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Aronson Capital Partners’ Market Update: M&A Activity: 2013 Summary & 2014 Outlook

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2013 M&A Recap

M&A deal volume in the Government Services market dropped by 22% this year as compared to 2012 due to sequestration and budget uncertainty which has resulted in a lack of visibility in a target company’s business for both buyers and sellers. However, signs of a revival in M&A activity have begun to develop in the last couple months of 2013 as the deal count significantly increased compared to the rest of the year. Enhanced revenue visibility and a better understanding of the new environment played key roles in this increase.

In 2012, the market experienced a similar spike in deal volume in the last months of the year. This was primarily driven by the expiration of tax breaks effective January 1, 2013. Unlike 2012, the increase in CY Q4 2013 is expected to continue

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M&A Deal Volume is Picking Up!

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November showed signs of a strengthening M&A environment as announced deals in the government services sector totaled eight for the month, which is 60% higher than October and in line with November of last year.  The market has continued to see deal volume pick up in the first part of December.  Over the last 30 days, ACP has closed two transactions:

ACP Recent Deals:

  • The sale of Kimmich Software Systems to Vistronix
  • The divestiture of certain Assets from a Tier 1 Defense Contractor to a Confidential Buyer

As shown in the chart on the right, government services deal volume in Q4 is expected to account for more than a third of the government services deals in 2013.  Part

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Aronson Capital Partners Advises Haystax Technology on its Acquistion of FlexPoint Technology

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Aronson Capital Partners (ACP) is pleased to announce the acquisition of FlexPoint Technology, LLC by Haystax Technology, a portfolio company of the Edgewater Funds. ACP provided buy-side advisory services to Haystax in this transaction.

FlexPoint Technology, headquartered in Reston, VA, specializes in private and public cloud solutions that deliver secure collaboration and application development capabilities in security-demanding environments.  FlexPoint’s cadre of software and systems engineers leverage commercial off-the-shelf technologies to facilitate secure computing and information sharing throughout the Defense and Intelligence Community markets.

Haystax Technology is a high technology company created to revolutionize the defense and intelligence markets by integrating innovative, leading edge technology companies with capabilities in multi-source collection and data fusion, big data analytics, visualization and exploitation. Haystax announced its partnership with Chicago-based Edgewater Funds in July 2012, and closed its first acquisition, Digital Sandbox, in April 2013.

We believe this transaction illustrates a number of key trends in government technology M&A:

  • The Intelligence Community’s commitment to information sharing and secure computing is a catalyst for M&A activity
  • Significant market interest for federally focused service providers that can identify and integrate cutting edge commercial solutions in response to USG challenges
  • Private equity backed companies continue to demonstrate interest in well positioned, high growth targets despite budgetary headwinds


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Financial Sponsors – Continued Interest in Government Services

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Over the last five years, the Government Services industry has seen continuous interest from financial sponsors. Private equity firms have acquired publicly-traded services providers (e.g., Providence/SRA; Ares/GTEC), divestitures of large systems integrators (e.g., Veritas/The SI; General Atlantic & KKR/TASC), and both middle and small market contractors (e.g., Arlington/White Oak Technologies; LLR/Paragon). In 2012, private equity firms and their platforms accounted for one-third of the acquisition activity within Government Services. Financial sponsors are expected to continue to play a significant role in the Government Services M&A market as contractors (public and private) seek new opportunities to grow in an environment of sequesters, budget cuts, and funding uncertainty.

The Draw of Government Contracting

Financial sponsors like predictable cash flows and large addressable markets. Compared to the commercial sector, federal contractors have relatively high revenue visibility and backlog and enjoy greater confidence in their ability to collect pending customer payments. In addition, the sector is highly fragmented with opportunities for industry consolidation to either enhance an established contractor’s capabilities/customer base via bolt-on acquisitions (e.g., Camber/Novonics), or to roll-up several small companies and form a more competitive contractor with greater scale and ability to meet customer needs (e.g., Arlington/Novetta).

The Need for Financial Sponsors

As the market environment continues to evolve, opportunities become available for those with capital. After being acquired by Ares Management in 2011, Sotera Defense Solutions (formerly GTEC) President and CEO John Hillen said, “Being a part of that investor group gives us access to a lot of capital to do more and bigger deals than we could as a public company.” Within a year of the change in ownership, Sotera outbid its competitors to acquire Software Process Technologies and Potomac Fusion. With flattening growth and shrinking market sub segments, several contractors are leaning towards a more active M&A strategy as a key avenue to grow revenue streams in priority markets.

Deal Mechanics of Financial Sponsors

Borrowing capacity and cash balances have increased for many public contractors since last year, but M&A deals in 2013 have been sparse. Sequestration, budgetary concerns, the debt ceiling, and other topics on the Hill have increased uncertainty in today’s market. As a consequence, the gap between buyer and seller valuation expectations has widened. In this environment, financial sponsors have an important role to play through structuring instruments like earnouts, equity rollovers, and seller notes. These instruments are typically less likely to be included in a strategic buyer’s consideration, or at least to a lesser degree. Forms of consideration that provide paths for additional value through structure may be the only way to bridge the gap between buyer and seller expectations in the current environment.

This article is contained in ACP’s April Market Update.

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Forbes: “As Budget Cuts Bite, Defense Contractors’ Fortunes Diverge”

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While federally-focused service providers have been hit hard in recent times, weapons systems integrators have not been immediately impacted. Large weapons systems programs are more difficult to cut than IT and training contracts. This has allowed weapons manufacturers to focus on longer-term margin expansion strategies as service providers downsize and restructure.

Click here to read the entire article from Forbes.

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