When BAE Systems divested itself of its 20% stake in Airbus, many observers wondered where the money would go. CEO Michael Turner’s statement that: “We believe that now is the right time for us to divest our Airbus shareholding to… concentrate on our core transatlantic defence and aerospace strategy” left much to the imagination. An aircraft life-cycle maintenance play? A key components & electronics supplier like DRS or Honeywell? An armored vehicle firm like Force Protection to enhance the position it had built through its $4 billion acquisition of United Defense LP?
It would appear that BAE will use the equivalent of its entire $2.3 billion (EUR 1.7 billion net) Airbus proceeds, and more besides, to acquire Armor Holdings of Jacksonville, FL. The deal will be a one-step merger at a price per common share of $88.00, a 7% premium over Armor holdings’ May 4th closing price of $82.15. Including the assumption of net debt of $388 million, the transaction is valued at $4.53 billion.
That’s a big bet from BAE. Investment bankers will want it to make financial sense. Over the longer term, a bet of this magnitude also needs to make strategic sense.
Armor Holdings is a major military truck builder (esp. FMTV family), and a leading provider of vehicle and helicopter up-armoring, military and commercial aircraft seating, and individual armor systems (helmets, SAPI & ESAPI ceramic plate inserts for body armor, et. al.) and survivability equipment (MOLLE packs, hydration, goggles, et. al.) for the military and adjacent law enforcement and commercial security markets. For the year ended Dec 31, 2006, they reported sales of $2.36 billion and profit before tax of $214 million, with total assets of $2.32 billion. Armor Holdings employs over 8,000 people in 63 locations throughout the US and internationally, including the UK (Pinzgauer trucks).
In the near term, the deal looks financially solid for BAE. The firm’s large cash reserves are invested in a company whose core contracts for FMTV truck construction and Hummer up-armoring should remain strong for the next couple of years, while the acquisition itself will immediately enhance its earnings. BAE’s US subsidiary in Rockville, MD has roughly $10 billion in annual sales, and the firm reportedly predicts that the addition of Armor Holdings will increase U.S. sales by $3 billion. BAE North America’s release predicts returns in excess of BAE Systems’ cost of capital in the second full year (2009) following the proposed acquisition, before goodwill and amortization.
BAE adds that:
“The US and UK armed forces, and many other nations’ armed forces, are experiencing an increased demand for tactical wheeled vehicles with increased survivability. Approximately 60% of the US Army’s current stated medium truck requirements is still to be manufactured. This requirement, together with additional opportunities in relation to new vehicle programmes – such as the Family of Medium Tactical Vehicles (FMTV), the Mine-Resistant Ambush Protected (MRAP) vehicle, and future prospects such as the Joint Light Tactical Vehicle (JLTV) – are expected to be valued at over $10 billion.”
This is likely true, and then some.
Armor Holdings’ Pinzgauer trucks are in use by several countries, including Britain’s recent buy of up-armored versions for use in Afghanistan & Iraq. The FMTV family of trucks, currently manufactured by Armor Holdings subsidiary Stewart & Stevenson, is the US Army’s medium truck and continues to attract foreign interest as well. The current multi-year contract is coming to an end in the next couple of years, however, and past phases have seen renewed competitions. Stewart & Stevenson’s FMTV trucks have performed excellently, improvements are continuing, and the US Army has received about 34,000 FMTV trucks out of a planned buy of around 82,500. Even so, there is no guarantee that BAE/Armor Holdings will still be producing the Phase 4 FMTV vehicles 5 years from now.
The MRAP program alone has about $7 billion left to run, and both BAE (RG-33 & RG-33L) and Armor Holdings (FMTV derivative) have vehicles among the pool of finalists. At the very least, the acquisition offers a significant boost to BAE’s manufacturing capacity for its RG-33 series vehicles during the competition, while also bringing in minor amounts of workshare via existing subcontracting agreements with competitors like Force Protection. The immediate question is whether BAE + Armor Holdings will be enough to take a substantial chunk of MRAP business away from the current incumbent, Force Protection.
JLTV is imagined as the replacement program for the USA’s Hummer fleet; Armor Holdings has played a major role in the Hummers’ up-armoring program, and is partnered with Lockheed Martin to create the initial JLTV demonstrator vehicles. If JLTV falters, however, MRAP positioning becomes even more important. The most likely scenario is one in which Army maintenance pileups, rising costs for Future Combat Systems, and pressure from Congress and constituents to field survivable options right now will have squeezed the US Army’s budget. Not to mention the rationale for a multi-year, multi-billion development program to create something similar to vehicles that it’s already buying off the shelf.
BAE’s PDF release also adds:
“The proposed acquisition creates a significant opportunity for growth in readiness and sustainment activity. Armor Holdings has an installed base of more than 30,000 tactical wheeled vehicles and is addressing potential requirements to produce up to 60,000 more over the next 10 years. Combined with BAE Systems’ existing installed base of approximately 88,000 vehicles worldwide, this acquisition enables Armor Holdings customers to benefit from enhanced logistics and support through integration with BAE Systems’ well established reset, upgrade and support capability.”
The challenge for BAE will be turning these potential requirement numbers into firm orders from lasting programs that will justify the $4.3 billion purchase 5 years from now, both in absolute financial terms, and as a better use of capital than other strategic alternatives. Right now, the vast majority of Armor Holdings’ income comes from the Aerospace & Defense group; FMTV trucks and Hummer up-armoring contracts are the keys to its fortunes [Year-end 2006 release | Q1 2007 release]. BAE has bought earnings, therefore – but are they recurring earnings?
A happy future in which BAE takes a significant share of the MRAP program to solidify its global leadership in the mine-resistant vehicle sector, plays a major role in through-life servicing of the Hummer and FMTV fleets, and picks up a majority share of either the FMTV/FTTS or JLTV contract, is possible 5 years from now.
So, too, however, is a future in which FTTS or the Phase 4 FMTV is produced by a competitor, Force Protection has taken the lion’s share of MRAP orders and leveraged that into new vehicles for other competitions, and BAE finds that Armor Holdings didn’t bring enough design, technology, and sales heft to the table as JLTV, too, eludes it.
Regardless, BAE Systems has placed its money, and made its strategic bet. Now, time will tell.
The proposed acquisition will be financed through a combination of a placing of new ordinary shares in BAE Systems and existing internal resources. The placing is being launched on May 8, 2007, and is not conditional upon the completion of the proposed acquisition, which is subject to approval of Armor Holdings, Inc. shareholders and to customary closing conditions. These include compliance with The Hart-Scott-Rodino Antitrust Improvements Act of 1976, and approval under the Exon-Florio National Security Test for Foreign Investment. The transaction is expected to close in Q3 2007. BAE release | Armor Holdings release.
July 30/09: BAE takes a charge of GBP 256 million related to the purchase of Armor Holdings Inc. Revenue growth in the Land & Armaments division trailed the company average as BAE sold fewer Mine-Resistant, Ambush-Protected vehicles to the U.S. military. Bloomberg News.
* DID – FMTV 2010-2015: Oshkosh Wins The Re-Compete. With MRAP production ended, M-ATV lost to Oshkosh, and now AH’s FMTV mainstay taken away, things are not looking good for BAE’s 2007 acquisition.
* DID Spotlight – USA Looks to Bridge FMTV Truck Orders Until 2011. BAE Systems retains production until the end of 2010, while the scheduled re-compete takes place.
* DID Spotlight – M-ATV: A Win, At Last, for Oshkosh. This MRAP follow-on is fielding vehicles designed to perform better off-road in Afghanistan. It’s being accompanies by suspension refits for existing MRAPs, using Oshkosh’s TAK-4 suspension.
* DID Spotlight – BAE’s Diverse MRAP Orders. Includes both RG-33 family vehicles, and Armor Holdings’ FMTV-derived Caimins.