Changes in Defense-Related M&A?

​The Pentagon has been keeping a concerned eye on Defense-related M&A activity since at least 2008, monitoring the U.S. industrial base to ensure that it maintained some level of diversity of suppliers.  The Department of Defense (DoD) has long been concerned with the small number of large firms able to bid on major weapon systems acquisition: four major contractors bid for the F-15, five for the F-16.  But the F-22 and F-35 programs attracted only two bidders each.  Last week, Pentagon leaders began to voice warnings to the industry: Secretary Carter told the press that “it [is] important to avoid excessive consolidation” and that he “[does not] welcome further consolidation among the very large prime contractors.”

This warning was reinforced by Frank Kendall, the Undersecretary for Acquisition.  In the aftermath of the Department of Justice’s (DoJ’s) approval of Lockheed’s purchase of Sikorsky, he recommended Congress develop guidelines to constrain mergers amongst the major defense primes, and to preserve competition among bidders on large programs.  Mr. Kendall suggested that DoD and Congress “explore additional legal tools and policy to preserve the diversity and spirit of innovation that have been central to the health and strength of our unique, strategic defense industrial base, particularly at the prime contractor level.”
The current concern is primarily focused on the largest defense integrators, with less concern about the second tier and below.  This is not simply about appearances: the Defense Department prefers the optics of large numbers of Prime bidders as much as the potential cost savings. 

​But with the Pentagon, and potentially Congress, watching Defense M&A more strictly, what does this mean for the market? After all, Congress has yet to act, and the defense industrial base does not appear to be a high priority of either the Legislature or Executive.  Warnings like those last week are intended to head off ‘giant’ mergers before the Pentagon and Justice have to disallow them.  Yet the question remains: will the markets listen; will M&A activity continue on its current pace until it is forced to stop, or will self-discipline prevail?  For now, consolidation in the lower tiers can continue unabated.  At the end of the day, Boeing and Lockheed won’t be allowed to merge, but CSC, SRA, L-3, Engility, Exelis, Harris, ManTech, CACI, and all the others are free to roam.  

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