M&A SPECIAL REPORT

103 deals chasing the next big thing

Contractors turned to M&A in 2012 as they anticipate new opportunities

Several factors were at play in the 103 mergers and acquisitions that closed in 2012, but two common themes were transformation and anticipation.

The prevailing wisdom says that in a market where budget uncertainty rules the day, investing millions in an acquisition might not be a wise use of resources. But government contractors are forever in search of the next hot opportunity. That above all else is what Washington Technology’s annual M&A roundup teaches us.

Government contractors are always attuned to customer demands and try to shape their offerings to meet those demands. In some cases, they make deals with a long-term goal in mind.

For instance, Science Applications International Corp. acquired maxIT last year for nearly $500 million. On the surface, the deal is another move to expand SAIC’s health IT capabilities in areas such as consulting and electronic health records.

But SAIC sees EHRs as a data platform that will bring more analytics and business intelligence to health care providers and improve the delivery of care, the company said. It is a vision that could take years to bear fruit.
A panel of M&A experts picked the deal as one of the top acquisitions of 2012 and the best in the health care category.

Reconfiguring to meet agency needs

With defense spending under severe pressure, smart contractors that rely heavily on defense customers are investing in areas that will likely be growing. Indeed, many of the deals that closed last year reflect customer demands or at least anticipated demands, which include cloud, cybersecurity, health and data analytics.

For instance, CACI International bought multiple health IT companies because it believes that, regardless of budget cuts, spending on health care will continue. The company was recognized as the best large-business dealmaker. CACI took the same approach to building its intelligence business a decade ago.

And intelligence spending is expected to be another safe haven, which explains why private equity groups such as Arlington Capital Partners continue to fund deals in the federal market. In 2012, the firm created Novetta Solutions by combining two companies and buying two more. It was picked as the best private equity deal of the year.

Again, the acquisition was driven by customer demand. In this case, Arlington Capital saw an opportunity to create a leading company that provides intelligence and cybersecurity services to government agencies through data analytics and identity intelligence.

KEYW Corp. was recognized as best overall dealmaker for its four acquisitions and for the best intelligence deal for one of those acquisitions, Poole and Associates. That acquisition also illustrates another trend among buyers: making deals to get access to specific contracts. Poole had just won a five-year, $150 million contract with an unnamed intelligence customer that KEYW considers one of its most important clients.

But besides following customer demands, two other trends drove the high number of completed deals. Both are related to divestitures.

In the first trend, companies reshaped their portfolios by divesting themselves of particular businesses — a move that is often driven by concerns about organizational conflicts of interest. SAIC’s sale of its test and evaluation business to American Systems Corp., which was picked as the best deal by a midsize company, is a prime example.

Such concerns can keep a company from bidding on certain contracts if other parts of that company have worked on the development of those contracts. Agencies are increasingly making companies choose one part of a project to bid on and do not allow them to bid on both components, no matter how the companies mitigate conflict-of-interest concerns.

Therefore, companies have started selling off businesses in hopes of letting both sides gain access to more opportunities.

In the second divestiture trend, companies are responding to tight budgets and pressures on profits by selling off businesses that are not central to their core strategies so they can focus their resources more effectively.

This is what led MorganFranklin to sell off part of its business to SRA International. The deal was one of three picked as the best divestitures of the year.

The role of federal budget uncertainty

Last year saw 103 M&A deals — 21 more transactions than in 2011. That again goes counter to our expectations given the budget uncertainty and tepid economy.

But in this case, the budget uncertainty aided the dealmaking because as 2012 was coming to a close, the country was facing the so-called fiscal cliff, which included changes in capital gains and other taxes.

Twenty-one deals were completed in December — far more than any other month of the year. The next busiest month was November, with 11 deals. Our M&A experts, who represent some of the leading investment banks and law firms, attributed the year-end rush to sellers, particularly entrepreneurs, who wanted to cash out their businesses before tax rates went up.

We expect the M&A activities to continue in 2013, though perhaps at a slower pace. And through it all, contractors will continue to listen to customers, track spending habits and invest accordingly.

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