MARKET WATCH

I don't know about you, but I feel much better about America today than I did two months ago. During the past year, the country seems to have been cleansed of excesses and mistaken priorities. Generally, the spirit of America is strong, and determination is steadfast as we confront a clear threat to our freedoms and governing principles. The recent disasters, on the human side and in the financial markets, seem to have created a strengthened base, a foundation from which sustained, healthy growth can emerge. Certainly, in defense and public-sector markets, there is widespread consensus that things are looking up.For now, we're in one of those rare periods when the government services and defense sector is viewed by investors as attractive, both in terms of industry fundamentals as well as relative to other industry sector opportunities.Price-performance ratios for government technical services companies in the public market reflect this combination of strengthening company fundamentals ? revenues, profits, cash flows ? and relative sector appeal. While industry growth rates should increase, the price earnings multiple in the government technical services group, of about 26, is indicative of growth rates that will be difficult for companies to achieve.This price/earnings level is about 50 percent above longer-term norms. Clearly though, there is good reason to be optimistic. The release of the long-anticipated Quadrennial Defense Review revealed a set of goals and initiatives that seem on point in our current environment for defense and intelligence activities ? and positive for technology-based contractors.It seems to me that many of these goals and initiatives are appropriate for civil government entities as well. Accordingly, absent misguided legislative or regulatory initiatives, such as the Truthfulness, Responsibility and Accountability in Contracting Act or the Abercrombie amendment, both of which would hinder outsourcing to the private sector, the government technical services industry should prosper well into the future.The principal elements of the defense review involve several main themes: ?Developing transformational capabilities; ?Focused modernization and recapitalization of legacy forces and systems;?Re-engineering infrastructure; ?Outsourcing functions where applicable to create greater effectiveness, and deal with government personnel shortages in a wide array of technical and specialty areas. While the entire review is directed at military and intelligence functions and assets, most of the underlying logic, as well as the prescribed action initiatives, apply to federal governmental units of all types. After all, the federal government is no different than the private sector in that it must adapt to changing external conditions, internal resources and priorities.Rapid technology changes in IT, communications, biotechnology and security, among other things, suggest that transforming government is timely, essential and, in fact, overdue. Like the war on terrorism, transforming government is a long-term process, an evolution rather than a revolution. The factors are in place to get moving now. At the highest level, the federal government must maintain a clear focus on policy and oversight. Government employees will perform this selectively, with most implementation outsourced to the private sector. The highest priority in contractor selection should be demonstrated performance at a competitive price, rather than minimally acceptable work on the cheap.Recent remarks by senior Defense Department officials suggest they recognize that a healthy government services and defense sector is essential to the government's success in achieving its goals. Should transformation initiatives gain traction and political support, government will regain the high ground as a career for distinguished thinkers and doers, as well as succeed in getting the results needed while spending taxpayers' money wisely. Before you accuse me of impersonating Pollyanna, remember that I'm talking about goals and direction here, not anticipated outcomes. Movement on transformation initiatives will provide the context for continuing health in the government services and defense sector. Solid companies serving government markets will be able to recruit and retain the quality of people essential to delivering on the government's responsibilities. Performance-based contracting will result in getting things done while providing the environment for company financial success. A strong following on Wall Street and in the capital markets will ensure that capital is readily available and valuations are strong.