European investors bet on defence as war creates opportunities for growth

Russia’s invasion of Ukraine has prompted a surge of interest from private investors in European companies in defence and related technologies as they bet that the coming boost in military spending in response to the conflict will offer growth opportunities.

Private equity executives in France, including Sanofi chair Serge Weinberg and former Airbus manager Marwan Lahoud, are among those spearheading a move to consolidate the country’s fragmented aerospace and defence supply chain, which includes many small companies still suffering the effects of the Covid-19 pandemic.

“The bigger defence companies are concerned about having a solid supply chain. This is becoming even more important given the perspectives of additional military spending that is set to come through with the next multiyear military budget,” Weinberg told the Financial Times.

“There is a need for additional production capacity, ability to build up stocks, and therefore there is a need to strengthen the financial structures [of these groups],” he added.

His private equity firm Weinberg Capital Partners has raised more than €100mn for a new fund that will invest in French defence companies, and hopes to double that amount as fundraising continues.

Private capital investment in the aerospace and defence industry stretches back decades, but has long been the purview of the larger private equity funds given the complexity of operating in a highly regulated sector where governments play an outsized role.

The long-term nature of defence contracts can be a deterrent to private investors that typically look to exit after five years, while national security concerns can make selling out of companies more difficult.

Many funds, particularly in Europe, have also been wary of backing weapons manufacturers because of the risk of running foul of environmental, social and governance (ESG) rules, preferring instead to back players developing dual-use technologies for both civil and military applications.

However, as governments have started to invest more in new capabilities such as drones, sensors, cyber and artificial intelligence that have broader applications, private investors have begun to take notice.

The war in Ukraine has also sparked plans for a significant increase in military spending in many countries including France, Germany, Poland and the UK, which private investors are eager to cash in on.

Global deal activity in aerospace and defence companies by private equity and venture capital investors stood at $20bn in 2022 and $34bn in 2021, according to data compiled by PitchBook for the FT. That represents an uplift from before the pandemic when money flowing into the sector averaged $10.4bn annually from 2015 to 2019.

European private equity deal activity in defence-focused companies reached €3.8bn in 2021, according to data from PitchBook, the second-highest over the past decade after €5.3bn in 2019. The two top PE defence deals by value were done by Advent International, which bought UK-listed groups Cobham for £4bn in 2019 and Ultra Electronics for £2.8bn in 2022.

Lahoud, chair of private equity at Tikehau Capital, which has invested roughly €1.1bn in aerospace and defence through four funds since 2004, said the sector “has become more popular” lately.

“Before it was seen as something to be ashamed of, so no one talked about investing in defence, but since the war in Ukraine, the dynamic has changed, and investors are bragging about it,” he said.

After president Emmanuel Macron called for French defence contractors to go on “war economy” footing last year, the government also declared its support for the creation of more investment funds in defence to strengthen the roughly 4,000 small and midsized companies that supply the likes of Airbus, Dassault Aviation and Thales.

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Boosting suppliers’ capacities will be key if France is to realise the goals set out in Macron’s 2024 to 2030 military budget that calls for spending to rise by roughly 40 per cent to €413bn.

France is also trying to coax companies to bring back manufacturing of weapons from abroad, such as with a recent plan to help finance a project at Eurenco group to build a new factory to make powder for artillery shells near Bordeaux.

France took a similarly proactive approach during the Covid-19 pandemic by encouraging private equity funds to come into aerospace. The state invested €200mn in a newly created fund, which was backed by contributions from Airbus, Safran, Thales and Dassault Aviation, and managed by private equity group Tikehau Capital.

Nato has since followed suit, launching a €1bn fund in June to invest in start-ups and VC funds developing dual-use technologies, including artificial intelligence, novel materials, propulsion and space.

Shonnel Malani, managing partner at Advent International in London, said even before the war in Ukraine, private capital had been flowing into the defence sector given the increasing geopolitical risks posed by China and Russia. For Advent, the defence sector is a “priority” and it has a particular interest in “innovative technologies focused in areas of hypersonics, cyber, space and submarine defence”. 

Venture capital funds are also investing more in European defence-related companies and put in €96mn in 2022, a 50 per cent increase from a year earlier and the highest level in a decade, according to PitchBook analysis.

Portuguese drone company Tekever is among those that has attracted greater interest since the start of the war. The company, whose drones have been used for maritime surveillance missions in the English Channel while also being tested by Nato navies, raised €20mn through a funding round led by UK-based investor Ventura Capital in 2022.

“We’ve seen some increase since the war started, particularly because our technology is dual-use and can be applied in a wide number of markets, including defence,” said Tekever chief executive Ricardo Mendes.

Other recent fundraising examples include Germany’s AI start-up Helsing that produces live maps of battlefields.

Despite the tailwinds bringing more private funding into defence, it remains to be seen whether these will prove to be profitable investments.

French investors Lahoud and Weinberg both separately cautioned that private equity funds had to choose their targets well to avoid running into problems when seeking to exit given that governments were under pressure to protect key strategic assets.

“It is not possible to run a worldwide auction for a business, but you can run a French or European one,” said Lahoud, adding that such limitations could hurt valuation multiples.

The UK, which has historically had a more open approach to foreign takeovers, stepped in to secure binding commitments from Advent in relation to its purchases of both Cobham and Ultra. The latter makes submarine-hunting equipment as well as control systems for the fleet of Trident submarines that carry the UK’s nuclear deterrent.

France in 2021 blocked private equity group Ardian from selling Photonis, which makes image intensifier tubes for night vision technology, to a US company and required it to sell to a European buyer instead at a lower price.

To avoid such issues, Weinberg’s fund has hired a former official from a French government department that oversees purchasing for the military. “You have to have a certain proximity with the state to really know where you can invest and how you can exit,” he said.