Market Watch: Pool of midsize contractors remains deep and strong

Jerry Grossman

Mergers and acquisitions over the past three years in the federal market have fed the notion that mid-tier companies are being squeezed out.

The mix of companies has changed within each industry revenue band, but the idea that mid-sized companies can't survive is wrong.

The aggregate level of prime contract dollars increased nearly 54 percent between fiscal 1999 and fiscal 2003, according to Eagle Eye Inc., a market research firm.

During the past five years, nearly 400 mergers and acquisitions occurred in the government services sector. The average transaction was in the $35 million to $40 million range. On average, revenue acquired per transaction fell between $40 million and $45 million. Accordingly, somewhere between $16 billion and $18 billion in revenue changed hands.

Many of the acquired companies were well known in the industry, having grown and developed over 15 to 30 years. Many of these companies had significant domain expertise and world-class technical depth. Their customer relationships, technology and staff expertise became attractive to tier-one primes, newly public federal IT companies and sizeable private companies with acquisition capacity.

More recently, private equity sponsors and other institutional investors have purchased industry businesses with a plan to build them organically and through acquisitions.

The consolidation produced by these transactions has spawned the notion that industry is taking on an hour-glasslike shape, with the middle portion getting tighter and tighter. This perspective is augmented by increased contract bundling ? favoring the big guys ? and renewed emphasis by the government on small-business preferences, aiding companies under $30 million in revenue.

But the evidence from the Federal Procurement Data Center suggests otherwise. In fiscal 1999, there were about 3,000 companies with prime contract revenue above $5 million. Of these, approximately 2,400 had revenue between $5 million and $30 million, 380 companies had revenue between $30 million and $100 million, and 160 had revenue between $100 million and $1 billion. For these same three revenue bands in 2003, there were 3,170, 620 and 240 companies, respectively, reflecting increases of 32 percent, 63 percent and 50 percent.

In each of these revenue bands, the aggregate prime contract revenue increased at about the same pace as the number of companies, resulting in average revenue per company remaining nearly constant.

A significant increase in aggregate prime contract dollars occurred among companies earning more than $1 billion in revenue. In 1999, 20 companies had aggregate prime revenue of $80 billion, averaging $4 billion each. In 2003, there were 31 companies with more than $1 billion, collectively producing $128 billion in prime revenue, or about $4.1 billion each. The increase in companies in this segment was equal to the increase in aggregate prime contract dollars.

Companies earning less than $30 million saw their share of aggregate dollars shrink from 16 percent to 14 percent, but the revenue per company increased from $11.4 million to $11.7 million. Companies with more than $1 billion increased their share of aggregate revenue from 47 percent to 48 percent, while those having between $30 million and $1 billion increased their share from 37 percent to 38 percent.

Relative to size, the shape of the industry has remained constant over this four-year period. Arguably, the business is somewhat more competitive as the revenue per company is nearly unchanged, suggesting that in real terms, the businesses are slightly smaller. Individual companies, however, have grown within each of these segments, and many of the companies with revenue of less than $50 million are growing more rapidly than in the past.

Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va. He can be reached at jgrossman@hlhz.com.

About the Author

Jerry Grossman is managing director at Houlihan Lokey Howard and Zukin.

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