Commercial aerospace is a cyclical industry, yet the current cycle is marked by an unprecedented convergence of events, and a resulting uncertainty as to its magnitude and duration. Despite the tremendous concern regarding the commercial aerospace industry that existed immediately after the September 11th attacks, there were hopes within the industry for a rebound by the end of 2003. However, the appearance of improvements in passenger traffic and public company valuations during the first half of 2002 were soon exposed as false signals. Passenger traffic did not bounce back and parking aircraft and reducing workforces did not stem the losses. As airlines sought to wrest labor concessions from workers and to avoid or emerge from bankruptcy, the continuing softness in the world economy, significant increases in fuel prices, the war in Iraq, and SARS conspired to damage the state of the industry further. Many large airlines remain at risk, struggling to meet their debt obligations and scrambling to restructure their business models to avoid insolvency. As part of this effort, they continue to reduce capacity, and are canceling or deferring many of their orders for new aircraft. As a result, aircraft original equipment manufacturers have repeatedly reduced production rates, which has in turn significantly depressed business activity and profitability at the subcontractor level.
What is perhaps most striking about this cycle is the continued level of uncertainty, nearly two years after the September 11th attacks. Have we reached the bottom? Which airlines will survive? How long will the recovery take? The only issue on which there appears to be a consensus is that the recovery continues to be pushed further and further to the right.
Somewhat perversely, the lengthening of the timeline for recovery has stimulated a recent up tick in merger and acquisition activity in the commercial aerospace industry. During the months following the September 11th attacks, there was little deal activity in the sector, as prospective sellers took a wait and see approach. Many thought the industry might be at the bottom of a brief trough, and that recovery was not far off. As it becomes clear that the recovery is no longer potentially six or twelve months away, sellers are moving forward with divestiture initiatives.
These sellers can be grouped in two general categories: original equipment manufacturers and prime contractors divesting non-core assets, and small and mid-sized companies selling some or all of their assets. While recognizing that the present is not the time to maximize value in a divestiture, original equipment manufacturers and prime contractors have elected to place greater value in achieving the strategic objectives they have articulated to Wall Street – namely, reducing costs, focusing on systems integration and aftermarket services and exiting the component manufacturing business. These include subsidiaries, business units and divisions that produce non-core, low-tech, build-to-print components; and cost centers, or internal suppliers, that supply components to the seller at a cost that is higher than that of an external supplier. In contrast, many small and mid-sized companies are divesting assets for the simple reason that their business has declined significantly, recovery is no longer imminent,and they are not able to compete effectively, meet their obligations or remain a viable business without selling assets and restructuring their balance sheets. Though not for the reasons industry participants had hoped, the stand-off between commercial aerospace buyers and sellers that started with the September 11th attacks has ended, and eager buyers should continue to see a small but steady flow of sellers entering the market.