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Facing leaner times, defense firms hunt for M&A

WASHINGTON (Reuters) - The defense world is bracing for a whirlwind of dealmaking as tighter budgets and new security threats prompt the Pentagon’s large contractors to move resources from traditional weapons to cybersecurity and unmanned defense.

Tess Oxenstierna, Managing Director, Head of Aerospace and Defense Group at Bank Street, speaks during Reuters Aerospace and Defense Summit 2010 in Washington, September 7, 2010. REUTERS/Hyungwon Kang

Top executives of Boeing BA.N and Lockheed Martin LMT.N told the Reuters Aerospace and Defense Summit in Washington that they would make targeted acquisitions to boost offerings in areas of growing demand: cybersecurity or intelligence, surveillance, reconnaissance and unmanned systems.

More defense assets are also expected to come up for sale as the Pentagon’s cost-cutting drive pressures companies in the industry to make their organizations leaner and sell off units to generate shareholder value, Lockheed Chief Executive Robert Stevens told the Reuters summit on Tuesday.

Deal volumes in the aerospace and defense industry have reached $4.2 billion so far this year, up 45 percent from the same period a year earlier, according to Thomson Reuters data. That still remains far short of the $14 billion worth of deals consummated in 2008.

Executives and bankers expect dealmaking activity to continue to pick up given low valuations, ample cash and shifting priorities under the Obama administration to move funding from traditional weapons to areas of unmanned war.

“Cybersecurity is an interesting area for me and us because it has so many dimensions,” Stevens said. “If you think you have the best cyber defense, and you think it has a shelf life of several years, I would tell you to check your data.”

Boeing, which bought Argon ST for about $775 million in June to beef up its capabilities in sensors and communication technologies, continues to actively search for attractive deals in those areas, said Dennis Muilenburg, chief executive of Boeing’s defense, space and security division.

“As we look at the marketplace, we’ve identified growth areas. We continue to actively look at opportunities there,” Muilenburg said.”

Asked if Boeing would consider a large-scale merger with a major defense contractor, Muilenburg said: “I’m not going to rule out or rule in any options.”

“Obviously as we see defense budget pressure, that does at times lead to potential consolidation,” he said.

Tess Oxenstierna, head of the aerospace and defense group at boutique investment bank Bank Street, said cyber warfare, unmanned armed vehicles and intelligence and surveillance represent the key bright spots in an industry where growth outlook is hampered by flat or declining budgets.

“In this market where the defense budget is declining faster than most people expected, we expect acquisitions to ramp up,” Oxenstierna told the summit.

“They’re not going to be undisciplined. They are going to be very much focused on their core strengths and the key growth areas.”

One name doing the rounds as a potential target is Applied Signal Technology APSG.O, whose products are used by U.S. defense and homeland security agencies to intercept cellphone, microwave and military communication signals.

The company could draw interest from big contractors such as Raytheon RTN.N, BAE Systems BAES.L and Cobham Plc COB.L, a source familiar with the matter said.

Others likely to attract interest include Mercury Computer Systems MRCY.O, ComTech Telecommunications CMTL.O, Integral System Inc ISYS.O, which helps the military control ground systems and satellites, and drone maker AeroVironment Inc AVAV.O, analysts have said.

Meanwhile, big defense contractors led by Lockheed and Northrop Grumman Corp NOC.N have also taken strategic steps to adjust their portfolios and sell off units to generate growth for shareholders.

Lockheed is expected to receive about $1.5 billion for the two defense services units, Enterprise Integration Group and Pacific Architects and Engineers Inc, it put on the auction block in June, people familiar with the matter told Reuters last week.

Stevens said he has seen “very healthy” levels of interest from several parties and the company is making good progress toward completing the transaction by the end of the year.

Stevens and Boeing’s Muilenburg both said they were not interested in the shipbuilding division that Northrop recently put up for sale.

Additional reporting by Andrea Shalal-Esa and Deepa Seetharaman; Editing by Steve Orlofsky

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