Market Watch: Public market winds of change blow for federal ITs
Public capital markets have been receptive to federal IT companies since the Sept. 11, 2001, terrorist attacks. Since then, more than $4 billion of equity has been raised for federal companies via initial or follow-on public offerings.
The 18 months following 9/11 were the most active, with more than $2.6 billion in equity raised from 16 initial and follow-on offerings. An additional $800 million was raised over 2003 and 2004.
The window remained open in 2005 with four initial public offerings for an aggregate value of $600 million. Dyncorp, the largest at $375 million, initially was seen as federal IT, although its greater business is in technical services. Its share price since the offering has declined by more than 20 percent.
NCI Information Systems Inc. raised $54 million, and its share price has declined by 4 percent. The other two 2005 IPOs were special-purpose application corporations: Federal Services Acquisition Corp. at $126 million, and Fortress America Acquisitions Corp. at $42 million. Fortress is up by 10 percent, and FSA Corp. is about the same price as at the initial offering.
The first IPO in 2006 was just completed Sept. 28 by ICF International Inc. It was expected to price between $14 and $16 per share, but went out at $12 a share and raised $56 million. We anticipate SAIC's IPO will take place in mid- or late October. It will be a bellwether for any future IPO or follow-on activity. Stanley Associates Inc. has filed for an IPO.
The public capital markets for federal services companies remains open, but the markets are more volatile and discriminating. Wall Street has been rewarding growth and margins more than other factors, such as capabilities and service offerings.
Over the past two years, federal service companies that have exhibited both revenue growth and earnings before interest, taxes, depreciation and amortization margins in excess of industry averages have enjoyed a price-to-earnings ratio 30 percent higher than those companies with lower growth and margins.
While valuations for federal IT companies have declined about 15 percent over the past year, the valuation gap for those companies exhibiting strong growth and good margins has increased.
Wall Street has also rewarded those companies that have made acquisitions since they went public. Wall Street generally expects public companies in the federal IT sector to grow revenue and earnings by 15 percent to 20 percent annually.
Because the overall federal IT budget has historically averaged about 5 percent annual growth, many companies must turn to acquisitions to bridge the gap.
Some examples are CACI International Inc., which has appreciated by 369 percent since January 2000; SI International Inc. has appreciated by 110 percent since its IPO in November 2002; ManTech International Corp. appreciated by 70 percent since its February 2002; and SRA International Inc. has appreciated by 146 percent since its IPO in May 2002.
Unlike the public markets, where there has been a recent decline, the merger and acquisition and private capital markets for government IT companies remain strong. Valuations have held reasonably firm over the past two years at relative highs for the industry, although the outlier premium prices for certain unique companies (e.g., Intel Corp.), are less frequent. The M&A and private capital markets are also much more focused on capabilities, service offerings, customers and management strength than are the public markets.
Size also is a factor. The public markets require a minimum size an IPO (except for a special-purpose application company). That bar is probably a minimum of $200 million today for a federal IT company. But the public markets put a greater premium on growth and profitability than on size.
The M&A and private capital markets, on the other hand, do value larger companies more than smaller ones that have essentially the same capabilities and customers. The dividing line for higher valuations as a result of size is in the $75 million to $100 million range. Those companies typically have more infrastructure and are platformlike.
Richard Knop is senior managing director and co-head of the defense and government services group at BB&T Capital Markets/Windsor Group, Reston, Va.