By Pierre Six, Jingying Liu and Mathilde Heibig (HEC Paris), Ayushman Mukherjee, Divy Dayal, Junseok Choi and Amar Mian (Cambridge)
Photo: Ivan Diaz (Unsplash)
Overview of the deal
Acquirer: L3Harris Technologies
Target: Aerojet Rocketdyne Holdings, Inc.
Total Transaction Size: $4.7bn
Closed date: 2023 (expected)
Target advisors: Citi and Evercore Inc. (Financial), Wachtell, Lipton, Rosen & Katz (Legal)
Acquirer advisors: Barclays Capital Inc. and Goldman Sachs & Co. LLC (Financial), Simpson Thacher & Bartlett LLP(Legal)
L3Harris, a global defence and aerospace firm, is to purchase Aerojet Rocketdyne, also an aerospace and defence leader in the US, for $58 per share in a $4.7 billion all cash transaction, inclusive of net debt. The deal is yet to be approved by antitrust regulators since such deals can have a crucial impact on the US defence market. As a matter of fact, such concerns had led antitrust regulators to block Aerojet’s attempt to merge with Lockheed Martin earlier in 2022.
This deal also follows L3Harris’s recent acquisition of Viasat’s Link 16 Tactical Data Links. The company expects these mergers to foster innovation - space-related innovation when it comes to Aerojet. This horizontal expansion should also allow L3Harris to strengthen its position in the US industrial defence base and its partnership with the Pentagon, in a context where demand for defence technology has been rising, and to realise economies of scale.
“We’ve heard the DoD leadership loud and clear: they want high-quality, innovative and cost-effective solutions to meet both current and emerging threats, and they’re relying upon a strong, competitive industrial base to deliver those solutions,” said Christopher E. Kubasik, CEO and Chair (L3Harris)
Company Details (Acquirer - L3Harris)
L3Harris Technologies is an agile global aerospace and defence technology innovator, delivering end-to-end solutions that meet customers' mission-critical needs. The company provides advanced defence and commercial technologies across air, land, sea, space and cyber domains. A broad customer base, R&D, order backlog, and profitability are the company’s major strengths, even as legal proceedings and huge debt remain causes for concern. Global electronic warfare market, focus on aircraft business, strategic acquisitions, and new contracts are likely to offer growth opportunities. L3Harris is committed to sustainability and has set 2026 as the deadline to reduce greenhouse gas emissions by 30% and to reduce water use by 20%.
Founded in 1895, headquartered in Melbourne, Florida
CEO: Christopher E. Kubasik
Number of employees: 48,000
Market Cap: $40.8bn (as of 17/02/2023)
EV: $47.7bn
LTM Revenue: $17.1bn
LTM EBITDA: $2.9bn
LTM EV/Revenue: 2.8x
LTM EV/EBITDA: 16.6x
Company Details (Target - Aerojet Rocketdyne)
Aerojet Rocketdyne Holdings, a California-headquartered company, specialises in manufacturing rocket, hypersonic, and electric propulsion systems for a range of applications including space, defence, civil, and commercial use.
In December 2020, Lockheed Martin made a $4.4 billion bid to acquire Aerojet Rocketdyne, but the plan was abandoned on February 13, 2022, after facing opposition from Raytheon, a rival US aerospace and defence company. The Federal Trade Commission moved to block the acquisition as a result of this opposition.
Founded in 1942, headquartered in Sacramento, California
CEO: Eileen Drake
Number of Employees: 5,000
Market Cap: $4.5bn
EV: $4.5bn
LTM Revenue: $2.2bn
LTM EBITDA: $272.8mn
LTM EV/Revenue: 2.0x
LTM EV/EBITDA: 16.6x
Projections and Assumptions
Short-term consequences
L3Harris announced it would remain a merchant supplier of rocket engines made by Aerojet, while broadening its reach in weapon systems and space by acceding to new markets and technologies, notably in missiles, missile defence and space exploration. The transaction would maintain competition in the defence industry. Indeed, L3Harris describes itself as a non-traditional supplier that brings competition in the market, and the company expects the transaction to strengthen the firm.
Following Russia’s invasion of Ukraine, over $30 billion of funding was approved by the US for defence-related assistance to Ukraine, including missiles and air defence systems. It has increased demand for the defence market, which L3Harris hopes to benefit from. The announcement of the merger was followed by an increase in the trading volume of Aerojet’s shares.
However, as the US defence industry is mainly controlled by five companies, this increased consolidation is becoming a contentious issue, with a report published by the Pentagon in 2022 stating that the deal reduced the sector’s industrial capability and capacity. In January, some US Senators wrote to the Federal Trade Commission, urging them to block the merger between L3Harris and Aerojet Rocketdyne under antitrust rules. Following the act, the stock price for Aerojet dropped by 1%.
Moreover, as the transaction was announced, Moody's downgraded L3Harris’ rating outlook from stable to negative. Indeed, L3Harris will pay $58 per share entirely in cash. This means the company will take on new debt, but in the context of soaring interest rates, it implies high interest rates eating up a consequent sum of the operating profit. This elevated leverage and L3Harris’ acquisitive nature will constrain the rating at Baa2, Moody’s said.
Long-term Upsides
The acquisition has been struck at a time of high demand for aerial defence weaponries amidst the still-persisting Ukrainian war in Europe. L3Harris has recently signed yet another $40mn contract with the U.S. Department of Defense in exchange for provision of the Vampire counter-drone system to be deployed on the Eastern Front. Rocketdyne is an unrivalled innovator within the propulsion systems space, providing the most wide-ranging solutions for missiles, space exploration and other aerial vehicles.
Thus said, Rocketdyne Technologies is in an excellent strategic position to complement L3Harris’s existing presence in defence systems and data technologies with its physical portfolio of propulsion systems. This enables L3Harris Technologies to gain direct foothold and expansion opportunities within the missiles space without bearing the risks of taking on losses in an internal development scenario into this high-barrier market.
Further accretion can be expected through synergies with the recently added portfolio—TDL, a military data network systems asset acquired only 3 months ago—by establishing L3Harris as the sole champion within the aerial defence industry. The ever-increasing U.S. defence budget, fueled by the increasingly apparent tension and potential threats from China, is also in favour of the acquisition with strong expected demand over the longer term.
Risks and Uncertainties
Anti-trust regulations are likely to remain at the top of investors’ concerns regarding this transaction. Just last month, Lockheed Martin backed out of a deal to acquire Aerojet following an intervention by the Federal Trade Commission – which assessed the deal as having a detrimental impact on other defence contractors.
However, the L3Harris bid is unlikely to face the same resistance. The acquisition does not feature a horizontal overlap of business lines (Aerojet focuses on rocket motors, while L3Harris produces primarily electronics) – and is thus unlikely to result in any particular market becoming uncompetitive. Similarly, the deal does not involve any vertical integration, which had been a key concern for the Federal Trade Commission – in part because competitors doubted whether Lockheed could be trusted as a supplier of rocket engines to Lockheed’s competitors post-acquisition. Indeed, some commentators believe the deal may even bolster competition – by providing a powerful and well-funded competitor to the aerospace giant Northrop Grumman.
The financing of the deal will, however, require a credible commitment from management to lower debt over time. Fitch Ratings, a rating agency, revised the outlook of L3Harris to “negative” in December of last year. The outlook reflects an elevated post-transaction leverage profile with pro forma initial EBITDA leverage of around 4x, as the transaction is expected to be financed entirely with new debt. Fitch believes that management will need to limit or pause share repurchases, and shift capital deployment to debt repayment until EBITDA leverage returns to 2.5x by 2025. Integration risks are also high due to the differences in business lines, a challenge that could compound as L3Harris is also in the process of closing a separate transaction – the $2 billion debt-funded acquisition of Viasat’s Tactical Data Links. Management will need to demonstrate that they can commit to prudence.
“This agreement will accelerate innovation for national security propulsion solutions while providing a premium cash value for our shareholders and tremendous benefits for our employees, customers, partners and the communities in which we operate” - Eileen P. Drake, CEO and President (Aerojet Rocketdyne)