Defence spending in Europe has gained a lot of attention this year with private equity firms previously highlighting the growing opportunity to deploy capital. While private credit firms were a little more sceptical at first, the strategy is now gaining traction.
For example, Sienna Investment Managers announced in September that it had raised over €270m (£234m) in commitments for a dedicated strategy targeting small- and medium-sized enterprises (SMEs) and mid-caps in a first close. The fund is targeting up to €1bn by the end of 2026.
Philippe Roca, co-director of Sienna Hephaistos fund, said that a large part of the defence ecosystem is made up of SMEs that provide parts to the larger corporations and need to increase their production capacity at short notice.
“They already increased their debt during Covid,” he said. “They are now asked to increase their production capacities. So they need further financing following the rearming of Europe and the increase in the backlogs of military equipment manufacturers.”
Sienna is looking across Europe for opportunities, although Roca says that they are seeing a lot of businesses in France in particular.
The fund is getting ready to approve its first investments in the next few weeks.
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Although Roca said that there are some interesting opportunities in drone manufacturers, he is also interested in the supply chain of the defence industry.
Tikehau Capital’s head of private debt Cecile Mayer-Levi, said that there is definitely increased activity in the space driven by private equity firms.
“It used to be a bit in the grey zone and it wasn’t very clear from the bylaws whether you could invest in defence businesses, but there have been changes at the regulator level to make sure that the bylaws of the funds and enviromental, social and governance rules don’t limit investment in this area,” she explained.
Although Tikehau has been investing in this area for some time, it has not launched a dedicated debt fund like Sienna. Instead, it has decided to keep it as one of its active sectors from its existing pool of assets.
The group has previously lent to aerospace defence subcontractors, such as maintenance operators and economic intelligence providers.
“One of the key concerns of the diligence process is understanding the government-led contracts,” Mayer-Levi said.
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“They are privately-held companies but they are all subcontractors for governments, so you need to understand that when it comes to working capital requirements, they often depend on large orders with long payment timelines. They will have a long order book that seems active but there are systematically some deferred orders and that’s very sensitive in that environment.”
The current geopolitical turmoil has prompted many firms in this sector to ramp up their activity. As a result, Mayer-Levi has seen more companies come under stress because they did not have the full financing in place to increase their revenues and order books.
“It’s important to make sure those long-term contracts are secured and not cancelled,” she added.
