Companies turn to acquisition for growth

Aerospace and defense firms expand IT efforts; midsize services providers get larger

The government information technology services market has become a hotbed of merger and acquisition (M&A) activity because of a confluence of trends in recent months.

chart They include aggressive moves among aerospace and defense firms seeking growth in their IT businesses and midsize services firms looking for scale. Nontraditional players are also contributing to the current boom, including foreign firms and special purpose acquisition corporations (SPACs). The bevy of buyers has pumped a sizeable amount of money into the government services space, boosting transaction prices. The pace of M&A activity shows no signs of abating, industry executives said.

“The M&A market is robust, and it’s going to stay robust,” said Barry Landew, executive vice president of corporate development at SRA International. “There is a flood of capital in our industry.”

In a March report, Input states that it recorded 118 M&A transactions in the government IT and defense markets during 2005. Ashlea Higgs, manager of new markets at Input, said 2006, thus far, is keeping pace with 2005.

Aerospace and defense companies rank among the most fervent suitors in the government IT services market. L-3 Communications’ acquisition of Titan last year and General Dynamics’ pending purchase of Anteon are prime examples. In the latter case, General Dynamics in December agreed to purchase Anteon for $2.2 billion.

“I think what we are seeing right now is a lot of M&A activity in our area, particularly among aerospace companies that have decided they need to skate to the puck with respect to IT services companies,” said Renny DiPentima, president and chief executive officer at SRA.

Defense Department spending has shifted from big-ticket weapons platforms to IT. That means many companies feel an urgent need to change their strategies, which often requires them to acquire companies that can broaden their range of offerings, DiPentima said.

“Clearly, they are trying to increase their presence in the services sector,” said Brad Antle, president and CEO at SI International.

Midsize players seeking mass also have contributed to the M&A boom. Alion Science and Technology, a $200 million-plus technology solutions provider, has acquired two IT services-related companies this year: Washington Consulting and BMH Associates. The former provides enterprise IT consulting services while the latter specializes in software and systems engineering for military simulations.

In a similar move, Stanley Associates, a $282 million company, acquired Morgan Research, which has an annual revenue of about $70 million, in February.

Input, noting the smaller size of some recent acquirers, found that six of the 20 firms they tracked that conducted multiple acquisitions in 2005 had revenue of less than $300 million.

Foreign companies have recently acquired U.S. firms to enter the federal market. Examples include QinetiQ’s 2005 purchase of Apogen Technologies and Nortel’s purchase of PEC Solutions. QinetiQ is based in Britain, while Nortel hails from Canada.

Private equity investment firms, once a rarity in the government market, are also in the hunt. “We see interest from private equity players,” said David Heinemann, senior vice president of corporate development at Input. He said such companies exhibited little or no interest just five years ago.

SPACs are a different kind of buyer altogether. They are shell companies, doing nothing on their own, that gather investment capital with the objective of acquiring companies. Government-oriented SPACs include Fortress America Acquisition, which executed an initial public offering in 2005 and aims to acquire “one or more operating businesses in the homeland security industry,” according to a filing with the Security and Exchange Commission.

The seemingly unlimited appetite for acquisitions has bolstered transaction multiples, a term that refers to the acquisition price compared with the acquired firms’ revenue. Three years ago, a multiple of 1 was the norm, according to Input. In 2005, that had risen to an average of 1.4. With some costs factored in, multiples are averaging seven to nine times the acquired company’s earnings before interest, taxes, depreciation and amortization, Antle said. Companies in a niche attractive to buyers may command a premium above that range, he added.

Industry executives said they don’t believe the supply of quality candidates is drying up, despite the spate of acquisitions. “I don’t see it becoming a situation where there aren’t very many properties on the market,” said Jack London, chairman, CEO and president at CACI International. “We have not had any lack of opportunities.”

Acquisition targetsExperts consider the following types of companies to be prime targets for acquisitions:

  • Companies with business in the intelligence and homeland security sectors.

  • Companies with technical expertise in military communications, simulation and visualization.

  • Companies with major operations in areas benefiting from the base realignment and closure process.
  • Sources: CACI International, Input and SRA International

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