Recent M&A Activity Sees Emergence in Spin-Offs and Divestitures
Federal contractors continue to adapt to the well-documented budget constraints. Competition for government contracts has increased, leading to bidding wars with more aggressive offers and slimmer margins. An increase in competition can typically spark M&A activity as companies vie for contracts and resort to acquisitions to expand their capabilities and win business. Through Q3 of 2014, public companies have been involved in roughly 50% of the deals, sparking a reemergence of mega mergers and consolidation amongst large industry players. While some companies have consolidated through acquisitions, like Cobham’s $1.5 billion purchase of Aeroflex, and AECOM’s $6.0 billion acquisition of URS Corporation, other major contractors have been spinning off, or divesting, divisions to increase focus on specific business segments more aligned with companies’ overall strategic initiatives. B/E Aerospace announced on June 10, 2014, its spin-off into two separate publicly-traded companies, focusing on manufacturing and services. On September 27, 2014, Exelis announced the successful spin-off of its mission systems division, now known as Vectrus (NYSE:VEC), from its C4ISR and IT-focused businesses.
There are certain factors that can motivate companies to focus on restructuring. From an operational perspective, the flexibility to pursue new business opportunities and the ability to implement new cost structures and control capital investments can drive spin-offs. Alternatively, Board of Directors may view a segment of the business as undervalued in the context of the larger company, and seek to unlock additional shareholder value through a spin-off. Lastly, the more stringent enforcement of organizational conflict of interest (“OCI’s”) rules has required larger companies to divest conflicted business units.
On September 27, 2014, Exelis, Inc. (XLS, $18.13, Market Capitalization: $3.4 billion), an aerospace and defense contractor that originally spun off of ITT Corporation in 2011, completed the spin-off of its mission systems division. The Colorado Springs-based spin-off, now known as Vectrus, Inc. (combination of “vector” and “trust”), will employ 5,600 workers at 110 locations in 18 countries, and is estimated to gross more than $1.1 billion in revenue in its first year as an independent publicly traded company.
Exelis is expected to benefit by stripping the underinvested mission systems services business, which is experiencing severe declines in revenue due to budget constraints and the drawdown of troops in the Middle East. The mission systems business has been weighing on the rest of Exelis and concealing the improved growth profile of Exelis’s C4ISR and IT systems business unit. In 2013, Vectrus had $1.5 billion in revenue with 100% generated from the U.S. federal government, 90% of which was from the U.S. Army, and roughly 30% from Afghanistan operations. Revenue is expected to be down 25% in the mission systems business in 2014, with additional downward momentum into 2015.The newly formed Vectrus will operate in three main business lines: Infrastructure Asset Management, IT & Network Communications Services and Logistics and Supply Chain Management Services:
Along with Exelis, there have been other similar divestitures and spin-offs in the last 24 months in efforts to unlock value and drive improved performance for the parent company:
These companies had similar themes prior to a transaction, such as organizational conflicts of interest, high cost structures, lack of scale and synergies and overall strategic constraints impeding growth. Each company has adjusted their strategic roadmap, pushing to become more specialized and nimble organizations. The results are better positioning the companies for new contract opportunities, higher probabilities of winning business and implementing return-focused capital deployment plans for stakeholders.
For further information about recent M&A transactions and market updates, please click HERE to download the complete version of Aronson Capital Partners’ September newsletter.