WASHINGTON U.S. regulators are increasingly taking a tougher stand on foreign takeovers in the defense sector to protect technology designed to deal with the growing and unseen threats of the cyber age.
As security threats evolve from tanks and guns to the bits and bytes of cyber and communication networks, foreign suitors eyeing high-end U.S. security assets face deeper regulatory scrutiny, senior industry dealmakers said at the Reuters Aerospace and Defense Summit this week.
Such a trend could undercut efforts by foreign companies such as EADS EAD.PA to expand further into the U.S. defense market, which is bracing for steep cutbacks in spending under a U.S. deficit review, but which remains by far the world's largest.
"I think as the threat changes, the regulatory regime is trying to adapt to focus on sensitivities in communications network, communications technologies, cybersecurity and some of the information-based technologies," said Michael Urfirer, co-chairman and chief executive of investment bank Stone Key Partners.
Foreign takeovers affecting U.S. security are screened by the Committee on Foreign Investment in the United States (CFIUS), an inter-agency panel set up in 1975 by then-president Gerald Ford.
A growing portion of deals are submitted to a more detailed investigation lasting 45 days, after an initial review of 30 days, and regulators may insist on putting the assets behind a firewall or "proxy board" with limited or no foreign oversight.
"Deals are being approved, but there is some concern over the time deals are taking," said Nancy McLernon, president and chief executive of the Organization for International Investment (OFII), a lobby group for subsidiaries of foreign-based firms.
Some 38 percent of CFIUS cases proceeded to the second-stage investigation in 2009 and 2010. OFII says this is equivalent to the total number of investigations in the previous 20 years.
"They've migrated to erring on the side of conservatism," said Greg Starkins, managing director at Deutsche Bank. "They've decided that if they're going to make a wrong decision, to be wrong on the side of conservatism and not on leniency."
A U.S. Treasury spokeswoman declined to comment.
The more stringent regulatory environment is another complication for foreign buyers who already face an uphill battle when trying to acquire a U.S. security company. Some purchases require a proxy board structure designed to protect U.S. national security assets from foreign nationals.
"If a company believes they will need to have a proxy board over the operation, it is often enough to dissuade them from making the acquisition," said Adam Palmer, who manages aerospace and defense investments for the Carlyle Group private equity firm.
"In proxy board structures, a lot of times no officers of a foreign entity have any idea what's going on, and it's very difficult to manage a business."
That has not stopped foreign contractors from seeking greater exposure to the U.S. military market, which accounted for roughly half of global defense spending worth about $1.4 trillion before the latest downturn.
"The growth is going to be in the kinds of technical services that are highly sensitive," said Loren Thompson, a military analyst at the Lexington Institute think-tank.
But foreign buyers would need to lower their expectations if they set their sights exclusively on U.S. targets dealing with more sophisticated modern threats, even though that is where the most value is.
"If they go into it with a willingness to try to come up with a workable solution, in most cases foreign buyers have been able to get to something they may not be ecstatic about, but they get to something that's at least viable," Urfirer said.
"It doesn't go so well if the attitude is 'I want to buy this and that's it.'"
(Reporting by Tim Hepher and Soyoung Kim, Editing by Phil Berlowitz and Matt Driskill)