DynCorp's State and Local Deal Not What It Seems

When DynCorp announced in April it was merging its state and local government unit with a California company, some analysts and industry officials surmised the company wanted to unburden itself of a business segment that was insignificant and unprofitable.

Nothing could be further from the truth, according to Holli Ploog, president of DynCorp Management Resources Inc., the state and local unit being acquired by TekInsight.com Inc. of Irvine, Calif.

"DynCorp's interest is in unlocking the value in its subsidiary companies," Ploog said. DynCorp's management, she said, believes that it may be more profitable in the long run "to spin off certain high-growth, high-profit areas than to keep them in the company."

Other analysts have taken her side. If investors perceive the growth dynamics of the state and local market as greater than the federal market, then it makes perfect sense to spin off the company either as a separate or public business, said Jean Stack, a vice president with the investment banking firm of Houlihan Lokey Howard & Zukin, McLean, Va.

"DMR within DynCorp is a small unit lost inside the larger company, whereas if it were on its own, then it could be valued independently for its own growth and risk dynamics," she said.

The challenge facing DynCorp was how to make such a company strong enough to compete on its own in the state and local marketplace, she said. The merger gives the companies a wider offering and deeper technical base to operate from. It also enables them to cross-sell their products and services to existing customers, Stack said.

Because DynCorp will be given about 40 percent ownership of TekInsight, some of the earnings from the merged companies will flow back to DynCorp's employee shareholders, she said.

"The merger is one of the most exciting and boldest moves in the state and local market in some time," said Tom Davies, senior vice president at Current Analysis Inc., Sterling, Va.

Davies said the merger combines old and new economy companies. DMR has a growing base in business process management and outsourcing, while TekInsight has some advanced software technology capabilities, he said.

The merger combines TekInsight's e-government capabilities with DMR's strong presence and customer base in the state and local market, thus creating a more complete company, company officials said.

"The combined entity should be able to leapfrog many competitors in the market," Davies said.

Still, not everyone is convinced.

"It is a very questionable deal," said one analyst who asked to remain anonymous. Because a merger such as this is a complex and difficult process, it may turn out to be harder than the company thinks to sustain its goal of $100 million in annual revenue, the analyst said.

"However, it might be a successful company with a smaller annual revenue anyhow," the analyst said.

Under the merger agreement, which must be approved by TekInsight shareholders, DynCorp of Reston, Va., would obtain about 40 percent of TekInsight's fully diluted, common equivalent shares. In addition, DynCorp would have three seats on the company's seven-member board, Ploog said.

She said DynCorp would limit its involvement in the company to the traditional setting or review of company policy through the board and refrain from interfering with the day-to-day management of the company.

The deal with TekInsight is one of several projects DynCorp has under way to spin off internal units as separate companies. DynCorp created AdvanceMed Corp. to sell health care related services, and DynRide LLC to provide transportation services to Medicare and welfare recipients.

TekInsight's stock closed at $2.37 June 7. Over the past year, the stock has traded from a high of $3.31 and a low of 62 cents.

TekInsight and the DynCorp unit are about equal in size and value, officials with the companies said. DMR has about 250 employees and expects to have sales of about $50 million in fiscal 2001, while TekInsight has about 200 employees and expects to report sales of slightly more than $50 million in fiscal 2001.

This means that when the acquisition closes in September the company will have business in excess of $100 million.

At that time, TekInsight will change its name, perhaps to DynTek, said Steven Ross, TekInsight's president and CEO, who said he wants to retain the DynCorp "heritage" upon merger.

Ross will head the company, while Ploog either will move to an unspecified corporate role or, at a minimum, continue to head her unit, she said.

To smooth the merger, the two companies have established six transition teams in the areas of contracts, finance, human resources, marketing, operations and sales, Ploog said.

Before the acquisition is completed, the teams are to report back to corporate management with recommendations regarding the company name and a possible consolidation of existing business units, she said.

The acquisition "should be fairly easy to digest," Ross said. He also said TekInsight intends to use its position as a publicly traded company to make more acquisitions.

"If their strategy is to become one of the top players [in the state and local market,] then growth through acquisition is the only way to do it," said Kimberly Baker, senior vice president of consulting at Federal Sources Inc., McLean, Va., a market research firm.

TekInsight owes its current success

partly to two major acquisitions of

Internet solutions companies made last year. TekInsight purchased Bigtechnologies Inc. of Boston in May 2000 for $1.05 million in stock, $150,000 cash and an incentive plan worth an another $650,000 in stock.

TekInsight purchased Data Systems Network Corp. of Farmington Hills, Mich., in August 2000 for convertible preferred stock with an approximate market value of $12.5 million.

As a result of these acquisitions, TekInsight now offers e-government consulting services, infrastructure planning and deployment, application development and legacy integration. These capabilities will be used to pursue opportunities where DMR plays, such as health and human services, justice and transportation business.

The two companies have contracts in about 17 states, Ploog said.

Ross said DMR is one of three companies that was selected to participate in a seat management contract in Virginia. He said the merged company will aggressively pursue seat management.

"This is a wonderful fit, because TekInsight has tools to support [seat management]," Ross said. n