PitchBook News - PE ups its bets on defense sector

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The Weekend Pitch

August 22, 2021

Presented by Elements Global Services

(Drew Sanders/PitchBook News)

In the same week that Afghanistan's capital, Kabul, fell into the hands of Taliban militants, ushering in a new era of regional instability, two major deals in the defense sector also hit the headlines.

I'm Andrew Woodman and this is The Weekend Pitch. You can reach me at andrew.woodman@pitchbook.com or follow me on Twitter via @adwoodman.

Private equity touts its ESG cred but ups its bets on defense deals

On Monday, Advent International-owned British aerospace company Cobham agreed to buy Ultra Electronics, a major UK supplier of sonar equipment to the Royal Navy, for nearly £2.6 billion (about $3.5 billion). A day later came news that TransDigm—a US-based aerospace company that counts The Vanguard Group among its investors—is seeking to acquire UK aerospace defense specialist Meggitt.

Ultra and Meggit are the latest in a series of British companies that have been targeted by foreign firms rummaging through London's stock exchange for bargains. The deals have caused concern about whether the UK is doing enough to protect its defense sector from outside investors in the interest of national security. Kwasi Kwarteng, the government secretary for business, energy and industrial affairs, has already called on regulators to review the Ultra transaction on security grounds. Whether this will impede a deal remains to be seen, given that Advent's acquisition of Cobham underwent similar scrutiny in 2019, but the deal still went through.

What's more striking about these pacts is that they underscore a growing, and arguably cynical, appetite for aerospace and defense assets against an increasingly unstable geopolitical backdrop. In an era when many PE firms are seeking to burnish their credentials as socially responsible investors, it seems counterintuitive (at best) to invest in a sector traditionally eschewed by many public market investors concerned about ESG.

In a July report, KPMG detailed the opportunity for private equity in the aerospace and defense sector, citing the "increased geopolitical instability" that is driving increased government defense spending. Not unlike the kind of increased instability that is unfolding in Afghanistan as I type.

PitchBook data shows that investors have been jumping on that opportunity. Last year saw a record $9.9 billion worth of PE investment funneled into 140 deals in the global aerospace and defense sector. This year, meanwhile, has so far brought in $5.5 billion across 116 deals.

Companies that sell so-called dual-use civilian and military products related to aerospace, radar equipment, or even software, offer an acceptable proxy for private equity to invest in conflict. Investments in explicitly offensive-defensive assets—such as missile and gun manufacturers—go beyond what many limited partners would consider to be compliant with their ESG mandates.

However, as the technology deployed in warfare has gotten more sophisticated, the definition of "defense assets" has broadened. Defense now includes a whole range of non-kinetic technologies such as cybersecurity, radar and reconnaissance equipment, which arguably remove what KPMG's report describes as "reputational barriers to investment."

That said, aerospace and defense is still regarded as a high-risk sector from an ESG standpoint. According to a July 2020 report from Morningstar's Sustainalytics unit, the sector ranked 37th out of 42 industries, with 62% of companies classified as high-risk, and 21% considered a severe risk.

Moreover, it's hard to ignore the fact that defense contractors still stand to gain from conflict and instability. So while these companies may not make weapons, they still reside in a gray area in ESG risk terms.

If the definition of defense investing has evolved with new technology and new methods of waging war, it's probably also time to revise our definition of socially responsible investing.

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Quote/Unquote

(Stefan Cristian Cioata/Getty Images)

"We want what's best for ourselves. We want what's best for our pets."

—Meagan Loyst, an investor at Lerer Hippeau, an early backer of BarkBox.

Consumer spending trends and pandemic puppies are driving a funding boom for startups in the pet industry, a market that has swelled to more than $100 billion in the US, according to the American Pet Products Association. Pet parents are increasingly dropping hard-earned cash on pet insurance policies, activity-tracking smart collars and more.

Did you know ...

... That patient data collected in real time is changing the way new drugs are discovered, evaluated and approved?

The emerging field of real-world evidence gathers data from a variety of real-time sources including biometric trackers and health apps. These insights help track how diseases function over time, reduce the number of patients required for clinical trials and identify off-label uses for approved therapies.

Real-world evidence startups have raised more than $1.8 billion in venture capital funding since 2019, according to a recent PitchBook Emerging Tech Research analyst note.

Ackman's SPAC is now aiming for a SPARC

(Bryan Bedder/Getty Images)

Bill Ackman is ready to scrap the biggest SPAC to date by returning the $4 billion he collected from investors if US regulators allow him to form a different vehicle. The new structure—which Ackman is calling a SPARC, short for special-purpose acquisition rights company—would let him continue to search for a large company to take public, but without being subject to the customary two-year deadline for a SPAC to land a merger agreement.

The move comes after shares of Pershing Square Tontine Holdings, Ackman's blank-check company, dipped below their $20 IPO price following a shareholder lawsuit alleging that his SPAC is an illegal investment company. If approved, the SPARC's structure wouldn't require investors to put in funds until a target is identified and agrees to be taken public via Ackman's vehicle.

The Pershing Square SPARC, which would also trade on the NYSE, has a similar structure to the current SPAC. But instead of shares, it comprises warrants that are exercisable once a deal is on the table.

Each SPARC warrant gives its owner the right to invest in the eventual reverse merger. Unlike a SPAC, where funds must sit in a trust, the benefit of a SPARC structure is that investors' money is not locked up while Ackman is hunting for a company to take public.

Ackman's proposal to give his SPAC investors their money back aims to keep them in the long game: Owners of the Pershing Square Tontine SPAC would receive $20 in cash per share, as well as one SPARC warrant.

Deal Flow

(John M Lund Photography Inc/Getty Images)

Travel is roaring back, delta variant notwithstanding, and dealmakers aren't shying away from the pandemic-sensitive sector.

This week, travel booking company Hopper raised $175 million in a Series G led by GPI Capital. BlackRock and Knighthead Capital have also reportedly backed low-cost airline startup Breeze Airways in a $200 million round that values it at $1.4 billion, according to PitchBook data.

On the buyout front, KKR and KSL Capital Partners are selling resort management company Apple Leisure Group to Hyatt for $2.7 billion in cash. Hyatt is betting on a robust return to leisure travel, especially the all-inclusive packages that Apple Leisure is known for.

So far this month, US travelers are flying at about 78% of 2019 levels, regularly surpassing 2 million people per day, according to the Transportation Security Administration.

Datapoints

As a rule, general partners tend to raise successively larger funds over time, but the size of those step-ups has rocketed this year. The median private market fund so far in 2021 is 60% larger than its predecessor, compared with sub-40% in recent years. More than eight in 10 funds have represented some kind of size jump so far this year.

Bigger isn't always better, as our latest Private Fund Strategies Report explains. Possible side effects of ever-larger funds include managers losing focus, wading into larger deals or adopting other behaviors that potentially damage returns.

Recommended reads

After battling a series of down years, a pandemic and a bankruptcy, one hedge fund manager is back to focusing on a place that "everyone else is running from." [Institutional Investor]

An interview with YouTube's chief business officer Robert Kyncl about protecting minors, the company's recent acquisition of an Indian social commerce startup, and whether or not he has a TikTok account. [The Information]

As wildfires rage across the US, a crisis of another kind is also spreading. [The Guardian]

A new battle is taking shape over a virtual realm that most consumers don't even know exists. [The Wall Street Journal]

Earlier this month, Authentic Brands acquired Reebok in a $2.5 billion deal. Can the shoe company's new owner bring back the 1980s glam? [Bloomberg]

The pandemic has helped to renew an interest in virtual reality. The latest development in the space involves virtual meeting rooms complete with avatars. [The New York Times]

This edition of The Weekend Pitch was written by Andrew Woodman and James Thorne. It was edited by Alexander Davis, Angela Sams, Kate Rainey and Sam Steele.

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