COMMENTARY

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Strategic tuck-in acquisitions dominate the current M&A landscape

As pricing and competitive pressures in the government contracting industry continue, companies must differentiate themselves from competitors to be able to grow at attractive organic growth rates and sustain attractive margins. In what most industry observers expect to be a more austere defense spending environment, better solutions at attractive price points will prevail.

Consequently, companies are seeking to position themselves through targeted acquisitions in the faster growing segments of the market, often with proprietary technologies where possible. Such strategic tuck-in acquisitions dominate the current mergers and acquisitions landscape. This is in contrast to the period from 2002 to 2007, which was highlighted by many high-profile transactions that were substantially driven by the need for scale. For example, General Dynamic Corp.’s acquisition of Veridian and Anteon, BAE Systems Inc.’s acquisition of DigitalNet, and L-3 Communications Corp.’s acquisition of Titan.

Companies in the industry are focused on acquisitions in high-growth areas such as cybersecurity; intelligence; command, control, communications, computers, intelligence, surveillance and reconnaissance; signals intelligence; and unmanned aerial vehicles. Prominent examples of transactions in these sectors include Cobham plc’s acquisition of Argotek, Raytheon Co.’s acquisitions of SI Government Solutions and BBN Technologies, NCI Information Systems Inc.’s acquisition of TRS Consulting, and Boeing Co.’s acquisitions of Digital Receiver Technology and eXMeritus.

As the most effective management teams seek to differentiate themselves from their competitors, many are seeking to use proprietary technologies to do so. Whether software, hardware or a combination of the two, companies that can deliver a more effective and efficient solution to their customers will be in the greatest demand.

Such companies tend to generate higher margins by delivering high-end capabilities along with the possibility of highly profitable software licensing revenue, as an example. When companies can deliver their proprietary technology and services to the strongest, most rapidly growing segments of the government market, they become the most attractive acquisition targets for acquirers. Consequently, those companies typically command the most favorable prices in the market.

Kratos Defense is an interesting case study of the implementation of a highly targeted acquisition strategy. During the past five years, Kratos completed six acquisitions to completely reshape itself into a government contracting business in excess of $350 million in annual revenue. Four of those acquisitions closed in a 24-month period that ended in December 2008.

Kratos sought to position itself in the following areas: ballistic missile defense, C4ISR, cybersecurity, unmanned aerial systems, electro-optical/infrared technologies and weapons systems sustainment. The four most recent acquisitions were Digital Fusion (for UAS technologies and EO/IR), SYS Technologies (for C4ISR, information assurance and cybersecurity), Haverstick Consulting (Aegis BMD, proprietary rocket technology and C4ISR), and Madison Research (weapons systems sustainment and foreign military sales weapons). Their geographic strategy centered on establishing strong footholds in regions benefiting from base realignment and closure activity, such as Huntsville, Ala.; San Diego; Hawaii; Washington, D.C.; and Fort Bliss, Texas.

Thus, we expect this tuck-in acquisition trend to continue as strategic acquirers remain selective in looking to find highly specialized companies before they are willing to part with precious capital in the current economic environment.

About the Author

John Hagan is head of the defense and government services group at BB&T Capital Markets | Windsor Group.

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