,648 1,536 7% 244 220 11%65 CAE 1,647 1,480 11% 262 223 18%66 Trimble 1,644 1,294 27% 156 128 22%67 FLIR Systems 1,544 1,388 11% 313 360 -13%68 Kongsberg Gruppen Defence and Protech 1,443 1,510 -4% 182 207 -12%69 Hexcel 1,392 1,174 19% 192 130 48%70 Xi'an Aircraft International Corp 1,372 1,602 -14% 17 56 -70%71 Orbital Sciences 1,346 1,295 4% 80 73 10%72 Cubic Corporation 1,285 1,194 8% 112 106 6%73 TransDigm Group 1,206 828 46% 487 363 34%74 Chemring Group 1,196 923 30% 228 167 36%75 Ultra Electronics 1,174 1,097 7% 196 170 15%

76 Barnes Group 1,169 1,029 14% 128 86 49%77 Bharat Electronics 1,164 1,170 0% 406 221 84%78 Loral Space & Communications 1,107 1,159 -4% 93 81 15%79 Titanium Metals (TIMET) 1,045 857 22% 175 121 45%80 Fuji Aerospace 1,039 1,061 -2% 27 55 -51%81 Volvo Aero 1,001 1,069 -6% 52 40 29%82 GenCorp 918 858 7% 39 38 3%83 Aselsan 899 788 14% 140 142 -1%84 SIA Engineering 879 740 19% 108 81 33%85 Woodward Governor Aerospace 843 769 10% 130 112 16%86 Smiths Detection 819 887 -8% 103 138 -25%87 ViaSat 802 688 17% 39 43 -9%88 Latecoere 801 615 30% 62 60 4%

89 Alion Science and Technology 787 834 -6% 35 39 -10%90 Ball Aerospace 785 714 10% 80 70 14%91 OHB Technology 773 564 37% 38 30 25%92 Heico Corporation 765 617 24% 138 109 27%93 MacDonald Dettwiler & Associates 761 688 11% 117 100 17%94 Aeroflex 729 655 11% 53 68 -22%95 Indra Security & Defense 709 787 -10% 71 88 -20%96 Magellan Aerospace Corp 699 710 -2% 60 61 -2%97 Crane Aerospace & Electronics 678 577 18% 146 109 34%98 Senior Aerospace 614 516 19% 88 57 55%99 Jamco Corp 599 489 23% (2) 22 -111%

100 Ducommun 581 408 42% (34) 26 -231%

Total 677,261 647,593 5% 60,033 59,129 2%

In summary

Source: Company reports; PwC


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For more information contact:

Neil Hampson

Global Aerospace &Defence Leader+44 20 7804 [email protected]

Scott Thompson

U.S. Aerospace &Defence Leader+1 703 918 [email protected]


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PwCs global aerospace and defence practice

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advisory services. Through our global network, we can draw upon the

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Huw Andrews +86.21.2323.8800

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Guillaume Rochard +33 1 56 57 8208

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Jrgen Seibertz +49.211.981.2845

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Dhiraj Mathur +91 11 4115 0309

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Corrado Testori +39 06 5702 52442

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Bill Lay +971.4.304.3651

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Alexander Staal +31 (0) 887927242

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U.S. Aerospace and Defence Leader

Scott Thompson +1 703 918 1976

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U.S. Aerospace and Defence Advisory Leader

Charles Marx +1 602 364 8161

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James Grow +1 703 918 3458

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Gina Reynolds +1 973 236 4648

[email protected]


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