Although the national capital region is home to businesses in a broad range of industries, it’s most well known for its ecosystem of defense, aerospace and government contracting companies. These enterprises work closely with federal agencies and the branches of the military to help them accomplish their missions and effectively serve their constituents – regardless of whether that involves helping these agencies meet staffing requirements, embrace new technologies or build new national security and defense programs and systems.
Aronson Capital Partners – which supports the M&A and financial advisory needs of middle market companies – is one of the leading companies offering support to the enterprises in the aerospace, defense, and government services industries.
Each quarter, the people at Aronson take a deep look at the industries they serve and identify the larger, overarching financial trends that are impacting the market. They release these findings in their Aerospace, Defense Technology & Government Services Market Update. The most recent of which – the Q3 2016 Aerospace, Defense Technology & Government Services Market Update – was just released.
The Q3 2016 Report showed a government contracting market that was growing at a time of higher certainty and stability. To get some more insight into the report’s findings and what’s driving the growth and M&A activity that Aronson is reporting, we sat down with report authors, Tim Schmitt and Michael Potolicchio.
Here is what they had to say:
Corporate Growth, Capital Style (CGCS): The report claims that Tier-1 contractors beat projections and registered strong EPS growth. One of the reasons that was provided for this was a decrease in uncertainty around federal spending. What was creating this uncertainty in the first place, and what changed in the federal government that led to this decrease in uncertainty?
Tim Schmitt: A significant portion of the uncertainty in the federal contracting sector stemmed from the automatic spending cuts that took place as a result of the Budget Control Act of 2011. The continued reduction in billions of dollars in cash outlays over the next couple years handcuffed federal contracting officers and negatively impacted contractors vying for government contracts.
In 2013, Congress passed the Bipartisan Budget Act, which provided approximately $63 billion of total sequester relief for 2014 and 2015 and allowed the Department of Defense to significantly reduce the amount of anticipated cuts in technology, operations and maintenance. The reduction in cuts has slowly trickled through the procurement system over the past two-three years and is finally contributing to better than expected performance.
CGCS: Another reason provided for the Tier-1 growth this past quarter was successful acquisition and merger activity. Can you give some examples of this activity, why the companies decided to move in this direction and what the outcomes have been?
Michael Potolicchio: Over the past few years, Tier-1 contractors have been highly selective with prospective acquisition targets. Instead, they have elected to increase shareholder returns through dividends, share repurchases, and select divestitures or spin-offs of non-core, low margin assets.
More recently, we’ve seen an uptick in Tier-1 M&A activity focused on targets with intellectual property and a product portfolio. While these acquisitions have not yet had a material impact to overall Tier 1 performance, we believe they are indicative of future trends.
Raytheon Websense’s acquisition of Stonesoft builds on the company’s cybersecurity technology platform via its proprietary TRITON APX product to provide a new level of defense-grade cybersecurity to combat the evolving cyber threat environment.
Boeing’s recent acquisition of Liquid Robotics was driven in large part by Boeing’s strategic decision to expand upon its Autonomous Systems capabilities. Liquid Robotics is the developer behind the Wave Glider ocean surface robot, the first wave powered, autonomous marine robot that functions as a persistent and versatile platform for scientific, industrial and defense payloads.
Finally, L-3’s acquisition of MacDonald Humfrey builds upon its aviation checkpoint security solutions. MacDonald Humfrey will add process automation and collaborative robotic capabilities to its already robust product portfolio. Shortly thereafter, L-3 announced its name change 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.
These acquisition targets are leaders in their respective areas of expertise and anticipate growth in the low to mid double digits over the next five to ten years.
CGCS: The report shows that mid-tier contractor growth was relatively flat or exhibited only modest growth. What are these mid-tier contractors doing during this time of flat growth to better position themselves to compete for government business in the future?
Tim Schmitt: There is a high degree of competition across the mid-tier government services community. These firms continue to make acquisitions to gain entrée into new markets, realize revenue synergies, expand capabilities and access to key contract vehicles.
Many mid-tier contractors are targeting larger transactions (over $200M) to add scale and “move the needle” in a more meaningful manner.
CGCS: Do you have any examples of mergers or acquisitions by mid-tier contractors in the past year that illustrate their growth strategies for the future?
Tim Schmitt: CACI, Engility and Leidos have made significant acquisitions of L-3 NSS, TASC/DRC and Lockheed Martin IS&GS, respectively. These three acquisitions add scale and allow them to effectively compete for larger contracts against bigger competitors in the market.
With these transactions come highly strategic IDIQ contracts that each combined entity can leverage into new business opportunities they couldn’t have pursued on a standalone basis.
CGCS: The report claims that nontraditional companies are looking to enter the federal marketplace. Why are they attracted to the federal government market, and what are they doing to position themselves as a player in this space? Do you have any examples of this to provide our readers?
Michael Potolicchio: Non-traditional buyers have become more confident in the federal market’s future growth prospects, and are therefore once again pursuing federal M&A targets.
Accenture has reemerged with two acquisitions: Agilex to enhance its agile delivery capabilities for the federal market and FusionX to round out its security capability.
In early 2016, Aronson Capital Partners advised Wavefront Technologies on its sale to Ball Aerospace and Technology. The acquisition strengthened Ball’s federal market position in systems and network engineering, software development and analytical services for cyber and mission-focused programs.
In November 2016, Huntington Ingalls Industries, which was not an active federal acquirer since its spin-off from Northrop Grumman Corporation in 2011, acquired Camber Corporation to broaden its existing capabilities and expand its federal customer base.
KBR acquired Wyle to build a flagship platform for its government services business in May 2016 and recently closed its second acquisition of Honeywell Technology Solutions to round out its government services organization.