The wind of change has been blowing on Capitol Hill. In 2015, half-way through Barack Obama’s second term in office and within days of the US Justice Department approving Lockheed Martin’s planned $9bn acquisition of Sikorsky Aircraft, the then Defense Secretary, Ash Carter, spoke out against further consolidation amongst US defence primes. Roll on almost exactly two years, however, and in September 2017, Northrop Grumman announced their agreement to acquire Orbital ATK in a deal valued at much the same – $7.8bn in cash and $1.4bn in a debt for equity swap.

While the Trump administration have not gone so far as to declare open season on mergers and acquisitions (M&A) between the big-boys of the industry, the pace of M&A in the US sector in general has been steadily increasing, undoubtedly aided by the greater transparency surrounding future defence spending. Against that backdrop, could the Northrop /Orbital deal, which was approved by the European Commission in February, and is expected to be finalised by the middle of the year, subject to US Federal Trade Commission’s review, be a sign of yet more things to come?

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Strategic step: Expanding capability and accelerating innovation

Speaking at the time of the announcement, Wes Bush, chairman, CEO and president of Northrop Grumman, described the take-over as an “exciting strategic step” that would yield expanded capabilities and accelerated innovation. Certainly there is very little direct overlap between the two companies, which means that both portfolios are genuinely complementary, and when unified, should open the door to a number of new and emerging opportunities, with missile defence likely to be high on the list.

While Kim Jong-Un may have dialled back on the rhetoric for now, last year’s glut of rocket launches left many nations anxiously re-examining the whole issue – and for Northrop, gaining Orbital brings some highly desirable capabilities into the fold at just the right time. At a stroke, Orbital bolsters the Northrop product line-up with the addition of its missiles, rocket motors and electro-optical countermeasures – and the coffers by some $4.4bn in annual revenue in the form of existing contracts with both the US Army and NASA.

Space; the new battleground

Gaining Orbital’s space launch business could prove to be every bit as important as its offerings to the munitions market. The company currently enjoys a virtual monopoly on American mid-range payload launches, with its Minotaur and Antares rockets capable of lifting space vehicles of up to 1.3 and 6.5 tonnes respectively into low earth orbit (LEO). However, in 2016, Orbital was awarded US Air Force funding worth an initial $46.9m, with an option for up to a total of $180.2m, to develop a system to reduce its dependency on the Russian designed and built RD-180 rocket engines for large payload launches, and most specifically, for national security ones.

“Orbital currently enjoys a virtual monopoly on American mid-range payload launches.”

Since then, Orbital has been working on its Next Generation Launcher (NGL), specifically aiming to be able to get payloads of five to eight tonnes beyond LEO into the higher geosynchronous / geostationary orbits as required. It would put the NGL broadly on a par with the United Launch Alliance Atlas V as a medium-heavy launch vehicle, but without the Atlas’ need for the RD-180 as its first stage.

In addition, the deal also brings Orbital’s considerable satellite expertise under the Northrop umbrella, at a time when many in the industry are predicting a boom for small satellites in particular, both military and commercial. Given the Pentagon’s increasing focus on space as the likely next battleground, constellations of new reconnaissance satellites, hardening technologies for orbiting communication systems, in-orbit servicing capabilities and more are all likely to feature on the shopping list of required services.

Could Northrop/Orbital spur an M&A uptick in the US?

The deal with Orbital positions Northrop very well for the future – and looks to be fitting into something of a trend. September’s announcement followed just days after United Technologies, one of the world’s biggest aerospace suppliers, agreed terms to acquire aviation systems and cabin equipment maker Rockwell Collins for $30bn – a major coup for the sector, and another sign that further consolidation in the defence/aerospace arena might yet be possible.

So is this the start of something big and will others follow suit?

“It could well spur more take-overs,” says defence blogger, Newton Hunter. “We’ve seen a sizeable uptick in M&A activity in the US sector over the last several quarters, and I think that is going to continue, but I don’t see it extending to mergers between the primes themselves. Those days are gone.”

Hunter says that although the new administration seems better disposed to the general idea of takeovers in the defence sector, the concerns over decreasing competitiveness and innovation remain when it comes to the big players in the industry. He expects to see prime contractors setting out to acquire new capabilities and technologies by buying up small or medium companies, particularly in niche markets, so they can widen their products and services base to exploit opportunities in emerging high-priority areas.

Beyond the US: Europe’s need for consolidation

As the world’s top defence spender – at $611.2bn according to the latest available data from the Stockholm International Peace Research Institute – US annual military expenditure is almost three-times higher than second place China, and the US is home to 15 of the world’s top 25 defence contractors. The defence sector, and the shape of the M&A landscape, elsewhere inevitably looks rather different; the European market, in particular, seems long overdue for serious consolidation.

“The industry in Europe remains substantially organised along national lines and hugely unconsolidated.”

Here, in some ways the situation today resembles the US at the end of the Cold War, with over competition and heavily duplicated capacity. There has been no European ‘Last Supper’ – as the meeting of major US defence firms convened by the then Defence Secretary Les Aspin and Deputy Secretary William Perry has come to be known – to kick-start the process of rationalisation. The industry in Europe remains substantially organised along national lines, and hugely unconsolidated, leaving European states and companies “competing each other into the ground,” in the words of Dr. Sven Biscop, Honorary Fellow of the European Security and Defence College and director of Egmont’s Europe in the World.

“Europe’s defence sector seems ripe for mergers,” says Hunter, “but it has done for a very long time. Perhaps 2018 will see the beginning. I think it will take a lot of political will to get over the national rivalries, though, so I’m staying cautious – but who knows?”

Only time will tell how much further the M&A trend in the US will go, or if it will finally catch on in Europe, but the geopolitical landscape is undeniably shifting. It is hard to imagine that the defence industry on both sides of the Atlantic will not have to reshape itself in some way to adapt.