ACS Extends Reach With Lockheed Unit Buy

With its planned purchase of Lockheed Martin IMS, Affiliated Computer Services Inc. moves from being a strong player in key state and local government niches to a broad-based integrator that can now reach big states and across large, complex projects.

ACS of Dallas has established a substantial business in recent years operating Medicaid and child health insurance programs for states around the country, but the acquisition of Washington-based IMS will take it into new areas, such as child support payments collection, operation of welfare-to-work programs and processing traffic violations, industry analysts said.

ACS has added "critical mass, new customers and agency expertise," said Bob Kipps, a senior vice president at the investment banking firm of Houlihan, Lokey, Howard & Zukin, McLean, Va.

"They're going to be a monster player in the state and local market now," said Tom Meagher, vice president of equity research at BB&T Capital Markets, Richmond, Va. Meagher's company upgraded ACS from a hold to a long-term buy following the announcement.

In the cash deal announced July 19, ACS agreed to pay $825 million to Lockheed Martin Corp., Bethesda, Md., which has been trying to divest its state and local unit for more than a year to focus on its core aerospace, defense and federal information technology business. The acquisition is expected to close within 45 days, following regulatory approval.

The IMS deal follows closely on the heels of ACS' purchase of the state and local business of Systems & Technology Corp., Malvern, Pa. On July 1, ACS purchased SCT's state and local unit for $85 million.

With these two purchases, ACS has tripled its state and local business and now joins Electronic Data Systems Corp. of Plano, Texas, and IBM Corp. of Armonk, N.Y., as one of a select group of systems integrators that can boast more than $1 billion of annual sales in state and local technology services.

For fiscal 2001, ACS is estimating state and local government revenue of about $400 million, and IMS is estimating revenue of $700 million. ACS officials said in a July 19 conference call announcing the IMS purchase that revenue from all lines of business would total $3.1 billion in fiscal 2002. At the close of business July 23, ACS stock was selling at $79 per share, with a 52-week high of $83.12 and low of $41.25.

Analysts said the deal will be equally beneficial to IMS, which is moving to a company that will try aggressively to exploit its strengths.

"This gives IMS a strategic boost," Kipps said. "They now have a strong, dedicated partner behind them, which is ACS."

In the conference call, ACS officials gave yearly guidance but not quarterly guidance for 2002, said Mark D'Annafalo, managing director of IT services at Duetsche Banc Alex. Brown Inc., Baltimore.

ACS may struggle through one or more quarters next year as it digests the acquisitions, said D'Annafalo, whose firm rates the company as a strong buy. "Growth is sometimes slow following acquisitions," he said.

Unlike some other integrators, ACS and IMS do not specialize primarily in IT services. Rather, they are almost entirely focused on business process outsourcing, Kipps said. The companies find ways to improve specific government services, and then literally take over the administration of those processes or services, improving efficiency and generating revenue for the customer.

ACS President and Chief Executive Officer Jeff Rich and other company officials said ACS is now a leading provider of business process outsourcing in the state and local market.

"We think this is an important vertical to be in, since it is larger than the federal market, it is growing as fast as our commercial markets, and less than 10 percent of the market is outsourced today," Rich said.

To augment its Internet expertise, an important part of business process outsourcing, IMS announced July 12 that it had hired 35 employees from Netgov.com of Chicago and Carta Inc. of Sacramento, Calif., and paid $500,000 for Netgov software. Those companies are no longer in business.

ACS will fund the $825 million IMS purchase transaction through a combination of a new $550 million, 18-month credit facility, borrowing on the company's existing credit facility and existing cash, the company said.

Following the closing, ACS will put in place permanent financing by issuing equity and bonds to replace the interim facility and reduce the credit facility. While the precise mix of equity and bonds in the subsequent financing is yet to be determined, ACS anticipates a $500 million equity offering and a $300 million bond offering.

ACS, which said the deal will be accretive to earnings, was one of the few companies looking to expand its state and local business that was large enough and performing well enough to swing the deal, Kipps said.

For its part, Lockheed Martin will apply the cash from the IMS sale toward its $9.9 billion debt, spokesman James Fetig said.

"It's a fantastic deal for both sides," Kipps said.

ACS has retained both Mike Daniels and Brophy to continue in their positions as the heads of SCT and IMS, respectively. Brophy declined to say whether he has signed a contract to remain with IMS for a specific period of time.

Brophy fought to keep IMS in Washington for several reasons, including proximity to its customer base and the capital city's status as both an international and technology center, he said.

Allowing the units to remain independent is an interim step until ACS' leadership determines which parts of the management of the newly acquired units are strongest and will remain with the company, Kipps said.

Some things to watch following the SCT and IMS acquisitions will be how well ACS integrates the new units, how happy the customers are with the service, and whether the management of these new units stays on with the new company following the acquisition, D'Annafalo said.

Ellen Zidar, an analyst with market research firm Input Inc., of Chantilly , Va., said ACS eventually will have to integrate its new purchases.

One thing ACS is not likely to do, however, is cut loose any of IMS' subject matter experts, because they have specialized knowledge of complicated, sensitive programs, such as child services, and that is not easily replaced, she said.