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Capstone Headwaters C4ISR M&A Coverage Report Q2 2019

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Capstone Headwaters C4ISR M&A Coverage Report Q2 2019 C4ISR M&A COVERAGE REPORT Q2 2019 COMMAND, CONTROL, COMMUNICATIONS, COMPUTERS, INTELLIGENCE, SURVEILLANCE & RECONNAISSANCE (C4ISR) Q2 2019 MERGER & ACQUISTION OVERVIEW Transaction activity involving Aerospace & Defense (A&D) companies continues to be supported by spending increases in the President’s Budget 2020 (PB20) growing to $718.3 billion and focusing on innovation and modernization across all warfighting domains. Specifically, the PB20 includes the largest research and development request in 70 years, targeting high-end warfare rather than regional conflicts or counterinsurgencies. The focus on delivering “critical enabling technologies” to the warfighter continues to become an increasingly persistent theme in high priority modernization programs. As a result, differentiated C4ISR capabilities are at a premium. The increase in drone operations tempo, investments in strategic and in-theater intelligence gathering platforms, and the national priority placed on missile defense, are driving heightened valuations. Firms in this sector are providing software, engineering, and training services that allow advanced technologies to impact mission success. In 2018, pure C4ISR deals accounted for 11% of deals closed. M&A activity remains strong in 2019 with 44 announced or closed transactions TABLE OF CONTENTS year-to-date (YTD) compared to 46 in YTD 2019. The most significant transaction this year is the announcement of the $91 billion Raytheon- M&A Overview United Technologies merger. The companies’ ability to leverage each Key Trends & Drivers other’s research and development resources well positions the Company Spotlight combination to further dominate share of DoD funding for C4ISR. Other significant highlights include: the close of the $19 billion merger of L3 Notable Transaction Technologies, Inc. (NYSE:LLL) and Harris Corporation (NYSE:HRS); the Select Transactions close of the $2.4 billion merger of Science Applications International Public Company Data Corp. (NYSE: SAIC) and Engility Holdings, Inc.; and two acquisitions by the Parsons Corporations (NYSE:PSN) in concert with its May initial public Firm Track Record offering (IPO) which raised ~$500 million at a valuation of $2.6 billion. M&A Activity: C4ISR CONTRIBUTORS 80 64 Tess Oxenstierna 60 56 46 Managing Director 44 40 203-524-0888 27 [email protected] 20 Hilary Morrison Vice President Number of Transactions 0 917-763-0121 2016 2017 2018 YTD 2018 YTD 2019 [email protected] Year-to-date (YTD) ended September 13 Source: Capital IQ, PitchBook, FactSet, and Capstone Headwaters Research 3 www.capstoneheadwaters.com September 2019 KEY TRENDS & DRIVERS PROJECTED CAGR OF GLOBAL A&D do AI-enabled mission command? How do we get faster 14.3% ARTIFICIAL INTELLEGENCE MARKET at sensor-to-shooter? How do we do data link faster than we do it today? There is great promise and potential 2 Current M&A activity has largely been driven by though the entire C4ISR enterprise.” technology and intelligence, with buyers expanding capabilities in software, data analytics, and predictive In a recent M&A AI technology play, General Dynamics intelligence. Modern technology is key to effectively Mission Systems, Inc. acquired Deep Learning Analytics, synchronizing complex intelligence data between air, land, LLC (DLA) in March for an undisclosed deal amount. DLA sea, space, and cyber to rapidly communicate with forces is a five-year-old company based in Arlington, VA that around the world and mobilize a successful response utilizes advanced algorithms to predict threats and inform team. Additionally, the speed at which technology decision-making. In 2015, DLA beat leading defense evolves in the commercial space continues to draw contractors including Boeing, Raytheon, and Northrop leading defense companies to seek opportunities for Grumman for a prime contract to improve the analysis of technological superiority through M&A. radar images and went on to be selected to execute Phase II of the previously contracted project in 2017. Artificial intelligence (AI) has rapidly emerged as a key technology target. The global AI market within the “Deep Learning Analytics brings to General Dynamics an Aerospace & Defense industry is projected to grow at a extensive expertise in artificial intelligence and specializes compound annual growth rate (CAGR) of 14.3% to reach in deploying deep learning algorithms on small, power- $17.6 billion U.S. dollars by 2025, according to Kenneth efficient appliances and mobile devices,” Chris Brady, Research.1 Building on the launch of Project Maven in General Dynamics Mission Systems President, said in a 2017 (which used AI to process drone footage), the DoD press release.3 “Through data science, research, machine has continued to seek opportunities for data maximization learning, predictive analytics and software engineering, through AI. our government and commercial customers can better exploit their data—a tremendous value to their missions.” Joint Artificial Intelligence Center (JAIC) Director Lt. Gen. Jack Shanahan explained to C4ISRNET:“Idon’tthinkthere The DoD’s demand for modern technologies will continue is any part of C4ISR that does not have the potential to be to drive leading prime defense companies to target improved through AI-enabled capabilities. I want JAIC to technology and intelligence companies with innovative help the services and the combatant commands with the commercial off-the-shelf solutions which can be adapted ops side. How do we do ops-intel fusion? How do we to serve the complex needs of the U.S. military. FY 2020 Budget Priorities Enhance Competitiveness Modernize in Air, Through Emerging Compete Maritime, and Warfighting Land Domains Domains Deter Sustainand Build Develop and Field on Readiness Win Innovative Gains Technologies Source: Department of Defense FY 2020 Budget Proposal C4ISR | Q2 2019 3 COMPANY SPOTLIGHT L3 Harris Creates Leading Defense Ticker: NYSE: LHX Technology Company Stock Price as of 09/16/19: $214 USD Headquarters: Melbourne, FL Diversified Business Mix Nine months after the announcement, L3 Technologies, Inc. and Harris Corporation completed their merger in June to form L3Harris Technologies 32.0% (NYSE:LHX) – the sixth-largest Aerospace & Defense prime contractor in the U.S. and a top 10 defense company globally. 68.0% Strategic benefits of the $19.2 billion dollar merger (13.7x EBITDA), as noted in the press release,4 include: Increased scale with a diversified business mix - The Prime Contractors combined company has a product range spanning Sub Contractors from military radios and space hardware to air-traffic control systems. There is limited overlap between their products and the combined portfolio brings depth and Merges with balance of relationships across a diverse spectrum of customers. The increased scale will expand capabilities Strong Customer Relationships to provide more comprehensive products and services, allowing the company to be more cost competitive. 21.0% 23.0% Shared culture of innovation and operating philosophy creates stronger platform to drive growth - The deal combines two of the industry’s most robust technology-driven research and development 56.0% (R&D) spenders with a combined workforce of more than 20,000 engineers and scientists. The combined company plans to accelerate investment as a means of International establishing a more significant leadership position in Department of Defense key strategic domains including national security. Other Meaningful value creation opportunity - Annual gross pre-tax cost synergies are expected to be close to $500.0 million. Over the course of the next three years, the company is expected to invest ~$450.0 Culture of Talent and Innovation million cash to achieve synergies. Overhead costs will be reduced by consolidating corporate and segment 24,000 headquarters and establishing shared IT services and 20,000 finance platforms. Strong balance sheet with significant cash flow generation - The combined company will target $3.0 billion in free cash flow by year three, driven by organic growth, cost synergies, working capital improvement, Engineers Cleared Personnel and capital expenditure efficiencies. Source: L3 Harris Technologies Investor Presentation, July 1, 2019 C4ISR | Q2 2019 4 NOTABLE TRANSACTION United Technologies Corporation to Merge with Raytheon Company (June 2019, $91.1 Billion) United Technologies Corporation (NYSE:UTX) and Raytheon Company (NYSE:RTN) have agreed to an all-stock merger of equals for $91.1 billion. As the largest defense industry merger ever completed, it underscores the key industry theme of defense companies moving up the value chain to access more prime contract awards. Raytheon is a Waltham-based military contracting company, primarily supplying To merge with global Military and Government markets with aircraft and missile equipment. United Technologies Corporation (UTC), based in Farmington CT, provides technology products and services to building and commercial systems. The combined company will operate as Raytheon Technologies, addressing the Military, Government, and Commercial Aerospace & Defense markets. The merger offers significant long-term value creation, according to the press release, with key benefits including: 1) a balanced and diversified portfolio; 2) complementary technology and R&D with more than 60,000 engineers and a combined annual $8 billion in R&D spending; 3) a strong cash flow with an expected combined gross annual run-rate of more than $1 billion
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