Domestic programs offer ticket to growth

Market Share | Financial views of a competitive environment

As 2007 drew to a close, the public federal information technology services firms' stocks were up 22 percent, compared with the aerospace and defense firms, which had risen 34 percent, excluding the acquisition of EDO Corp. The overall stock market was up 2 percent as measured by the S&P 500.

Although growth generally remains sluggish in the federal IT market ? and budget battles delayed budgets again in fiscal 2008 ? revenue growth improved in 2007 after a slow start. This occurred because as strong contract awards in 2006 converted to revenue and after several years of tough budget environments for IT services, companies brought their cost structures and operations in line with their low revenue growth.

A handful of companies managed to gain significant market share and show strong, double-digit organic revenue growth during the year, including Stanley Inc. and NCI Information Systems Inc. ManTech International Corp. also appears poised to show solid, double-digit organic growth during the next several quarters following a strong pickup in contract awards.

The budget battles were particularly frustrating, with all but the regular defense bill being passed at the end of the year ? three months late.

Although the regular defense bill was the first measure to pass, it was without any supplemental spending bills. The first fiscal 2008 defense bridge supplemental bill passed at the end of the year was $70 billion, still far less than the $196 billion total fiscal 2008 supplemental request from the Bush administration.

A bridge supplemental will buy some time ? maybe through March ? but if Congress takes the rest of the supplemental spending bill down the same path as the fiscal 2007 one, we could see reprogramming of funds and delays to pay war costs in late spring and early summer.

This type of action led to weaker results and underperformance in the stocks in the first half of 2007, and it appears 2008 could be a repeat unless the remaining supplemental spending measure is passed before April.

Looking through 2008, President Bush's fiscal 2009 budget will likely be similar to the fiscal 2008 one, with defense priorities favoring large weapons and platform procurement and research and development initiatives over IT spending.

It will be interesting to see how the 2008 congressional and presidential elections will affect the fiscal 2009 budget process. I expect it will be a repeat of the fiscal 2008 process. President Bush won the budget and legislative battles with the new Democrat-controlled Congress in fiscal 2008, and the Democrats will likely try again harder in fiscal 2009 before the elections. As a result, I am not expecting a significant increase in federal IT and professional services market growth.

I still believe domestic priorities will be the focus of voters in the elections and therefore for the winning administration and members of Congress. Areas such as health care, energy, environment and education will probably see new government initiatives and require new IT and service programs to support them.

Although companies focused on defense programs have been the favored acquisition targets, I believe we will see a pickup in acquisition interest in civilian agency-focused firms during the next few years.

Bill Loomis is a managing director at Stifel Nicolaus. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. For additional information and current disclosures for the companies discussed herein, please visit the Stifel Nicolaus Web site.

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