Market Share: New IPOs reflect federal market's magnetic attraction

Federal IT has regained its public market momentum. Three successful initial public offerings in the past three weeks could re-ignite investor attention and interest in the federal IT sector.

The acquisition of large companies Anteon International Corp., Titan Corp. and Veridian Corp. over the past three years has had a diminishing effect on the aggregate market capitalization of the sector. The transactions removed about $5 billion in revenue and more than $6 billion in market value from the federal IT public peer group.

Accordingly, public market investors seeking to participate in the federal IT sector, particularly on the New York Stock Exchange, had fewer companies from which to choose. Together, the three new public companies add more than $8.5 billion in revenue and about $7 billion in market value to the market.

This "restocking" of the public market is positive for the industry and its investors, both public and private.

The Science Applications International Corp. offering, well more than $1 billion, has been anticipated eagerly in and out of the industry, since more than a year ago when the company filed with the Securities and Exchange Commission its initial S-1 registration statement announcing its intent to go public.

With a long-term track record of successful organic growth and a recent history of targeted acquisitions in the sector, SAIC is broadly representative of the federal IT and professional services business. The company has a wide range of domain expertise and technology depth, particularly in defense and intelligence segments, but ranging into civilian agency markets as well. Its employee-ownership culture, fostered over many years, is well known by competitors and customers. The company's substantial size, $8 billion in revenue, and the dollar magnitude of the IPO make it a headline event.

Stanley Inc. and ICF International Inc., albeit much smaller companies, offer distinctive sector investment alternatives, given their particular customer focus, historical development and capabilities mix.

Both companies have employee ownership elements coupled with aspirations to continue growing their businesses as independent entities. Stanley's business is oriented toward Defense Department customers, while ICF has built its business with emphasis on federal civilian, international and commercial customers.

Together, ICF, SAIC and Stanley have doubled the market capitalization of the pure-play federal IT group.

The price-to-performance ratios of the three companies, calculated from their IPO prices, fit well within levels of more seasoned members of the peer group, including CACI International Inc., ManTech International Corp., SI International Inc. and SRA International Inc. Although trading prices for all three companies are above the initial offering prices, the companies' pricing ratios remain reasonably in line with those of their peer companies.

For example, EBITDA (enterprise value to trailing earnings before interest, taxes, depreciation and amortization) ratios fall in the 11 times to 13 times range, and market value of equity to trailing earnings ratios are in the 24 times to 27 times range.

All three of these companies have achieved organic growth while augmenting their capabilities mix and customer rosters with acquisitions. Their successful public offerings have expanded their shareholder base and equity capital foundation while simultaneously increasing their capacity to raise debt capital.

Accordingly, they have increased their ability to accelerate the acquisition component of their growth strategy, as appropriate, relative to their strategic vision and capital structure comfort zone.

An expanded roster of public market companies broadens the base of institutional and individual investors, providing increased exposure and awareness of individual companies as well as the industry as a whole.

This public market restocking, and the investor attention it attracts, likely will have a positive impact on the industry.

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

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