March 6, 2024

After years of budget restrictions and staff cuts, the European defense sector is now on the upswing.

Since the Ukraine crisis in 2014, the major European powers — France, Germany, the UK, Italy and Spain — have increased their defence spending. The invasion of Ukraine in 2022 has prompted NATO members, particularly Germany and Poland, to increase their equipment budgets. Nevertheless, challenges such as government budget constraints, inflation, recruitment barriers and supply chain adjustments remain. Despite robust order books, securing defense financing remains a major problem. The greatest difficulties faced by mid-tier businesses include regulatory restrictions, banking sector’s aversion to reputational risk, compliance risk but also lack of qualified interlocutors and sector-specific banking policies. In order to maintain the positive momentum in the European defense industry, the problem of the defense financing must be addressed.

The greatest difficulties faced by mid-tier businesses

Major defense contractors, whose activities are generally dual-purpose, are largely unaffected by bank financing difficulties. The situation is quite different for the SMEs and mid-tier companies belonging to the European Defense Technological and Industrial Base (EDTIB). The origins of these difficulties are many and varied: normative inflation within the European Union, credit risk, regulatory constraints, influence peddling and pressure from governments and NGOs, but most of all, reputational risk. This network of small and mid-tier companies plays a crucial role in the value chain, and financing difficulties are hampering their growth and that of the industry. It should be noted that the defense financing difficulties are shared across Europe: all the representative bodies of the defense industries report the same difficulties, from the GICAT, the Group of French Industries for Land and Air-land Defense and Security to the BDSV, the Association of German Security and Defense Industries.

Private Equity funds as one of the solutions for the defense financing problem

Can Private Equity funds provide a solution for defense financing problem? Although they are not very active in this field in Europe, they are by no means the only option, but they could be part of the solution. In fact, the sector’s specific characteristics – namely, an illiquid market with few potential buyers, the heavy involvement of the State, and unusual cooperation arrangements between defense contractors (consortia, shared industrial programmes, etc.) hamper the involvement of Private Equity funds.

Nevertheless, the sector has a number of key selling points: visibility and regular cash flow, an attractive technological dimension, and high entry barriers. While the M&A market has been slowing down over the past few quarters, the SME and mid-tier sector remains buoyant, driven mainly by two underlying factors: i) safeguarding supplies, and ii) acquiring technological building blocks. These transactions are mainly aimed at preserving margins, developing new skills in niche markets, and bolstering the supply chain. The combination of these external growth strategies enables the emergence of more resilient players with more diversified revenues. Because over and above the defense financing aspects, Private Equity funds bring their expertise in structuring and streamlining operational and economic performance to the EDTIB.

How Eight International can provide support

With the industry expertise developed by its teams in project strategy, operations, finance, and transaction services, Eight Advisory is well equipped to support your projects in the aerospace, naval and defence sectors throughout Europe – from Acquisition and Fiscal Due Diligence, through Strategic Transformation and Valuation to Purchase Price Allocation. We can swiftly deploy seasoned and experienced professionals to help you navigate these complex environments.

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Enjoy the read: Financing the defense industry