Industrials M&A: What to expect with Defense, Energy, Manufacturing & Infrastructure this year

As we draw closer to the end of the first quarter of 2023, we have already seen and heard of several deal announcements that are expected to take place this year. Despite various macroeconomics issues and concerns, there are some industries, like the Industrials sector, that are expected to pursue M&A opportunities, no matter how small or large. The Covid-19 era, Post-Covid era, geopolitical tensions and current market conditions have made some M&A ventures possible to further strategic growth and diversification. Areas in the Industrials sector that we can expect some M&A activity this year include Aerospace, Defense & Government (ADG), Energy (Oil & Gas), Manufacturing & Production and Engineering & Infrastructure.

Aerospace, Defense & Government

Last year, the Aerospace, Defense & Government (ADG) sector announced over 433 deals totaling around $46B. Even though the deal volume was 10% lower than 2021, growth and interest propelled due to the geopolitical tension between Russia and Ukraine and the need for tighter global security. This is expected to continue in 2023.

Many businesses felt and still feel it is necessary to further advance their defense product capabilities, diversify their offerings, and enter new markets where governments are looking to strengthen their military capabilities. This was especially the case in Europe, where the Russia/Ukraine feud posed major risks to the sovereignty of many neighboring countries. With the continued geopolitical issues, governments, if not already, may increase their budget for defense spending and will have a high demand for cybersecurity and government technology. e.g. The US added $45B to their defense budget for FY 2023. This will provide the opportunity for companies to improve on their product offerings and strengthen their product capabilities, leveraging various small scale acquisitions and investments.

For the past 10 years, the ADG sector has been very stable in terms of deal volume, with annual transaction volume being impacted by the market conditions. The 10% drop in deal volume in 2022 was due to rising interest rates in the last 2 quarters, which made borrowing funds to finance deals very expensive. Deal volume is expected to remain stable in 2023 as well. Companies will continue to diversify their product offerings and enter into new markets, rather than seek mega M&A deals. Mega M&A deals in the U.S. will draw a lot of attention and scrutiny to the already vigilant U.S Department of Defense that has spoken out against large M&A transactions that could further consolidate the industry and hurt competition for defense contracts. Due to this concern and just the availability of capital (cash), it might not be a surprise to see more private equity transactions than strategic acquisitions.

Both governments and businesses are faced with inflation and interest rates concerns and will find ways to navigate them this year. Nevertheless, M&A for defense is still expected in some capacity.

Energy: Oil& Gas

Last year was a real test for the energy and industrial sectors with the onslaught of global supply chain issues, energy security issues, volatile energy prices and changes in law surroundings the energy practices.

The major players in the oil and gas sector made record profit and provided high returns to shareholders from the consumer-driven fear of global oil shortages that raised oil prices to record levels. No longer is there a main priority of revenue and growth, but more so having more energy security going into the 2023 headwinds of macroeconomic issues. The Russia/Ukraine ongoing feud has forced Europe to look to America as a major source of natural gas alternatives to Russia. This could be a key driver for investments in M&A related to natural gas, which is most beneficial for company with strong balance sheet and are already in the natural gas business. Supply chain was a major issue for this sector hence the reason why some acquisitions and investments will be pursued be to strengthen existing supply chain networks.

As the reality of energy transition come into play, companies in the sector will now find ways to balance their current oil and gas offerings as they pursue this long term route. There has been a true shift in the recognition and demand for clean energy alternatives which have recognized. This includes the technology, infrastructure, research etc. that is needed for transition to clean energy production. Businesses with more than enough cash flow from their 2022 earnings may use a portion to invest in clean energy M&A solutions long term to further diversify their portfolio. Clean and renewable energy alternatives have been globally supported by many nations with the overall goal to reduce our global carbon footprint. The U.S. Inflation Reduction Act that was recently passed includes provision for billions of dollars in loans and grants to support clean energy projects. With these investments in clean energy, we may begin to see possible divestitures of non-core oil and gas assets for some companies overtime.

Manufacturing and Production

The global pandemic along with recent macroeconomic issues have really exposed how much our global manufacturing relies on the timely production & transportation of goods, the negatives effects of having a sole major supplier, and the consequences that comes with a global labor shortage. Many businesses never really foresee such as combination of issues that would ever affect their manufacturing operations. This year and going forward, M&A's being pursued in this sector will focus on improving supply chain, mitigating supply chain disruptions, acquiring the relevant manufacturing technology (existing and emerging), and restructuring talent acquisition strategies to name a few. Will there be more divestiture or acquisitions? It depends on a business overall rationale, but the reasons outlined above will act as guiding factors.

The CHIPS & Science Act which seeks to revitalize the production and manufacturing of semiconductors in the US will open the door even further for strategic acquisitions in supply chain, semiconductor research, manufacturing technology needed for successful value chain. Major chip manufacturers such as Micron has already made $40 billion investment in memory chip manufacturing since the deal. Qualcomm and GlobalFoundries have announced a $4.2 billion partnership to manufacture chips with the hope of increasing semiconductor production in the US by 50% over the next 5 years.

It's expected that inflation, interest rates, energy costs and volatile commodity prices will continue to be a factor that affects manufacturing business operations. Companies with very strong balance sheet, especially those accumulated over the last 3 years, will have less difficult time navigating these issues.

Engineering and Infrastructure

The recent passing of the multi-billion dollar Bi-partisan Infrastructure Investment and Jobs Act (IIJA) is a signal to many players in this sector to be prepared for all the opportunities and projects that will come forth. Last year, and continuing this year in some capacity, this sector was hit with inflation, high interest rates and volatile prices of raw materials, on top of the global supply chain issues. However, with so many infrastructure acts being passed in the US, it presents new opportunity for growth in this sector.

The $560 billion-dollar infrastructure law investment over the next 4-6 years is a motivator for current businesses to seek strategic acquisitions of contractors and suppliers that will be leveraged by the government (both local and federal) to work on projects across the country. Infrastructure investment will come in the form of clean water, public transport, rail transport, solar power, roads and bridges, high speed internet, pollution just to name a few. Many contractors and suppliers, operate across these areas so business who want to diversify and benefit from the projects and investments in this sector will start making steps towards acquisitions.

Besides Oil and Gas, clean energy transition and renewable projects have infrastructure implications, which could be an opportunity for Energy companies to pursue infrastructure investments in this sector and diversity their portfolio. Another factor, labor, is very crucial to this sector and tight labor markets poses a challenge to contractors that will have to be addressed.

Overall, given the plethora of issues and challenges in the market, companies will be even more strategic than ever this year when looking at M&A opportunities to take their business into the next 5 years and strengthen their portfolio.

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Sources: HigherGov, PWC 2023 Outlook, Deloitte 2023 Outlook: Industrials, whitehouse.gov, Ernst & Young (EY), Bain & Company