Market Share: Forget size ? look at corporate culture to measure success

Bill Loomis

Investors often ask me whether bigger is better in the federal information technology industry. What size do companies have to become to be competitive?

I don't think bigger is necessarily better, particularly for investors seeking good growth stocks. Good management is much more important than the company's size when determining which to invest in.

History has shown there are small companies under $50 million in revenue, and certainly under $100 million in revenue, that are well managed.

A few have had successful initial public offerings, such as Advanced Communication Systems Inc. and BTG Inc. in the mid-1990s (both since acquired by Titan Corp.), and PEC Solutions Inc. in 2000.

SI International Inc. and MTC Technologies Inc. also were small businesses when they went public in 2002, with SI having about 1,200 employees, and MTC 1,000 employees at the time.

Although the last few years have been difficult for PEC Solutions, the company grew from $11 million in revenue in 1995 to $68 million in 2000, the year of its IPO, and $182 million in 2002, all with strong profit margins.

There also are instances in which larger companies have struggled at times, such as Titan and DynCorp, with either revenue growth or profitability. DynCorp, despite having more than $2 billion in revenue, said one reason for selling itself to Computer Sciences Corp. was that it wasn't big enough to compete.

Being larger generally means bidding on more competitive, lower profit margin and more politically visible programs in an effort to grow. Smaller companies can focus on higher-margin opportunities, which often are smaller contracts, typically earning a better return on capital in the process.

However, SRA International Inc. has shown that, even at more than $600 million in revenue, well-managed companies can earn above-average profit margins and return on capital, while still winning contracts from multibillion-dollar revenue incumbent companies such as Science Applications International Corp. and CSC.

I believe a strong management team and deep, strong corporate culture are important to maintain small business nimbleness in a big company environment.

Many books have been written on corporate culture. Having never started nor run a company myself, I have no experience to advise small business owners regarding how to establish and maintain a strong corporate culture. But as an analyst who has reviewed many businesses, I can tell which companies seem to have such a culture and which do not.

A strong management team and culture can help propel small businesses, or even industry giants such as Accenture Ltd. Despite having $15 billion in revenues, Accenture has delivered above-average profit margins, has led the industry in return on invested capital, and has made the transition from private partnership to a publicly traded company very successfully.

As venture capitalists and private equity investors know, a strong management team can deliver above-average results even as a small business competing against giants in a mature or shrinking market.

When I analyze a business, I give greater weight to the management and culture of the company than to the actual market segment in which they are competing or to the size of the business.

Bill Loomis is a managing director of the Technology Research Group at Legg Mason Wood Walker Inc. He can be reached at wrloomis@leggmason.com. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. For additional information and current disclosures for the companies discussed herein, please write to: Legg Mason Wood Walker Inc., 100 Light St., P.O. Box 1476, Baltimore, MD 21203, Attn: Research Department.

About the Author

Bill Loomis is a managing director at Stifel Nicolaus.

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