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Breakingviews - Britain brings the gloom to global defence party
November 13, 2017 / 1:09 PM / 12 days ago

Breakingviews - Britain brings the gloom to global defence party

LONDON (Reuters Breakingviews) - Britain is the killjoy at the global defence party. Shares in Ultra Electronics fell by almost a fifth on Monday as the UK defence contractor warned of tight UK spending. Mid-market groups might face foreign invasions of their own.

Ultra Electronics. Image courtesy of the company

Investors in defence companies tend to profit from geopolitical tensions. The year since U.S. President Donald Trump’s election has been no different: the Thomson Reuters Global Aerospace and Defense Index is up by almost a third since the truculent tycoon won the White House. Giants like Boeing and Lockheed Martin can thank North Korean missile tests, expectations of a more muscular United States and rising defence budgets in the Middle East and Asia, which are increasing spending on planes, arms and other equipment at a compound annual rate of 8 percent and 11 percent, respectively, according to Bernstein analysts.

As Ultra’s disappointing 2017 forecasts show, Britain is the outlier. The 1 billion pound group blamed “mounting pressures in the funding of UK defence” for the Ministry of Defence cancelling or delaying programmes. Revenue will be 770 million pounds this year, the company said after markets closed on Friday, compared with previous consensus forecasts of about 810 million pounds.

British defence spending has shrunk to 1.9 percent of gross domestic product from around 2.5 percent in 2010-11, according to data provider Statista. With Brexit likely to hurt output and potentially blow a hole in the public finances, mid-sized UK groups like Ultra and Cobham are unlikely to get much of a boost. They’re also hit harder than bigger peers, as more revenue comes from discretionary spending rather than long-term contracts. Their shares are down 33 percent and 37 percent, respectively, over the past two years.

The decline may make Ultra attractive to potential larger acquirers, which could cut costs and gain greater control over supply chains. After Monday’s drop, a buyer would have to shell out around 1.5 billion pounds for Ultra, including debt and a 30 percent equity premium. If the new owner could increase 2018 operating profit by about a 10th, the acquisition could deliver a decent 8 percent return, according to a Breakingviews calculation. Only the miserable outlook for UK defence spending might give potential invaders pause for thought.

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