Exit Focus: Defense Still a Good Offense

by Alex J. Stockham

Veritas sells two companies for more $1 billion as defense players seek acquisitions

Defense companies have always been on the private equity industry’s radar. Firms such as The Carlyle Group, Behrman Capital and Thayer Capital all have made investments in the sector; some employ former defense industry heavyweights as advisors.

Now, New York-based Veritas Capital has made a name for itself in the defense industry as well, especially after its recent sale of Vertex Aerospace to strategic buyer L-3 Communications for $650 million in cash. The firm realized a 10-times invested capital profit on the sale, according to Robert McKeon, the chairman of Veritas Capital.

Vertex Aerospace was acquired by Veritas in April 2001 from Raytheon, a defense electronics contractor, for approximately $270 million. Raytheon makes everything from missiles and radar systems to jet engines and aircraft. According to McKeon, that made Vertex, which was then called Raytheon Aerospace, something of a corporate orphan. The division specializes in aircraft maintenance, logistics support and repairing airline parts for government customers, such as U.S. Armed Forces.

“The company was neglected at Raytheon,” McKeon said. “During video conferences with people at Raytheon, the senior officer (of Raytheon) would come (on screen) and put his feet on the table, so (Vertex executives) would see the guy’s shoes and not his face.”

Veritas saw inherent value in the company, though. In conducting its due diligence on Vertex, Veritas discovered that the company had a $3 billion backlog in orders that still had to be filled. The company was also held in high regard by its customers.

“It was a jewel,” McKeon said, “They had a good history and had grown rapidly over the years. They were successful at winning contacts.”

Winning contracts was one way Veritas planned to help the newly renamed Vertex Aerospace grow. In June 2001, after Veritas acquired a 70% stake in the company in a deal in which the firm invested a $44 million equity commitment, the firm sat down with the company to identify upcoming repair and maintenance contracts that were available from various government agencies. Vertex, following Veritas’ advice, went as far as to put teams on the ground in the cities where the contracts were being offered to lobby for the contracts.

Two of those contracts were known as the “Navy T-45” contract and the “Fort Rucker” contract, both of which Vertex was awarded earlier this year. The Navy T-45 deal, potentially worth $450 million over four years, contracts Vertex to supply maintenance and engineering services to the T-45 fleet, which are used to train naval aviators. The jet is also used to train prospective instructors. The 200 T-45 jets are based at Naval Air Stations in Meridian, Miss. and Kingsville, Texas.

The Fort Rucker contract is the real plum, though, according to McKeon. The contract, which is potentially worth $2.7 billion over 10 years, has Vertex supplying maintenance and engineering services for the rotary wing aircraft at Fort Rucker in Alabama. Approximately 650 aircraft are stationed there and the fort’s aviation operations account for approximately 40% of the U.S. Army’s total flying hours. Taken together, both contracts would employ about 3,700 people.

Veritas also helped Vertex Aerospace scout potential add-on acquisitions. One company the private equity firm identified was Flight International, which provides training services to the Navy – sending instructors, pilots and equipment to help train pilots and gunners. McKeon said these pilots fly missions simulating enemy aircraft to help train naval aviators. The company also has services to help train gunners on the Navy’s ships. For example, the training pilots will drag decoys behind their planes as target practice for the gunners.

Vertex Aerospace teamed with L-3 Communications, Paragon Systems and U.S. Helicopter to win the Fort Rucker contract. According to McKeon, that contract set the stage for L-3’s subsequent acquisition of Vertex.

This was not the first defense-related company that Veritas and L-3 discussed, according to McKeon. In August, Veritas sold portfolio company Integrated Defense Technologies to strategic buyer DRS Technologies for approximately $550 million. L-3 Communications had an interest in acquiring IDT as well, McKeon said.

“We built IDT over three years and L-3 looked at every piece (IDT acquired),” McKeon says. He adds that L-3 considered purchasing Integrated Defense as well, but wasn’t as aggressive as DRS Technologies was on that acquisition.

Veritas held a 48% stake in IDT after the company’s initial public offering in February 2002. That IPO netted Veritas about $32 million. When DRS agreed to acquire IDT, it agreed to pay $12.25 per share in cash and $5.25 per share in stock to IDT shareholders for a total of $375 million.

After such a successful exit strategy for IDT, McKeon says Veritas was in preparation to take Vertex Aerospace public as well. After the company won both the Navy T-45 and Fort Rucker contracts, steps were taken to file for an initial public offering.

“We were going to file on a Wednesday, and I got a call on the previous Friday from a guy at CSFB that L-3 was interested in the company,” McKeon says.

McKeon says he spoke with L-3 Communications’ chairman and chief executive officer Frank Lanza over that weekend while Lanza was out of town to discuss a deal.

“They’re very acquisition-minded,” McKeon says. “I told them what we wanted and what the IPO expectations were and we gave them three days to confirm that number, which was $650 million.”

L-3 made an offer a few days later, on a Tuesday afternoon – one day before the scheduled IPO filing.

“I’m a believer in running auctions when selling because you get a competitive process going, but the strategic fit with L-3 and our experience with them, I felt comfortable that we could get to an agreement quickly,” McKeon says.

Despite having recently exited two defense-related portfolio companies, McKeon still believes there is value in the sector simply because of the vast amount of consolidation that can still take place.

“There are still a vast number of middle-market companies in the defense world with roots back to World War II,” McKeon says. “The nature of defense spending is that Congress gives money and every little district has a small defense company. Congressmen make sure they survive.”

One example of a defense company created during WWII is a company that makes life support safety equipment for fighter pilots – H. Koch & Sons. Veritas invested in the company in 1992 – before the firm raised a fund. Founded in 1909, the company focused on making luggage, but WWII changed their business model.

“The entire economy was converted and they never went back to commercial models,” McKeon says.

McKeon says those small, disparate defense companies are only now beginning to be merged.

“L-3, DRS and us were the only ones putting these together,” McKeon says. “We believe there’s opportunity there, and we’re pursuing it.”

back to news