Rethinking the pure-play mandate

Market Watch | Financial views of a competitive environment

Most prospective buyers in the government services
markets are seeking pure-play, federal-oriented targets.
These acquirers are either already focused on the
federal segment and want to expand there or they
are seeking to enter the federal arena. This approach essentially
involves sticking to the market you know.

Many industry veterans recall the early
1990s, when defense companies undertook
diversification strategies into commercial
markets. The result of those initiatives was
aptly described by Norman Augustine,
Lockheed Martin Corp.'s chief executive officer
at the time, as a record unblemished by
success. Since 2001, the supply of pure-play
federal services companies has generally
stayed abreast of buyer demand.

But circumstances began to change in
2007. Increasingly, so-called dual-market
companies are emerging as the best targets.
It may be time for buyers to look more
closely at companies that are successful in
federal and commercial markets.

Several good reasons exist for buyers to
rethink their acquisition parameters. First,
the supply of attractive pure-play government
services companies has thinned. Six years of
active mergers and acquisitions have
removed most of the established small to
midsize companies from the landscape.

Newer federal contractors are usually laden
with small-business preference contracts,
which throws cold water on their sales
appeal.

Second, the development and implementation
of subject-matter expertise and technology
along with management concepts are
occurring in government and commercial
markets. Accordingly, companies with in-depth
expertise in sought-after disciplines
have achieved success in both markets.

Third, the pace of growth in federal
spending is slowing. The upcoming
general elections have increased
uncertainty about government priorities
in 2009 and beyond. Effective
participation in growing nonfederal
markets could provide some upside
momentum to offset anticipated
slowing in many federal segments.

This is not to suggest that participating
successfully in dual markets
is without challenges and risks ?
only that an increasing number of
acquisitions of this type are being done.
Some areas of deep expertise that lend
themselves to multiple markets are:
  • Network and communications engineering,
    implementation and operation.
  • Health care informatics.
  • Managed services ? architecture,
    design/build.
  • Energy management.
  • Business process outsourcing.

A few recent transactions are examples of
this trend. SRA International Inc.'s acquisition
of Constella Group in August gives SRA
a provider of health services to governments,
corporations and nonprofit entities
in more than 100 countries. Constella's subject-
matter depth meets priority needs
across markets. In addition, ICF
International Inc.'s recently announced
acquisition of Jones and Stokes
Associates adds expertise in resource management,
planning and implementation.

Also in August, Science Applications
International Corp. acquired Benham
Investment Holdings, an engineering
and life cycle technology implementation
company that serves corporate
and federal markets. Benham has
expertise in energy management and
alternative fuels in addition to software,
integration and
advanced visualization
systems.

In each instance, the
acquired company had
proven its ability to sell
effectively and gain
recognition in its commercial
markets while
being successful with
federal customers.

Many federal acquisition
officials prefer to
deal with companies that are successful
outside federal markets.

Finally, fewer buyers are pursuing dual-market
companies, frequently providing
buyers a less congested sale environment. It
merits some thought.

Jerry Grossman (jgrossman@hlhz.com) is managing
director at Houlihan Lokey Howard and Zukin.

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