COMMENTARY

Conditions are right for private equity buyers

Government market is increasingly attractive to buy out firms

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

How quickly the dynamics of a market can change.

Traditionally, larger, high-profile transactions in the government technology services sector were dominated by the larger strategic buyers. Although private-equity groups were active, their participation was best characterized by starting relatively small and growing in scale by financing multiple acquisitions over time. 

Given the attractive cost of capital in the public markets since the 2001 terrorist attacks, these private equity-backed firms often went public and eventually sold to strategic buyers that were typically able to outbid other private-equity groups competing to acquire those same companies. 

Examples include: Anteon (Caxton-Iseman) and Veridian (Monitor Clipper) both acquired by General Dynamics; DigitalNet (GTCR) acquired by BAE Systems; Apogen (Arlington Capital Partners) acquired by QinetiQ; and SI International (Frontenac Capital) acquired by Serco. 

More recently, we have seen large private-equity firms succeeding in securing a large number of high-profile transactions once dominated by strategic buyers. Examples include: SRA International’s recently announced sale to Providence Equity; Global Defense Technology and Systems Inc.’s sale to Ares Capital; Lockheed Martin’s divestiture of its Enterprise Integration Group to Veritas Capital; and Northrop Grumman’s divestiture of TASC to KKR and General Atlantic Partners. 

Three recent factors have converged to contribute to the increasing prominence of private-equity buyers in the market. The first is the decreasing level of interest in large government services companies from the large prime contractors. Increasingly stringent organizational conflicts of interest regulation on the part of many government agencies has made acquiring a services business more difficult. Consequently, such companies are less likely to bid aggressively, if at all, for large, diversified services companies. 

A second factor is the relatively low valuation levels of publicly held government services companies. 

At the time of this writing, for the nine companies in our government technology services stock index, the median enterprise value to latest 12 months earnings before interest, taxes, depreciation and amortization was 7.6x. On a forward-looking basis, the median enterprise value to 2011 estimated EBITDA was 6.8x and the enterprise value to 2012 estimated EBITDA was 6.3x. These levels are well below the valuations enjoyed during the past decade, and the resulting high cost of capital negatively influences the ability and willingness of the publicly traded services companies to aggressively acquire. 

Lower public valuations are largely because of budget pressures, budget uncertainty, procurement delays and other industry headwinds that led to a median projected organic growth rate for the group in the 7 percent range. 

The third factor is the increasingly favorable credit environment. The credit markets started improving dramatically in the second half of 2010 as both bank and institutional investor interest accelerated to the point that many observers believe the market is beginning to rival the one experienced in 2007. For example, some of the more recent transactions highlighted above enjoyed leverage of 6 to 6.75 times last 12 months EBITDA. With debt available at those levels, in concert with their equity infusion, private-equity groups can be as aggressive, if not more so, as small and midsize strategic buyers. 

In fact, the two most recent transactions, SRA and GTEC, secured multiples of pro forma EBITDA approximating 11 to 11.75 times, generating a very attractive premium for shareholders at valuations well above the 7.6 times EBITDA median for the industry currently. 

Although we believe the future is bright for government services companies despite the headwinds, those three factors are not likely to change materially in the near future. In combination with the higher cost of public equity and the lower cost of debt, this is resulting in the continued susceptibility of publicly held government contractors to a private-equity buyout.

Reader Comments

Please post your comments here. Comments are moderated, so they may not appear immediately after submitting. We will not post comments that we consider abusive or off-topic.

Please type the letters/numbers you see above

What is your e-mail address?

My e-mail address is:

Do you have a password?

Forgot your password? Click here
close
SEARCH
contracts DB

Trending

  • Dive into our Contract Award database

    In an exclusive for WT Insider members, we are collecting all of the contract awards we cover into a database that you can sort by contractor, agency, value and other parameters. You can also download it into a spreadsheet. Read More

  • Is SBA MIA on contractor fraud? Nick Wakeman

    Editor Nick Wakeman explores the puzzle of why SBA has been so silent on the latest contractor fraud scandal when it has been so quick to act in other cases. Read More

Webcasts

  • How Do You Support the Project Lifecycle?

    How do best-in-class project-based companies create and actively mature successful organizations? They find the right mix of people, processes and tools that enable them to effectively manage the project lifecycle. REGISTER for this webinar to hear how properly managing the cycle of capture, bid, accounting, execution, IPM and analysis will allow you to better manage your programs to stay on scope, schedule and budget. Learn More!

  • Sequestration, LPTA and the Top 100

    Join Washington Technology’s Editor-in-Chief Nick Wakeman as he analyzes the annual Top 100 list and reveals critical insights into how market trends have impacted its composition. You'll learn what movements of individual companies means and how the market overall is being impacted by the current budget environment, how the Top 100 rankings reflect the major trends in the market today and how the biggest companies in the market are adapting to today’s competitive environment. Learn More!