Deals in Defence

The global defence sector is on the brink of significant transformation. Increased tensions with Russia have led the UK government to set out a commitment to increase defence spending to 2.5% of GDP by 2027 and to 3% by 2030. Meanwhile, the EU has announced its “ReArm Europe” defence plan, worth €800 billion. These substantial rises in both threats and military budgets will affect joint ventures, partnerships, and acquisition trends globally.

The Demand Surge and Its Drivers

Rising defence expenditures across Europe—fuelled by renewed security concerns and commitments under NATO—are setting the stage for a competitive M&A landscape. Governments are boosting budgets to modernise ageing fleets, acquire cutting-edge technologies, and secure reliable supply chains. This investment frenzy draws interest from prime contractors and smaller, venture-backed disruptors, each vying to capture a share of newly available funds.

Global M&A Overall

In 2024, the overall global M&A deal value increased by 5% year-over-year, but deal volume declined by 17%, indicating a shift from volume-based acquisitions to high-value, transformational deals. The sectors that witnessed the most valuable M&A activity were Technology (specifically AI), Financial Services, and aerospace and defence. This year, private equity firms are expected to invest more heavily in these areas again, particularly as they now hold record levels of cash reserves and liquid assets.

When it came to private equity, we also saw shifts away from their usual LBO investment model as rising interest rates affected their cost of borrowing. Instead, in 2024, these firms opted to increase their minority stake deals and strategic partnerships.

Defence-Focussed Deals

We then expect this trend of fewer but higher-value deals to continue in the defence sector in 2025, primarily due to rising defence budgets that have already driven up the stock prices of companies in the industry. Rather than amassing diverse portfolios, larger defence companies may focus on transformative acquisitions that strengthen core competencies, especially in AI, drone technology, and cyber defence. Given the focus and investment being given to even the smaller defence companies to operate and thrive, we also expect fewer to be acquired outright. Instead, more strategic partnerships are likely to emerge as spurred demand from governments will require an expedited supply chain.

A core feature of command & control (C2) in the modern era is its dependence on data fusion and the real-time integration of multi-domain sensor inputs into coherent, actionable intelligence. This has elevated the value of companies offering advanced data integration, AI-enabled situational awareness, and cross-platform interoperability. As such, these capabilities are becoming M&A priorities in their own right, especially for firms seeking to be relevant in future joint and multi-domain operations.

With AI-driven-Tech and Defence as two of the strongest sectors for deals last year, we could expect their intersection to be of particular interest in the deals market, along with a few prominent others mentioned here:

• AI and Autonomy: AI facilitates the automation of C2 and mission-critical tasks, encompassing applications such as surveillance and autonomous navigation. Startups specialising in AI often offer agility, which means that they have the potential to accelerate the development of advanced algorithms and offer access to highly specialised teams.
• Unmanned Systems: Drones are becoming ever more indispensable across various applications, including strike, reconnaissance and logistics. Therefore, in a sector whose growth last year was limited by supply chain and talent shortages, organisations that provide secure and scalable solutions are considered highly attractive, particularly considering the evolving operational requirements illustrated by the conflict in Ukraine. We have already seen some early in this area, with Redwire acquiring drone maker Edge Autonomy for $925 million in Jan.
• Space and Hypersonics: There is an intensified initiative to advance missile technology, launch systems, and low-Earth orbit capabilities. This was shown in January when Castelion, a prominent developer of hypersonic missile systems, announced the completion of a $100 million fundraising round. Additionally, there is a burgeoning interest in expanding the defence landscape into space, integrating commercial applications such as satellite communications and earth observation while also addressing critical security requirements.

Geopolitical Underpinnings

Beyond Europe’s tensions with Russia, other geopolitical factors influence M&A in 2025. Australia’s focus on Indo-Pacific security, increased budgets in South Korea & Japan, and ongoing US-China competition underscore a global race for advanced defence systems. National security concerns lead many governments to scrutinise foreign investments in domestic defence firms.

There can be cross-border complexities with acquisitions, as stricter foreign direct investment rules and “golden share” rights can hinder or block acquisitions in sensitive areas, such as the semiconductor, satellite, and radar systems sectors. There are regular concerns with cross-border deals and their heightened threat to national security, especially in deals involving foreign investment. There are multiple risks to navigate here, including information leaks, espionage, and IP theft, which can occur when sensitive data and technology are provided to parties that aren’t entirely subject to domestic security protocols. Beyond this, international collaboration can result in the defence assets in one nation's arsenal being under the technical ownership of foreign powers, as seen in Ukraine, which can impact control over their use. Ukraine has needed to seek US approval to use long-range weapons against Russia, as American components power the weapon systems. For example, Project Brakestop in the UK has been limited to British-only engineering and defence firms to avoid this and remain exempt from external government usage restrictions and trade.

There are alternatives to this approach where companies often align with partners from politically friendly nations, thereby forging integrated supply chains that remain politically acceptable. For example, as part of the AUKUS defence pact, Australia agreed to acquire three US-built submarines and then build a new generation of their boats in collaboration with BAE Systems, based on British designs. However, this example also highlights why an increased threat of war may hinder cross-border deals. The US is now struggling to build enough submarines for its navy within expedited timelines, and there is a growing worry that its focus will always prioritise national interests above delivering to allies. This means that even in cases of allied partnership deals, risks to the supply chain may shape the scale and scope of inbound deals by shifting favour further towards domestic deals. Otherwise, the rising protectionism also results in any cross-border deals facing enhanced regulatory requirements and scrutiny.

Favouring Strategic Partnerships & Joint Ventures

As regulations and scrutiny intensify, joint ventures and strategic partnerships increasingly influence the future of defence by facilitating more agile and collaborative approaches to capability development. Compared to traditional acquisition methods, these alliances generally encounter fewer regulatory obstacles and distribute financial and operational risks among partner organisations. The accompanying material underscores that many emerging economies have historically relied on offsets when procuring equipment from established defence manufacturers. However, these offsets have not consistently fulfilled their promise of building local capacity. In contrast, well-structured joint ventures can effectively transfer technology and expertise, with 50:50 arrangements promoting equitable ownership distribution and encouraging authentic industrial development. In addition to the significant benefits of cost-sharing and cultivating local talent, there is a heightened focus on minimising complex foreign investment regulations and addressing evolving geopolitical priorities through collaboration with trustworthy nations.

Numerous examples illustrate this burgeoning trend. Recently, Leonardo and Rheinmetall formalised a 50:50 joint venture to produce next-generation land systems, with 60% of related activities to be conducted in Italy. This initiative strengthens domestic expertise and lays the groundwork for international export opportunities. Similarly, the partnership between Larsen & Toubro and MBDA in India exemplifies the evolution of such joint ventures, initially concentrating on localising core components and expanding into export markets as indigenous production capabilities mature. Likewise, Turkey's FNSS Savunma Sistemleri, established through collaboration between Nurol Holding and BAE Systems, continues to advance the development of sophisticated combat vehicles for domestic and international customers. These instances demonstrate that joint ventures transcend merely fulfilling local offset requirements; they establish sustainable channels for technology transfer, nurture skilled workforces, and strategically position partner companies to compete effectively in the global defence marketplace.

Private Capital’s Evolving Playbook

PE investors are increasingly eyeing the defence sector, spurred by rising geopolitical tensions and technological advances that promise more tech-like growth trajectories. Crucially, these shifts are occurring at a time when the PE industry as a whole has amassed an unprecedented amount of capital, with $2.49 trillion in global dry powder to be deployed. Yet while the sheer volume of available capital indicates substantial opportunities, dealmakers have grown more cautious about leveraged buyouts. Higher interest rates, stricter regulations, and a challenging valuation environment are prompting many firms to take alternative routes, including minority stakes in specialist defence technology businesses and growth-equity investments aimed at scaling production or R&D.

While the investment means may shift, the interest in PE grows as defence can be seen to offer predictable cash flows in uncertain times. This stems from recognising that certain defence subsectors, such as communications, components, and aftermarket services, offer the recurring, contracted revenue that private equity funds traditionally prize. The multi-year procurement cycles of defence contracts can also align neatly with a typical five- to seven-year private equity hold period.

At the same time, a wave of new entrants, including venture-backed start-ups, is reshaping the competitive landscape. Driven by the digitalisation of defence and an urgent push for innovation, young companies specialising in areas such as AI-enabled surveillance, cybersecurity, or drone systems have caught the attention of both PE and VC investors. Venture funding for defence alone has risen nearly eighteenfold over the past decade, from $0.5 billion worldwide in 2014 to $8.7 billion, accelerating the emergence of nimble, disruptive enterprises. For many funds, taking a minority stake in these firms or injecting growth equity to help them scale offers a strategic way to tap into fresh technology while mitigating some of the ESG complexities and capital intensity historically associated with arms manufacturers.

The broader fiscal backdrop, combined with the new government initiatives to foster defence technology start-ups, has broadened the investor base well beyond the specialised PE shops that once dominated the sector. Generalist funds, family offices, and institutional investors are all moving in, lured by consistent demand from national governments, rising defence budgets, and the appeal of dual-use technologies that can span both military and commercial markets.

In this evolving environment, private capital concentrates on investments that fuse innovation with reliability. This involves targeting mid-market or smaller businesses with substantial intellectual property in areas such as artificial intelligence, space systems, autonomous vehicles, or cybersecurity. Often, these targets boast recurring revenues from long-term government contracts, yet are agile enough to adapt to rapidly changing defence needs. The resulting deal structures can range from bolt-on acquisitions for existing platforms to more cautious minority stakes that allow investors to observe how a given technology or solution performs in a highly regulated space.

Challenges and Outlook

The recent influx of capital into the market has significantly elevated the share prices of defence firms. Following Sir Keir Starmer's announcement in early March regarding an increase in the UK's defence spending (an initiative echoed by similar commitments from the EU) BAE Systems in Britain experienced an immediate 15% increase in share price, Thales in France rose by 16%, Rheinmetall in Germany gained 14%, and Italy's Leonardo saw a 16% uptick. However, for those engaged in deal-making, these inflated valuations may obscure the true state of the market and pose challenges in achieving immediate returns on investment.

Additionally, regulatory challenges, particularly in the European Union and the United States, can extend deal-making timelines. Geopolitical tensions further contribute to uncertainty, as policy shifts may rapidly change defence spending priorities. Nonetheless, the overarching trend of governments pursuing next-generation capabilities remains, and the private sector recognises lucrative opportunities to meet this demand.

Conclusion

The increasing military expenditures in Europe, along with ongoing global tensions, suggest that the defence sector will experience significant activity in 2025. Strategic investments are anticipated to focus on transactions that enhance resilience, integrate advanced technologies, and leverage cross-border synergies while fostering innovation.

The variety of targets in the defence sector appears to be expanding alongside the growing pool of unallocated PE capital. However, high barriers to entry, debates around ESG factors, and national security regulations still pose challenges, especially for newer investors. Despite these hurdles, private capital remains undeterred. These challenges have shifted the focus toward specialised, technology-driven niches that promise strong returns while aligning with the changing priorities of governments worldwide.

As defence becomes increasingly digital, it is also becoming more recognisable and attractive for PE firms familiar with technology-oriented strategies. With $2.49 trillion in dry powder available, it seems highly probable that the partnership between private equity and the modern defence industry will grow in the coming years. This relationship will reshape the sector through carefully targeted investments and partnerships rather than traditional, debt-heavy buyouts.