With Fewer Defense Mergers, Banks Gauge Whether to Stay in Industry

The aerospace and defense industry saw a decline in mergers and acquisitions during the first part of the year as federal budget cuts set in, forcing the banks and financial advisers that facilitate those deals to reconsider their stomach for the sector.

The result has been several months of staffing ­changes at finance firms as some decide to close their Washington offices or trim their workforce here, and others hire or open their doors in anticipation of the market’s eventual return.

The total number of mergers and acquisitions in the aerospace and defense industry dropped 40 percent, to 25, in the first quarter of the year compared with the fourth quarter of 2012, according to a report from Deloitte Corporate Finance, an advisory firm.

The average disclosed value of those deals fell 77 percent, to $88 million, in the first quarter compared with the previous quarter, according to the Deloitte report, making them less palatable for larger banks that thrive on big-ticket transactions.

Greg Woodford and Greg Nossaman were among the bankers let go by BB&T Capital Markets this year as the company reduces the head count of its aerospace, defense and government services business.

BB&T Capital Markets did not respond to requests for comment.

Nossaman said many financial advisory firms saw opportunity in the defense and government services sector as federal spending began ramping up after the Sept. 11, 2001, terrorist attacks. Now, the market has begun to cool.

“The volume of M&A was at an unprecedented level for a five-year period. . . . [We] saw a surge of bankers coming into the sector,” Nossaman said. “What we’re seeing now is a surge of bankers exiting the sector that didn’t have both feet fully in.”

Nossaman and Woodford have since landed at the McLean Group. Partner Mitchell Martin said that the firm is mindful of federal budget uncertainty and the drop-off in deals but that it saw an opportunity to hire bankers with deep experience in the market.

“We want to get the good people, and we want to make investments that are very long term,” Martin said. “You have to always be ruthless with costs and manage very tightly what you’re doing. We are probably cutting back on some of the marketing.”

Those who have spent decades in defense and government services say the industry is known to be cyclical, meaning the current slow period should eventually give way to more activity.

“I do think in a period of decreasing defense spending these large traditional acquirers will have to go out and buy companies to grow their top lines, diversify and grow into areas that are more attractive,” Woodford said.

Bill Farmer expects activity could pick up as soon as the end of this year.

The longtime investment banker started Howard County-based Twelve Rolling Capital this year after Lazard, the firm where he was managing director and co-head of the aerospace and defense investment banking group, closed its Washington office.

Lazard has bankers in other locations who still service the sector. But Farmer said as the value of deals has come down, fewer of them met the size standards set by Lazard.

“If you’re at a larger bank, it’s probably very difficult to make hay because of the restrictions and the overhead placed on you,” Farmer said. “I think some of the smaller firms that have the knowledge and expertise in the space will do just fine from a market-share perspective.”

Lazard Capital Markets, a separate entity, dismissed two Washington-based stock analysts covering the defense sector at the end of last year. Michael Lewis and Michael Smith have since established the Silverline Group in McLean, providing management and M&A consulting services to companies.

“The investment firms are looking at the defense space, seeing uncertainty in the budget and making an ill-advised decision to leave the sector . . . at a time when we think it’s probably going to be a great opportunity for these firms,” Lewis said.

Others are eying opportunities to invest in the sector despite current market conditions.

Devin Talbott and Pierre Chao co-founded Enlightenment Capital in January 2012 to provide debt and equity financing to aerospace and defense companies after years of serving the industry as financial advisers and investors.

Enlightenment Capital has provided financing to three companies in the past six months, including professional services firm Vistronix, big data player Opera Solutions and transportation services provider Raymond Express International.

“There is an abundance of innovative, small and mid-sized businesses in the space that are developing the tools and providing the services to meet the disparate range of threats and challenges we face as a nation,” Talbott said via e-mail. “And these companies are under-served by the capital markets.”