2022 saw a sharp decline in the overall value of mergers and acquisitions (M&A) in the aerospace, defense and government (ADG) market and a modest drop in the number of deals with most of the attention on small and medium sized transactions, says a new report by the government market intelligence firm HigherGov.

However, singling out the defense sector, deal numbers rose nearly 12 percent to 203 in 2022 from 182 in 2021 “with activity focused on companies with unique IP or customer access and a continued focus on innovative defense electronics, electronic warfare, data gathering, artificial intelligence, modeling and simulations, and other technologies that provide the U.S. and European allies with strategic advantage,” HigherGov says.

Defense deals in 2022 were more tailored to contending with needs to meet challenges in Europe and Southeast Asia and there has been a shift away from the war on terror, the report says.

Transactions in the space sector slipped 16 percent to 38 in 2022 versus 45 in 2021, with activity down for commercial suppliers “as excitement from the first privately-developed spaceflights with private citizens waned,” HigherGov says.

Government cybersecurity, another sector highlighted within the ADG market, saw a 27 percent decline in volume to 33 deals in 2022 versus 45 the prior year. The report says transactions for “pure-play cyber” companies have fallen, but there is still interest in cyber capabilities as part of larger government information technology (IT) acquisitions.

Deal volume in the government IT space saw the biggest drop, 104 transactions in 2022 against 185 in 2021, a 44 percent decline. HigherGov says the drop is “unsurprising” given record deal volume in 2021 and “significant consolidation” within the sector over the past few years. On top of that, it’s possible that more companies are eyeing defense products and services, it says.

The overall transaction value of ADG deals was down 57 percent to $46 billion in 2022 from $108 billion in 2021, says the Jan. 11 report. The $46 billion was the lowest value since 2013 when $18 billion in deal volume was transacted, according to HigherGov, which looked at data going back a decade.

Private equity deals made up 41 percent of the transaction value in 2022 versus 27 percent in 2021.

The number of ADG transactions declined 10 percent to 433 from 479 in 2021, which was a record year. Still, the 433 deals in 2022 were the second largest ever in the sector, HigherGov says.

Reasons behind the volume decline include “normalization” in 2022 versus record activity in 2021 that was driven in part by pent up demand stemming from a slowdown in 2020 due to COVID-19, lower interest rates, and private equity firms working to meet their capital deployment goals, the report says.

Higher interest rates in 2022 helped drive down deal activity, which has been further complicated by federal anti-trust concerns, the report says, highlighting the failed Lockheed Martin [LMT] attempt to acquire Aerojet Rocketdyne [AJRD], which was blocked by the government, and Booz Allen Hamilton’s [BAH] acquisition of EverWatch, which the government tried to thwart but failed.

In 2022, 90 private equity firms accounted for 203 of the transactions, or 47 percent of the total. In 2021, there were 182 private equity-related deals.

The report says most of the private equity deals in 2022 were “add-ons” to existing platforms as part of a “buy-and-build strategies.” It also says there were 25 private equity-to-private equity transactions, up from 11 in 2020.

Private equity firms are showing interest in companies in the cybersecurity and space arenas, says the report. It also says that these firms see that government contractors have remained stable prospects “through several economic cycles.”

In 2023, HigherGov expects deal activity in the ADG market to stay “robust” given increased global defense spending. In Europe, Russia’s war against Ukraine may lead to more defense consolidation, it adds.

Large deals in the U.S. are less likely given government concerns around competitiveness but smaller transactions largely remain in play, especially for “those with differentiated intellectual property or capabilities,” the report says.

Deal activity in the space and cyber sectors will remain strong, although they “may have reached their short-term peak,” it says.