Budget Stabilization and Market Consolidation
The last five years of uncertain federal budgets have prevented most contractors from making significant investments, incentivizing them to return capital to shareholders. However, as budgets have stabilized (on a relative basis), the larger contractors are now able to make investment decisions with greater clarity. While there is overall better revenue visibility across the sector, the Defense budget is flat and the overall sector is perceived to be a slow growth industry. Therefore, we expect the recent mid-tier consolidation trends exhibited over the past 12 months to continue, with private equity backed targets being the primary acquisition candidates in this consolidation cycle.
With the appropriations bill providing a degree of visibility into the government fiscal year (“GFY”) 2015, the Tier-1 contractors reported solid results in Q4 while providing a cautionary outlook for fiscal year 2015. On numerous conference calls, corporate executives expressed concern over continued sequestration but were relatively optimistic with the growth prospects of their business, especially compared to their comments last year this time. Continue reading here.
Aronson Capital Partners is a leading middle-market investment bank focused exclusively on the government services and technology industry. We invite you to read our February 2015 Newsletter, featuring the following topics:
Please feel free to contact one of our principals with any questions.
Harris Corp. is buying Exelis in a $4.75 billion cash and stock deal that the company is calling transformational.
The deal will significantly increase the size of Harris, adding $3.25 billion in revenue to Harris’ $5 billion in revenue. Headcount will grow to 13,000 to 23,000. The transaction is expected to close by June.
Adding scale was definitely one of the factors the drove the deal, according to Harris executives and industry analysts.
“The combination of the two companies’ highly complementary core franchises creates a competitively stronger company with significantly greater scale,” said Harris CEO and chairman William Brown.
Much of that scale will come in the defense market, where Harris adds Exelis’ strong position to its own. Sixty-one percent of Exelis customer base comes from defense customers. About 75 percent of Harris’ revenue is DOD and intell related.
Exelis and Harris also both have significant international and commercial sectors. Pre-acquisition, the
2014 M&A Recap:
With 81 M&A deals announced in the Government Services market, transaction activity in 2014 increased by 25% compared to 2013 and was in-line with 2012 levels. Improved revenue visibility and better understanding of the new environment was a key factor to this volume increase. For public strategic buyers, higher company valuation, increased dry powder, and an attractive credit market contributed to the pickup in transaction volume. Similarly, well capitalized private and private equity-backed contractors deployed cash on their balance sheet and accessed the credit market to participate in the M&A market. Private equity sponsors remained active as they looked to invest a sizable amount of un-deployed private equity and traditional bank capital. Access to lower middle market leverage multiples combined with low interest rates contributed to the increase in M&A transactions.
In addition to M&A transactions, a continuing trend in Government Services market was the major divestitures and spin-offs of business segments. Rationale behind most of these transactions was to focus on core markets and capabilities, portfolio reshaping and to unlock value. Notable transactions of 2014 included QinetiQ’s sale of its North American business and Exelis’ spin-off of its Mission Systems
The majority of the completed Government Services transactions involve targets with annual revenue of less than $50M. This sector is incredibly fragmented, largely due to the government’s preferential awards, and it usually takes significant reinvestment and commitment of the shareholders to grow their business beyond this threshold. Therefore, most transactions involve targets with a contract portfolio comprised of (i) prime, F&O work; (ii) prime, small business set aside (“SBSA”) contracts or other preferential awards; and (iii) subcontracts.
We are often asked if it is easier to market and sell a business with prime, SBSA contracts or subcontractor work. Unfortunately, the answer is not clear-cut and is largely case specific based on the target company’s solutions and relationships.
All things being equal, a target with prime, F&O contracts will command greater buyer interest and a higher valuation than a firm with SBSA contracts and subcontractor work. These targets have proven that they can compete and win against the larger primes, which validates their future growth prospects, capabilities, customer relationships and competitive positioning. Moreover, there