European buyers carve up U.S. security firm L-1

PARIS/NEW YORK (Reuters) - Face-recognition software maker L-1 Identity Solutions ID.N is being sold to two top European defense companies as the arms industry diversifies more deeply into the battle against everyday security threats and fraud.

French group Safran (SAF.PA) confirmed a $1.09 billion cash deal to buy the U.S. security company and its core biometric business in a move that will also see British defense company BAE Systems (BAES.L) extend its reach in the United States.

The deal is the latest in a string of mid-tier security and defense companies that have been snapped up by traditional arms suppliers.

Diversified U.S. manufacturer 3M Co (MMM.N) agreed to buy Cogent Inc COGT.O for $943 million in early September, paying a premium of nearly 18 percent for the maker of identification systems used to screen travelers at border crossings.

As major contractors face sharp cuts in defense budgets, they are looking to acquire smaller companies with niche technologies in cybersecurity, civil security, surveillance and intelligence -- a deliberate shift in focus from bombs to bytes.

"We are definitely going to see more deals as the large defense players have very strong balance sheets," analyst Michael French of Morgan Joseph & Co said. "They are in a good position to spend. They can easily raise capital these days."

L-1's shares rose 20 percent to be the top percentage gainer in New York Stock Exchange trading after state-controlled Safran announced its bid, which represented a 24 percent premium to L-1's closing share price on Friday.

Shares of many niche defense technology companies, which are considered potential targets, also rose. Signal intelligence company Integral System Inc ISYS.O and drone maker AeroVironment (AVAV.O) both rose more than 2 percent.

American Science & Engineering Inc (ASEI.O) shares were also up about 2 percent, while Cubic Corp (CUB.N) shares were up more than 1 percent.

The deal will go ahead if L-1 completes a plan to sell its government consulting arm to BAE for $296 million.

Both transactions were announced on Monday after Reuters reported details and named BAE as the co-buyer.

L-1's face-recognition and other biometric products are used by government agencies to improve security and border management and commercially at financial institutions.

The use of biometrics, allowing machines to identify people through unique characteristics of each human body, is spreading quickly due to growing security fears. However, privacy concerns have slowed their adoption in some markets.

The technology is moving toward mobile applications, such as handheld scanners for use in law enforcement and voting. L-1's gadgets are even being used widely to enroll school bus drivers.

The $12 per share offer from Safran, which makes aero engines, military goggles and security equipment, matched the top end of analyst forecasts seen before the announcement.

Connecticut-based L-1, formed in 2006 through a merger of Viisage and Identix, put itself up for sale in February.

L-1 shares were up 20 percent at $11.63 in late afternoon trading on the New York Stock Exchange. Safran rose 5.2 percent to 20.395 euros in Paris.

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Paris brokerage CM-CIC Securities called the offer price "seemingly high" but said it was driven by "high growth in this type of activity." Industry forecasts say the biometrics and identity markets could grow at 15 percent annually by 2015.

Analysts said L-1 what makes the deal really "impressive" is the fact that the company has seen demand falling, hurting its numbers.

L-1 reported a wider second-quarter loss in July and cut its full-year revenue view, citing federal and international program delays.

"L-1 has been in a mess currently due to operating issues," analyst Brian Ruttenbur of Morgan Keegan said. "It has not been making money. But the buyers are definitely looking at the long-term growth prospects."

L-1 put itself up for sale in March. In July it revealed plans to split its businesses for a transaction.

"The company had been operating in a number of areas, and in a loss-making environment it would have been difficult to find a single buyer," Ruttenbur said.

BAE's role emerged when sources told Reuters on Sunday it was the surprise front-runner for L-1's consulting business, which had been courted by three U.S. companies including Virginia-based intelligence equipment supplier ManTech (MANT.O).

"The main advantage for BAE in buying L-1's government consultancy business is the segment includes cybersecurity," French at Morgan Joseph said. "So this is a good deal for BAE as well."

Locking in a definite co-buyer was crucial because without one the main transaction with Safran could have collapsed.

The sale is subject to completion of the BAE side deal, L-1 shareholder backing and a nod from a U.S. panel responsible for checking foreign purchases of nationally sensitive industries.

Deal volumes in the aerospace and defense industry have reached $4.2 billion so far this year, not counting the L-1 deal, up 45 percent from the same period a year earlier.

Safran bought control of security assets including a General Electric scanning machine business last year after buying some biometrics assets from Motorola MOT.N. Boeing (BA.N) recently bought U.S. defense technology manufacturer Argon ST.

BAE, which has already acquired a significant presence in the U.S. defense industry, faces potentially hefty cuts in a domestic British arms spending review and is looking to diversify.

(Additional reporting by Soyoung Kim, Helen Massy-Beresford and Tim Hepher; Editing by Gary Hill)