A total of 92 M&A transactions were announced in the defense technology and government services market in 2016, which was slightly below the 107 transactions completed in 2015, but in-line with 2013 and 2014 levels. M&A in 2016 witnessed a “normalization effect” after the flurry of activity that occurred in 2015. Contractors have started to notice the effects the 2013 and 2015 Bipartisan Budget Acts’ sequester relief has had on the overall procurement environment. This relief has allowed the Department of Defense to significantly reduce the amount of anticipated cuts in technology operations and maintenance, translating into strong performance across the defense technology and government services market. As a result, there was active participation across the entire buyer landscape in 2016, driven primarily by (i) private equity sponsors acquiring scalable platform targets and/or “doubling down” with add-on acquisitions that provide complementary capabilities to their existing platform companies, (ii) larger Tier-1 and Mid-Tier’s divesting noncore, low margin assets and focusing more on higher margin business segments aligned with the mission, and (iii) Non-Traditional buyers focusing on targets in high priority end markets in order to strengthen their capabilities, expand market share and add new customers.
The strengthening of the budgetary environment and positive sentiment in the government services public equity markets has enabled private equity firms to remain active in the space. Private equity buyers led 33% of the transactions, including new market participants Chart Capital (acquisition of Fed Data Systems), and Platinum Equity (acquisition of PAE from Lindsay Goldberg). Meanwhile, seasoned investors in the sector, DC Capital and Arlington Capital, both secured new government services platforms earlier in 2016 with the acquisitions of QRC Technologies and EOIR Technologies, respectively. Existing private equity backed platforms drove 21% of the private equity activity, as Arlington Capital continued its buying spree by acquiring ISS and PROTEUS Technologies and merging it with EOIR Technologies to form Polaris Alpha. In addition, Belcan, LLC (acquisition of Intercom Consulting and Federal Systems Corp), Preferred System Solutions (acquisition of Synaptic Solutions, Inc. and Tetra Concepts), Sirius Computer Solutions (acquisition of Force 3, Inc.) and Altamira Technologies Corporation (acquisitions of APG Technologies and Prime Solutions) all strengthened their portfolios with bolt on acquisitions. Lastly, private equity firms continue to utilize the favorable budget environment to exit their existing investments. Examples include the sale of Aquilent (backed by Warwick Capital since 2002) to Booz Allen Hamilton, Camber Corporation (backed by New Mountain Capital since 2008) to Huntington Ingalls Industries, Vistronix (backed by Enlightenment Capital since 2013) to ASRC Federal and PAE (backed by Lindsay Goldberg since 2011) to Platinum Equity.
Mid-Tier and Tier-1 contractors continued to reshape the federal government contracting industry with notable M&A deals in 2016. Leidos’ $5.0 billion acquisition of Lockheed Martin IS&GS earlier in 2016 has catapulted the SAIC mission focused spin-out into the largest mid-tier publicly traded Government Services focused contractor ($10.7 billion in enterprise value as of December 31st, 2016) and allowed them to effectively compete for even larger contracts sought after by Tier-1 defense contractors. In addition, ManTech Corporation acquired the Cyber Network Operations Practice of Oceans Edge in June 2016, to expand upon its vulnerability research, development and analysis capabilities and Edaptive Systems, LLC in December 2016 to strengthen its federal healthcare presence. Booz Allen Hamilton acquired digital and cloud services provider Aquilent for $250 million to strengthen its capabilities and enhance its presence within HHS. Finally, Tier-1 contractors, Boeing and L-3 have made the strategic decision to focus on their autonomous systems and collaborative robotic capabilities with the acquisitions of Liquid Robotics and MacDonald Humfrey, respectively. In addition, L-3 officially changed its name from L-3 Communications to L-3 Technologies in order to capitalize on its strong brand equity, while better reflecting the Company’s evolution into a leading global provider of technology solutions.
As shown in the table, the 2016 buyer mix continued similar trends when compared to 2015, with public strategic buyers representing the largest buyer group (35.0% of all M&A activity). However, this year it was mainly driven by non-traditional buyers making transformative acquisitions to strengthen capabilities in areas of funding priority, gain customer access, and expand their contract portfolios. These buyers in 2016 included KBR (Wyle and Honeywell Technology Solutions, Inc.) Huntington Ingalls Industries (Camber Corporation), Magellan Health, Inc. (Armed Forces Services Corp.) DLH Holdings Corp (Danya International, Inc.) Jacobs Engineering Group, Inc. (The Van Dyke Technology Group) and Ball Aerospace and Technologies (Wavefront Technologies). The non-traditional buyer activity over the past twelve months bodes well for the industry as it signals renewed confidence in the overall growth prospects of the federal market.
In today’s competitive market, contractors need to take on a new approach to differentiate themselves from the mass. The typical government customer sees the majority of contractors as being the same; most have the same objectives and same goals to win the contract, so why not go with the cheapest? Former Veterans Affairs CIO and current chief strategy officer for Agilex, Roger Baker, has coined the 10-8-10 model. According to Baker, “ten percent of contractors are worth fighting to keep because they deliver results and are focused on making the government customer successful. Ten percent you should fight to fire because they just don’t care about results. But with 80 percent of the contractors, it doesn’t matter who gets the work. The 80 percent hire the same people and put the same workers in charge of the majority of the projects.” Overall, this method is focused on profit and loss, not results.
One of the first ways to help differentiate yourself is by focusing on the customer needs. Contractors have to demonstrate that they understand the customer’s problem before trying to implement a solution. Being results-driven means you have to leave revenue “on the table” if the project does not dramatically improve its customer situtation, or if the solution only provides a short-term remedy rather than a long-term solution.
Summarized from Washington Technology, “You can’t afford to be a vanilla contractor in today’s market”
It’s not surprising that differentiation in turn drives value during sale process. Strategic buyers are no longer executing on “bulk up” acquisition strategies, and have become increasingly selective with their target criteria. Contractors that have historically focused on distinguishing themselves with their customers usually possess attributes that buyers covet – IP, technological differentiation, prime contracts, unique insight into funding priorities, etc. The preponderance of these attributes provides a buyer with a greater certainty that the seller will be able to continue to grow revenue and drive profitability in the future. Therefore, a real commitment to the customer not only yields short term benefits for the contractor, but can add long term value by better positioning the company for an eventual exit.