Defense Budget Growth and Its Impact on Industrials M&A

Introduction

The US defense budget reached $850 billion in FY2025, with FY2026 proposals from the Senate Armed Services Committee pushing toward $925 billion. NATO allies have committed to 5% of GDP on defense and security by 2035, a target that would push global NATO spending well above $2.6 trillion. For industrials bankers, the rising defense budget creates M&A opportunities not just for pure-play defense companies (covered in the A&D section) but for the broader universe of industrial companies with "dual-use" exposure: businesses that serve both commercial and defense end markets.

Dual-use companies occupy a strategically valuable position because they combine commercial market growth dynamics (organic demand, cyclical upside, PE operational improvement potential) with defense market revenue characteristics (budget-backed demand visibility, long-term contracts, high barriers to entry). This combination commands a valuation premium that makes dual-use businesses attractive acquisition targets for defense primes seeking to diversify revenue and for PE sponsors seeking to reduce portfolio cyclicality.

Dual-Use Industrial Company

A manufacturer or service provider whose products serve both commercial industrial and military/defense applications. Examples include: precision machining companies whose tight-tolerance components are used in both commercial aerospace and military aircraft, electronic testing equipment makers whose instruments serve both semiconductor manufacturers and defense electronics programs, advanced materials companies whose composites and specialty alloys serve both automotive and military vehicle applications, and environmental testing laboratories that serve both commercial compliance clients and defense base remediation programs. Dual-use companies often do not self-identify as "defense" companies, but 15-40% of their revenue may come from defense supply chain customers.

The rising defense budget increases the value of dual-use industrial companies in three ways. First, the defense revenue component grows as budget-backed procurement and sustainment spending increases, directly lifting the company's top line. Second, defense revenue carries higher valuation multiples than commercial revenue (because it is budget-backed and non-cyclical), so increasing the defense revenue share improves the blended valuation. Third, the ITAR and security clearance requirements associated with defense work create competitive moats that protect the company's market position.

Defense primes acquiring dual-use suppliers. As defense budgets grow, primes need to expand their supply chains to meet production demands (particularly for munitions replenishment and new platform production ramps). Acquiring established dual-use suppliers provides immediate production capacity and qualified capabilities that would take years to develop organically.

PE sponsors building defense-adjacent platforms. Defense-specialist PE firms (Veritas Capital, Arlington Capital Partners, AE Industrial Partners) actively target dual-use industrial companies for platform and bolt-on acquisitions. The thesis: acquire a commercial manufacturer with 20% defense exposure, grow the defense share to 40-50% through targeted business development and bolt-on acquisitions of other defense-exposed businesses, and exit to a defense prime or larger PE sponsor at a premium multiple reflecting the enhanced defense revenue profile.