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While government agencies and contractors understand the devastating impact of sequestration, many questions appear to remain unanswered. For instance, what will be the exact percentage of cuts to agencies and what impact will this have on government contractors? Also, what factors could impact businesses seeking new areas of growth through strategic acquisitions in the market

A recent ACG seminar sponsored by Venable LLP entitled, The Fiscal Cliff: Sequestration and Taxes, provided valuable insights on the sequestration process and the impact it will have on the government contracting community.

As noted in the presentation, “the major difference between these automatic cuts and the 1986 Gramm-Rudman Sequestration is that many more defense programs are subject to mandatory, across the board reductions.” Also, “spending cuts will be divided roughly equal between eligible defense and eligible non-defense programs, while many domestic programs are exempt from the cuts such as Social Security, Medicaid and cuts in Medicare which will be limited to 2 percent.”

As for contractors, some of the potential effects noted in the presentation include

  • Procurement delays for non-essential goods and services.
  • A significant decrease in the number of contract awards.
  • Government restructuring of existing contracts.
  • An even greater reliance on contract vehicles that place risk on contractors – i.e., firm-fixed price contracts.
  • Increased use of low cost/technically acceptable contracts versus best value procurements.

While these effects are destined to have a negative impact, several contractors are seeking to offset or mitigate some of these possible outcomes through the acquisition of companies considered to be high-priority areas of focus by the government.

We recently discussed this strategy and some areas of growth with Don Acker, managing director of a government contracting consulting firm, Turn 10, LLC

While several of these growth markets will be the target of acquisitions by government contracting companies, there are some factors for these companies to consider during this period. Such factors, as shared by Acker, include an increase in volume of sellers which will lead to growth in M&A activity, along with a diminished amount of financiers

According to Acker:

“I think you will start to see more activity in the last part of this year triggered by the threat of sequestration and just the unknowns surrounding the various tax laws.  I believe you’ll see companies that typically haven’t used M&A as a strategy for growth entering the marketplace looking for help with their numbers in 2013 and beyond as those that may have been too optimistic realize their organic growth goals are going to be cut short.

I also think we’ll see a larger volume of sellers in this market.  Those that weathered the previous storm may not be ready to face the next one on the horizon and are looking for someone else to take the wheel.  On the optimistic side it presents a lot of opportunity that probably would not be there if the current environment were different.

Also, related to that previous storm that took place, some of the financiers of these deals may not be as plentiful as before, as those in this market space are well aware of the impacts of sequestration.  This means that more cash may be needed up front than before to make a deal go through. This could put some pressure on the buyer to decide whether they are better off holding their cash and weathering the storm or investing it in M&A.  As we get closer and closer to the New Year, deals that were in the works may fall through as the risks become too great for the buyer (and/or their bankers) to overcome.”

Ultimately, while some companies will continue to switch gears to alleviate the damaging effects of budgetary pressures, agencies and contractors will need to brace for a fire storm.

Fellow ACG National Capital member and board director, Bob George, Director of Corporate Development at Exelis Corporation, provides instructions below for those who would like to consider voluntarily letting elected officials know how damaging sequestration could be to the government contracting industry. This online tool, provided by the Aerospace Industries Association (AIA), allows citizens to efficiently identify and contact their representatives and the President on this matter

If you’re interested in participating, here’s what you can do:

  1. Access the Second to None Outreach Tool at: http://act.secondtonone.org/6059/stop-sequestration/
  2. Enter your home zip code, click the red submit option and the site will identify your federal elected officials.
  3. Enter the text you would like to appear in the letters to your elected officials.  You may highlight the existing text and enter your own original text, or simply leave the text that AIA has pre-populated in the letter.  Do not include a salutation or closing, as the tool will do that for you.
  4. Enter your name, mailing address and company email address in the fields below the text field and then click on the red “Preview Letters” option
  5. Review the letter. If you would like to make any changes to the text, simply click “Edit Letter” in the top right corner of the text and go back to Step 3 above.
  6. When you are satisfied with the content of your letter, simply click the red “Send Letters” option at the bottom of the page and the process is complete.  AIA will print and delivery a copy of your letter to each of the elected federal officials indicated.