POLICY PAPER
By Lorenzo Scarazzato and Madison Lipson
Citation:
Scarazzato, Lorenzo & Lipson, Madison, 2023. “Going private (equity): A new challenge totransparency in the arms industry,” Security in Context Policy Paper 23-02. August 2023, Security in Context.
A downloadable version of this article is available at the bottom.
Abstract: The global arms industry has historically been a highly regulated and opaque sector, with governments and arms companies tightly controlling the flow of information about weapons systems and military technology. However, a new challenge to transparency in the arms industry is emerging: the growing involvement of private equity firms in the sector. This paper starts by focusing on the impact of the activity of private equities in the US, the country with the most significant presence in the SIPRI Top 100 Arms-producing and Military Services Companies along with the greatest presence of private equity firms.
Since the turn of the millennium, private equity firms have been increasingly interested in investing in arms companies, attracted by the sector's stability and long-term demand. Private equity firms typically seek to maximize profits by acquiring companies where they can streamline operations and cut costs, which can result in increased efficiency. At the same time, private equity firms are not required to publish annual reports on or submit financial statements for any of the companies in their portfolios, which reduces transparency. Less transparency means less oversight and accountability, posing a challenge for researchers and policymakers.
This paper underlines the importance of increasing transparency in the global arms sector, by demanding that private equity-owned arms companies follow requirements closer to the ones of publicly listed companies, in order to disclose more information about their operations. The current geopolitical situation makes the arms industry more appealing to investors, private equity included. There are also signs of industry expansion into regions with highly developed capital markets beyond the United States, such as Europe.
Overall, the paper suggests that the increasing involvement of private equity in the arms industry is a complex issue requiring all stakeholders' careful consideration. While private equity can bring benefits such as increased efficiency and innovation, it also poses risks to transparency and accountability. Policymakers and civil society organizations must hold private equity firms to high standards of transparency to ensure accountability and enable comprehensive analysis of industry trends.
The paper is based on a blog by the same authors originally published on the Stockholm International Peace Research Institute website, available at https://www.sipri.org/commentary/blog/2023/going-private-equity-new-challenge-transparency-arms-industry
Introduction
In the latest ranking of the world’s largest arms-producing and military services companies (the SIPRI Top 100) [1] , published by the Stockholm International Peace Research Institute in December 2022, two firms based in the United States – Peraton and Amentum – had been acquired by private equity firms. As a result, information on both companies’ arms sales has become unclear due to the lack of available financial information.
Since the turn of the century, a growing number of arms producers and military service providers have been acquired by private equity investors. These investors, who are not subject to the same public financial reporting obligations as publicly listed companies, have taken a particular interest in the high-earning potential of the sector. While this trend is not unique to the arms industry – indeed, the arms industry is coming rather late to the private equity party – it has important implications for scrutiny of a sector that is central to issues of peace and security.
Private equity firms invest capital raised from private investors. They use these funds to acquire stakes – often controlling ones – in existing companies, with the aim of increasing the acquired company’s value by restructuring and streamlining its operations before selling it for a profit. Unlike public companies, private equity firms in the US are not registered with the governmental financial watchdog, the Securities and Exchange Commission, and are not required to publish annual reports on or submit financial statements for any of the companies in their portfolios. Such firms enjoy similar exemptions in many other regulatory systems. This paper explores the increasing trend for private equity deals in the arms industry in the US – the country with the largest number of companies in the SIPRI Top 100 – before analyzing the implications for transparency and expanding its geographical focus to Europe.
Private equity and the arms industry
The involvement of private equity in the US arms industry rapidly expanded in the early 2000s when the US-led invasions of Afghanistan and Iraq raised the prospect of sustained high demand. [2] Data extracted from PitchBook’s database of company mergers and acquisitions highlights that around 3700 US-based arms companies were involved in market deals in 2000–21. Of these, roughly 25 percent were funded by private equity.
The number of private equity deals recorded by PitchBook has grown significantly since 2016 (see Figure 1), as more funds entered the market and there have been record amounts of cash to invest ($4.6 trillion in 2022, according to The Economist). [3]
Despite the sector’s more complex regulatory environment, from the private equity perspective, the attractiveness of the arms sector lies in its predictability and ties with governments. Long-term contracts, on-time milestone payments, and cost reimbursement in case of early contract termination are just some of the benefits offered by this market. [4] Increasingly, many governments view private capital as crucial to drive innovation and make efforts to harness its market force. In December 2022, the US Secretary of Defense established the Office of Strategic Capital to “build an enduring technological advantage by partnering with private capital providers … address investment gaps and add a new tool to the Department's investment toolbox.” [5]
The increases in world military expenditure [6] linked to the war in Ukraine [7] and tensions across the Taiwan Strait are likely to drive demand for weapon systems for some time to come, making the arms sector even more appealing to investors, private equity included.
A closer look at two private equity acquisitions
Amentum was ranked 25th in the SIPRI Top 100 for 2021, with estimated arms sales [8] – sales derived from the provision of military goods and services to military customers – of just over $5 billion. The company was created in early 2020 as a spin-off of AECOM’s management services business and acquired by the private equity firms American Securities LLC and Lindsay Goldberg. [9] Later that year, following patterns of sectoral integration that are characteristic of private equity acquisitions, Amentum added aerospace company DynCorp International [10] (ranked 67th in the SIPRI Top 100 for 2020) [11] to its broad portfolio of services including consulting, logistics, IT, and training. In January 2022, Amentum expanded further by acquiring Pacific Architects and Engineers (ranked 93rd in the SIPRI Top 100 for 2021) for $1.9 billion. Amentum CEO John Vollmer claimed in 2022 that the company was now the second-largest provider of services to the US government. [12] The company provides a ‘Year in Review’ document [13], but this has only five pages and does not disclose any financial information. A classic annual report is usually over 100 pages long and includes information on the overall situation of the company, such as profitability and employment levels, as well as forecasts, allowing assessment of its financial health status. The SIPRI estimate for Amentum for 2021 was deemed to be the same ratio of arms sales to total sales as the previous year.
Peraton (ranked 21st in the SIPRI Top 100 for 2021, with arms sales of $5.8 billion) has been owned by private equity firm Veritas Capital since 2017. [14] Peraton did not appear in the SIPRI Top 100 prior to 2021. However, Peraton’s acquisition of Northrop Grumman’s IT and mission-support services business for $3.4 billion in February 2021 [15] and subsequent acquisition of Perspecta (another military-related IT services company) in May 2021 for $7.1 billion earned Peraton its place in the ranking for the first time. [16] Like Amentum, no annual report was available and so the SIPRI estimate had to rely on the assumption that arms sales had grown by the same proportion of total sales had Peraton conducted the acquisitions in 2020.
However, the estimates made for both companies are valid only for a short time and, in the absence of new evidence, the data might soon be considered out of date or become too unreliable for them to be included in the Top 100. Because many arms industry researchers, watchdogs, and advocacy organizations use SIPRI data to identify major players and track conflict trends, this unavailability could seriously compromise the accuracy and comprehensiveness of future research.
Private equity and transparency
Literature on private equity and transparency has mostly focused on issues faced by companies and institutions when disentangling the complex multi-layered structure of private equity firms. The findings range from the disclosure of foreign ownership, control or influence, and conflict of interest prevention [17] to the impact private equity leveraged buyouts have on national security. [18] While intertwined with these aspects, the angle here explored is concerned with highlighting the relevance of making data accessible to the broader public.
In an industry that tends towards secrecy, public financial reports are one of the most important sources of information for those who want to observe arms industry trends and developments. As private equity firms are not required to publish such financial reports and often sell the companies (or parts of the companies) they acquire to other private equity firms, an arms company’s sales could be hidden from public scrutiny indefinitely – or at least until the company is acquired by a publicly listed firm or makes an initial public offering (IPO).
The growth of private equity acquisitions is far from the only challenge to arms industry transparency worldwide, but the fact that it affects the US industry on such a scale makes it significant. US companies have long dominated the global arms industry: the US accounted for 40 of the companies in the SIPRI Top 100 in 2021 and $299 billion of the $592 billion of the total arms sales. Therefore, if data on the sales of major US companies is made unavailable, it becomes harder to identify or predict global industry trends.
There are other ways of ascertaining arms companies’ sales beyond public financial reports, but these are less reliable and sometimes not open source. Initiatives such as SIPRI’s Arms Industry Database rely on open-source information so that everyone, regardless of position or location, has free access to the underlying data and can test the analyses.
Since 2018, the reporting of at least eleven arms companies has been affected by private equity acquisition: AECOM, AllClear, AM General, Cobham, Cubic Corporation, DynCorp, MD Helicopters, Navistar Defense, Pacific Architects and Engineers, Peraton and Ultra Electronics. Some of these companies had previously been ranked in the SIPRI Top 100. In addition to major acquisitions, there are signs of a broader interest of capital in the arms industry and a growing appetite across all its tiers, as venture capital shows interest in backing start-ups involved in dual-use technologies. [19]
In the global security landscape that emerged since Russia’s fully-fledged invasion of Ukraine, the combination of a rapid spike in demand, the onrush of money, and the additional cloak of secrecy provided by private equity could result in a worsened state of transparency, harming democratic oversight, research, and informed policymaking.
Looking ahead
Given the exceptional features of its arms sector and market, the US seems set to retain the primacy when it comes to the relevance of private equity deals in the arms industry, at least for the near future. However, there are also signs of private equity activity in other markets, notably in European markets. Figure 2 allows for the comparison of the volume of private equity acquisitions between arms companies headquartered in the US and the whole of Europe (Central, Eastern, and Western). [20]
While deals in both datasets seem to follow the same trend, on average, the ones concluded in Europe represent roughly 44 percent of the ones concluded in the US, both in number and value of capital invested. One key difference between the US and Europe is the size of the sector, with the 33 European arms companies [21] in the 2021 SIPRI Top 100 accounting for 24 percent ($141 billion) of the total arms sales, whereas US ones accounted for 51 percent ($299 billion).
Furthermore, despite its recent increases in military spending, European states (including Russia and Ukraine) still spend a fraction of what the USA does. In 2022, all of Europe spent $480 billion against the $877 billion spent by the USA. [22]
An assessment by the consultancy firm KPMG indicated that the ‘fragmented’ arms market in Europe could deter private equity investors. The absence of a common market complicates deals and prevents the scalability sought by private equity firms. [23]
Many European arms companies have close links with states, often being entirely or partly state-owned. This entails that governments have closer oversight of foreign investments in the sector, retaining the ability to hinder takeovers. The same KPMG report encourages investors to consider the scaling opportunities offered by entities located in countries that are part of the Five Eyes agreement (Australia, Canada, New Zealand, the UK, and the US) to leverage their common standards and procurement procedures.
US private equity firms have thus acquired several UK-based arms companies, including Cobham [24] and Ultra Electronics. [25] Like the US, the UK arms industrial base is entirely privatized; additionally, the UK participates in multiple US-led alliances (such as NATO or the above-mentioned Five Eyes). The closeness of the two countries is also reflected in the ties of their arms industry and – in 2022 – the UK flagship arms producer, BAE Systems, realized the majority of its sales in the US, where its most of its non-current assets are based and its workforce is second only to the one in the UK. [26] These factors made the UK arms industrial base a focal point for US private equity acquisitions in Europe. In the dataset, 42 percent of the deals concluded in Europe were targeted at arms companies based in the UK, followed by France with 28 percent.
Private equity acquisitions in both countries have sparked debates. In the UK, Advent, the private equity firm that purchased Cobham, immediately began breaking up its new purchase and selling its units for profit. In less than two years, more than half of the original company had been sold, leaving no manufacturing sites in the country. [27] Apart from workforce considerations, private equity deals involve weighing national security concerns and risk-mitigation measures. The fact that Ultra Electronics developed military communications equipment, including for the Royal Navy and the F-35 combat aircraft, was the reason behind the provisions the UK Business Secretary added before clearing the deal. [28] For a similar reason, in 2020, France halted the sale of private equity-owned Photonis – specializing in night vision technologies – to US-based Teledyne. The company was later sold for a lower price to HLD Europe. [29]
The trend of private equity acquisitions seems to be building steam in both the US and European datasets. Across the two-decade time frame, 21 percent of defense-related private equity acquisitions occurred in 2020 and 2021. While rising interest rates might make leveraged buyouts across all sectors less appealing, the Covid-19 pandemic and related supply chain disruptions had a lesser impact on arms companies [30], making them more attractive acquisitions for private equity firms.
Conclusion
This paper highlights the increasing trend of private equity deals in the arms industry, particularly in the USA. The involvement of private equity firms in the arms industry raises concerns about transparency due to the lack of public financial reporting obligations imposed on these firms. The paper emphasizes the importance of transparency in an industry central to peace and security issues.
The lack of financial information from private equity-owned arms companies makes it difficult to scrutinize their sales. While alternative methods of ascertaining arms companies' sales exist, they are often less reliable and not openly accessible. Public financial reports remain one of the most crucial sources of information for industry observation, making transparency essential.
The lack of transparency can hinder the identification and prediction of industry trends, especially considering that the USA has been a dominant force in the global arms industry. Without access to data on the sales of major US companies, it is challenging to gain a comprehensive understanding of the industry.
The current regulatory framework for private equity and the growth of private equity in the arms industry make it harder to get a clear picture of how the industry is evolving, in the US and beyond: a blind spot that restricts oversight and accountability of this critical sector and hampers informed policymaking.
Although private equity acquisitions in the arms industry are predominantly concentrated in the US market, the paper discusses the European market as well. It notes that private equity activity in Europe is comparatively lower, partly due to the fragmented nature of the European arms market and the prevalence of state-owned or state-linked arms companies. However, private equity firms have also acquired European arms companies, with the UK being a significant focal point for such acquisitions, given its degree of privatization.
In summary, the paper emphasizes the urgent need for transparency in the arms industry in the context of private equity acquisitions. It underscores the importance of accessible financial data to ensure accountability and enable comprehensive analysis of industry trends. By shedding light on the implications of private equity involvement, the paper contributes to a better understanding of the challenges and considerations surrounding transparency in the arms industry.
Citations
[1] Béraud-Sudreau, L. et al., 'The SIPRI Top 100 Arms-Producing and Military Services Companies, 2021,' 5 Dec. 2022 https://www.sipri.org/publications/sipri-top-100-arms-producing-and-military-services-companies-2021.
[2] Mahoney, C. W., Tkach, B. K. and Rethmeyer, C. J., ‘Defense Contractors, Private Equity Firms, and US National Security,’ Journal of Global Security Studies, vol. 7, no. 4 (23 July 2022).
[3] ‘Private equity may be heading for a fall’, The Economist (7 July 2022), https://www.economist.com/business/2022/07/07/private-equity-may-be-heading-for-a-fall.
[4] Lehman, J. F. and Brooks, S. L., ‘Rapid Escalation: An Overview of Private Equity Investing in the Aerospace and Defense Industry,’ The Journal of Private Equity, vol. 3, no. 2, Euromoney Institutional Investor PLC (2000).
[5] US Department of Defense, ‘Secretary of Defense Establishes Office of Strategic Capital,’ Press Release, 1 Dec. 2022, https://www.defense.gov/News/Releases/Release/Article/3233377/secretary-of-defense-establishes-office-of-strategic-capital/https%3A%2F%2Fwww.defense.gov%2FNews%2FReleases%2FRelease%2FArticle%2F3233377%2Fsecretary-of-defense-establishes-office-of-strategic-capital%2F.
[6] Tian, N. et al., 'Trends in World Military Expenditure, 2022', 24 Apr. 2023 https://www.sipri.org/publications/2023/sipri-fact-sheets/trends-world-military-expenditure-2022.
[7] Lipton, E., Crowley, M. and Ismay, J., ‘Military Spending Surges, Creating New Boom for Arms Makers,’ The New York Times, 18 Dec. 2022, https://www.nytimes.com/2022/12/18/us/politics/defense-contractors-ukraine-russia.html.
[8] Stockholm International Peace Research Institute, Sources and methods, https://sipri.org/databases/armsindustry/sources-and-methods.
[9] Lindsay Goldberg and American Securities LLC, ‘American Securities and Lindsay Goldberg to Acquire AECOM’s Management Services Business,’ Press Release, 14 Oct. 2019, https://www.businesswire.com/news/home/20191014005189/en/American-Securities-and-Lindsay-Goldberg-to-Acquire-AECOM%E2%80%99s-Management-Services-Business.
[10] Amentum, ‘Amentum Closes DynCorp International Acquisition,’ Press Release, 16 Nov. 2020, https://www.amentum.com/2020/11/16/amentum-closes-dyncorp-acquisition/.
[11] Marksteiner, A. et al., 'The SIPRI Top 100 Arms-Producing and Military Services Companies, 2020,' Dec. 2021 https://www.sipri.org/publications/2021/sipri-fact-sheets/sipri-top-100-arms-producing-and-military-services-companies-2020.
[12] Thropp, C., ‘Executive Spotlight With Amentum CEO John Vollmer Discusses Recent Acquisitions, Contract Awards,’ GovCon Wire, 16 Feb. 2022, https://www.govconwire.com/2022/02/executive-spotlight-with-amentum-ceo-john-vollmer/.
[13] Volmer, J., 2021 Amentum Year In Review, Amentum, https://www.amentum.com/blog/2021-amentum-year-in-review/.
[14] Peraton, ‘Peraton is the New Name of Former Harris Corporation Government Services Business,’ Press Release, 28 July 2017, https://www.businesswire.com/news/home/20170728005330/en/Peraton-is-the-New-Name-of-Former-Harris-Corporation-Government-Services-Business.
[15] Insinna, V., ‘Northrop sells IT business to Veritas Capital for $3.4B,’ Defense News, 8 Dec. 2020, https://www.defensenews.com/industry/2020/12/08/northrop-sells-it-business-to-veritas-capital-for-34b/.
[16] Veritas Capital, ‘Veritas Capital Completes Acquisition of Perspecta,’ Press Release, 6 May 2021, https://www.businesswire.com/news/home/20210506006172/en/Veritas-Capital-Completes-Acquisition-of-Perspecta.
[17] Howe, J. S. and Jack, S. W., ‘Defense and Government Contractor M&A—Special Concerns for Private Equity Buyers,’ The Journal of Private Equity, vol. 18, no. 4, Euromoney Institutional Investor PLC (2015).
[18] Mahoney, C. W., Tkach, B. K. and Rethmeyer, C. J., ‘Defense Contractors, Private Equity Firms, and US National Security,’ Journal of Global Security Studies, vol. 7, no. 4 (23 July 2022).
[19] Temkin, M., ‘VCs go outside their comfort zone with bets on defense tech,’ PitchBook, 26 Oct. 2022, https://pitchbook.com/news/articles/defense-space-vc-ukraine-recession.
[20] Stockholm International Peace Research Institute, Regional coverage, https://www.sipri.org/databases/regional-coverage.
[21] Includes Russian companies
[22] Tian, N. et al., 'Trends in World Military Expenditure, 2022,' 24 Apr. 2023.
[23] Rowan, L., Kumaria, R. and Campbell, B., 'The Private Equity Opportunity in Aerospace & Defense,' 2021 https://kpmg.com/xx/en/home/insights/2021/07/the-private-equity-opportunity-in-aerospace-and-defense.html.
[24] Advent International, ‘Advent completes £4 billion takeover of Cobham,’ Press Release, 22 Jan. 2020, https://www.adventinternational.com/advent-completes-4-billion-takeover-of-cobham/.
[25] Jolly, J., ‘Takeover of UK defence supplier Ultra Electronics set to be approved,’ The Guardian, 23 June 2022, https://www.theguardian.com/business/2022/jun/23/takeover-of-uk-defence-supplier-ultra-electronics-set-to-be-approved.
[26] BAE Systems, 'Annual Report 2022,' 29 Mar. 2023 https://investors.baesystems.com/~/media/Files/B/Bae-Systems-Investor-Relations-V3/PDFs/results-and-reports/results/2022/bae-ar-complete-2022.pdf.
[27] Wiggins, K. and Pfeifer, S., ‘Rapid break-up of Cobham fuels debate over private equity in UK,’ Financial Times, 5 July 2021, https://www.ft.com/content/7fba06a8-0ce5-4fa7-88a6-7dbf36cb99c0.
[28] UK Department for Business, Energy & Industrial Strategy, Ministry of Defence of the United Kingdom and Kwarteng, K., ‘Update on the proposed acquisition of Ultra Electronics Holdings plc by Cobham Ultra Acquisitions Limited,’ Press Release, 6 July 2022, https://www.gov.uk/government/news/update-on-the-proposed-acquisition-of-ultra-electronics-holdings-plc-by-cobham-ultra-acquisitions-limited.
[29] Guillermard, V., ‘La pépite tricolore Photonis reste française,’ Le Figaro, 15 Feb. 2021, https://www.lefigaro.fr/societes/la-pepite-tricolore-photonis-reste-francaise-20210215.
[30] Stockholm International Peace Research Institute, ‘Arms sales of SIPRI Top 100 arms companies grow despite supply chain challenges,’ Press Release, 5 Dec. 2022, https://www.sipri.org/media/press-release/2022/arms-sales-sipri-top-100-arms-companies-grow-despite-supply-chain-challenges.
References
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