Smaller IT Services Firms Beat New Path to IPOs

By Richard McCaffery, Staff WriterOne of the newest companies in a crop of privately held systems integrators is shaping up as the first to go public.AverStar Inc. of Burlington, Mass., expects to wind up an acquisition within a month and turn its attention to an initial public offering this spring, a top company official said."If the market is receptive, we'll do the IPO," said Michael Alexander, chairman and chief executive officer of Averstar, which does 85 percent of its business with the federal government. Its main customers are NASA and the Department of Defense."Financially, it would make sense if the markets are receptive to go public and use the funds for future acquisitions," he said. Alexander said he expects to decide in March or April.But analysts are mixed on whether smaller systems integrators will succeed in selling stock in 1999. The trend among integrators small and large is fast growth, and Wall Street is part of the push to get big. Analysts say size matters for three reasons: *A company needs size to attract institutional investors; *The market is shaky for small caps (typically firms with market values of less than $500 million); and *Competition is growing. Three years ago it was typical for technical consulting and integration companies with market values around $80 million to go public, said Dave Keil, an analyst at The Robinson Humphrey Co. in Atlanta. Not anymore.As a result, a clutch of private companies — all fast-growing government integrators — are thinking size first and IPO second. Companies like DynCorp, Anteon Corp. and SI International, all based in Northern Virginia, want to increase their top line before testing the market. "If you look at federal systems integrators like CACI, BTG and GRC, they're very thinly traded," said Paul Lombardi, DynCorp's president and chief executive officer. "Why? They're too small." The three integrators had 1998 revenues of $326 million, $351 million and $131 million, respectively.DynCorp, with expected 1998 revenues of $1.3 billion, is bigger but not big enough, said Lombardi, who expects to hit $2.5 billion in revenue by 2002. "At $2.5 billion, we've been told there would be shareholder interest," said Lombardi, who declined to set any kind of a timetable on an IPO for the Reston, Va., company.Joseph Kampf, president and chief executive of Anteon, Fairfax, Va., also wants to bulk up his IT services and engineering firm before a public offering. "We think you need to be in the $600 million to $700 million range," he said. "When we get closer to that range, we'll give it more serious thought." Anteon had revenues of $249 million in 1998.And Ray Oleson, chairman and chief executive officer of newly formed SI International, wants revenues of at least $250 million before turning to Wall Street. The Vienna, Va., firm plans to roll up government contractors in the $10 million to $65 million range to create a larger and ultimately public company.Oleson said some bankers advised him to go public by reverse IPO (purchasing a public company that's just a shell). He declined. "I decided against it because I thought it was important to build a solid base and have a solid management team," he said. Analysts set the revenue bar at different levels for an IPO, but all want to see some heft.Size and liquidity are key, Keil said. "Funds are larger and [managers] aren't able to take a large stake in small companies," Keil said. Wall Street is looking for companies with market values of at least $400 million, he said.Keil also said public markets are tight because the zoo is getting full. More than 60 technical consulting firms, most of them commercial, have gone public in the last two years, he said. "I think you're really going to have to have a story that differentiates you to go public in 1999," Keil said.For government integrators, size is especially important, since growth tends to be slower and profit margins are lower in the public sector, analysts said. Keil is strongly bullish on state and local IT markets and bullish on federal markets. "The good news is budgets have increased," he said. Thomas Meagher, an associate at Boles, Knop & Co., an investment bank in Middleburg, Va., doubts any small government integrators will pull off an IPO in 1999. "If you're below $250 million, it's going to be a tough row to hoe," said Meagher, who said it will probably take two years for the IPO market to settle down. "Internet companies are all that's going out so far." It wasn't always like that. Advanced Communications Systems Inc. of Fairfax, Va., went public in June 1997 and fared well. Its current market value: $119 million. The company, which offers systems integration and satellite communication services mainly to the Department of Defense, has grown steadily. Its 1998 income more than doubled, jumping from $2.1 million in 1997 to $4.4 million. Revenue more than doubled as well, soaring from $52 million in 1997 to $108 million.Bill Loomis, managing director of the Technology Research Group at Legg Mason in Baltimore, set the bar lower than other analysts. The public markets want to see revenues of at least $140 million (a market cap of about $100 million), earnings growth rates of 20 percent, high profit margins and expanding revenues, he said. "If you have a good story, then it's possible to go out now," he said.Regardless of when the integrators go public, all are growing rapidly. No question AverStar, formed in February 1998 by the merger of Intermetrics Inc. and Pacer Infotec Inc., has an appetite for growth. Alexander, who bought Intermetrics in 1995 and took it private, said growth is critical because the government is issuing bigger and bigger contracts. "In order to compete for them as a prime, you have to be larger," he said. AverStar had revenue of $130 million in 1998 and expects to hit the $500 million mark by 2003. The IT firm is seeking companies in the range of $30 million to $60 million with expertise in operations, systems design and year 2000 verification and validation. Oleson of newly formed SI International just bought Statistica Inc. of Gaithersburg, Md., and expects to close another deal by the end of March. Statistica had $30 million in revenue last year and has 300 employees. With the purchase of Statistica, SI has 306 employees. Oleson plans to be public in as little as three years.DynCorp's Lombardi said his one disappointment last year was that he didn't pull off a big acquisition, mostly because of the market slide in August. "In 1999, we're going to focus on key acquisitions and profitability," he said. DynCorp has acquired 19 companies since 1990, has 16,000 employees and a backlog that exceeds $4 billion. Sources said the company expressed interest in Boeing Information Services, which is on the block, but DynCorp officials refused to comment on a possible acquisition. Anteon's Kampf said he is looking at three or four deals in the $50 million to $400 million range and wants to close two this year. "The larger companies seem to have a leg up in government business," he said. Anteon has 2,300 employees and 1998 revenue of $249 million. Kampf expects to hit $500 million in revenue in the next 24 months. The only integrator interviewed who was lukewarm about acquisitions was SRA International Inc., Fairfax, Va. Ernst Volgenau, president and chief executive of the 1,700-employee firm, said he'll make an acquisition when appropriate, but he stressed it's not the company's main focus.SRA had $223 million in revenue last year, a 22 percent increase from 1997, and income jumped 30 percent to $6.4 million. Volgenau, who sees the company going public at some point, said his formula of organic growth and quality work has yielded growth rates similar to those achieved in 1998 for the last 10 years."We're not one of those folks that thinks you have to be a $5 billion company to compete," said Renny DiPentima, president of SRA's federal sector. DiPentima said SRA thrives in the space it is in — competing with system integration companies in the $250 million to $1 billion range. "I think many companies want to deal with a company where the chief executive officer is available to them. They don't want to wade through a 16-layer bureaucracy," said DiPentima, who joined SRA after 30 years at the Social Security Administration.