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What Drives Value in Government Services & Defense M&A?

M&A transaction volume in the government services & defense market in recent periods has trended upward. There were 112 government services & defense acquisitions in 2015, compared to 82 and 79 acquisitions in 2013 and 2014, respectively. There were 31 acquisitions in the space for Q1-2016, which was a significant increase over Q1-2015 activity.[1]

So what are the target company attributes that spark interest from potential buyers and influence valuations the most in these deals? Specific value drivers vary from company to company, but some common themes for government services & defense firms include:

  • Strong, long-term relationships with government customers
  • Services/capabilities that are sought after in higher-priority markets (e.g., cyber security, data analytics, healthcare IT, C4ISR)
  • Significant contract backlog (prime contracts, unrestricted, substantial funding) that yields clear revenue visibility
  • Access to large, prime IDIQ vehicles (e.g., GSA Alliant and OASIS, DIA SITE / E-SITE, VA T4 / T4NG, CMS ESD / SPARC)
  • Specialized workforce with security clearances or certifications in cutting edge COTS solutions
  • Distinguished technology or revenue-producing intellectual property

While this is not an exhaustive list, attributes like the ones cited above tend to impact a firm’s growth prospects and its capacity for sustaining profitable operations. These attributes may also provide an acquirer with opportunities to penetrate new markets and maximize pre-existing customer relationships.

Interestingly, these value drivers may be visible on the acquirer’s balance sheet after the deal closes. For financial reporting purposes, the acquirer must allocate the purchase price among the assets acquired and the liabilities assumed from the target company, at fair value. How the purchase price is allocated can be indicative of a target company’s value drivers. In order to explore this concept, we looked at acquirer business combination disclosures for approximately 30 deals occurring from Q1-2015 through Q1-2016 in the government services & defense market (see table below).

While every transaction is different, we found that on average 28% of the purchase consideration in these acquisitions was allocated to identifiable intangible assets and 67% of the purchase consideration was allocated to goodwill.[2] Most common among the identifiable intangible assets were customer-related assets (i.e., contract backlog and customer relationships), which accounted for as much as 39% of the purchase consideration in the deals analyzed (average 21%).[3] While less common, value was also allocated to technology-related assets in a number of the transactions studied; these assets accounted for as much as 33% of the purchase consideration (average 11%). But what about workforce-related assets, you may be wondering. Accounting standards require the value of the acquired workforce to be subsumed within goodwill.[4]

Capture

It may also be interesting to consider the useful lives assigned to customer relationships and developed technology. In the deals we studied (see table above), customer relationships were to be amortized over periods ranging from 8 to 20 years (average 13). Amortization periods for developed technology ranged from 4 to 15 years (average 8).

A final note with respect to customer-related assets. Middle market government contracting firms should be aware of recent standard setting activity in this area by the Private Company Council (“PCC”) that affects business combination accounting. For more information, click here.

Aronson LLC’s Financial Advisory Services practice assists clients in a variety of industries with numerous M&A-related activities, including pre-acquisition due diligence and post-acquisition purchase price allocation analyses and impairment testing. To learn more click here or contact Bill Foote at 301-231-6299.

[1] Source: Aronson Capital Partners Q1 2016 Market Update. Click here to read in full.

[2] Under business combination accounting, identifiable intangible assets (i.e., those that are recognized apart from goodwill) generally fall into the following broad categories: marketing-related; customer-related; artistic-related; contract-based; technology-based. Goodwill is a residual value, generally representing the excess of the purchase consideration over the aggregate fair values of the identifiable assets acquired net of the liabilities assumed.

[3] In some instances the values of customer relationships and contract backlog were disclosed on a combined basis; in other instances the values of customer relationships and contract backlog were disclosed separately.

[4] The financial statement disclosures don’t reveal how much of the reported goodwill relates to the workforce. The majority of the reported goodwill, however, tends to be attributable to (something along the lines of) “expected synergies from combining the operations” of the acquirer and the target.

Use QuickBooks-Compatible Apps to Reduce Data Entry

As a small business entrepreneur there is a lot of demand on your time from competing forces, not the least of which are accounting and administrative tasks. For most business owners and their support staff, these tasks are the necessary evil of doing business, often put off until the last possible moment in favor of revenue generating activities.

Technology innovations have made it possible to reduce time and effort expended on bookkeeping keystrokes. For those using QuickBooks (the number one small business accounting software in the U.S.), it’s easy to expand the capabilities of the basic software with apps from the Intuit app store. The website features web-based and mobile apps that link with QuickBooks desktop or QuickBooks Online, allowing businesses to capture specialized data once and import it directly and automatically into QuickBooks accounting software.

Some of the top-rated apps available for legal and professional service providers are:

  • Concur, Expensify , Tallie – These apps for travel and expense reporting allow employees to create reports from mobile apps that scan receipts, track mileage, etc., and automatically link to your QuickBooks accounts, vendor names, classes and location info.
  • BigTime, TSheets, Chrometa – These mobile time tracking apps will sync to QuickBooks for payroll or invoicing. Users can enter time through the web from computer or smart phone. Chrometa may be the most automated – its “passive timekeeping” feature logs every activity that takes place on your computer and the amount of time on each task.
  • Fundbox, BlueVine – Accounts receivable financing apps link directly to your QuickBooks invoice information to process cash advance requests. Total financing and fee structures vary for each of these products.

QuickBooks has been recognized by a broad range of technology developers for its top spot in the field of small business accounting products. These app developers are eager to capture new clients through integration of their product with QuickBooks, and users can benefit through administrative economies when the software integration meets their needs. This may be an opportunity for your accounting staff to benefit, too.

For general information or to discuss your particular situation, please call your Aronson advisor at 301.231.6200. Our Certified QuickBooks ProAdvisors are CPAs who can provide assistance with any QuickBooks issue.

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