Market Watch

The emergence of the government technology sector, or GTS, as a hot investment opportunity presents important questions for owners and executives running privately held companies. These leaders are seeking insight into how increased investor interest affects both their business strategy and their exit strategy. As usual, the answer is it depends.Overall, the U.S. economy is in recession, with many sectors suffering from soft demand and a lack of near-term, identifiable sources of growth. Lenders and investors continue to be very cautious. But the GTS sector is on a roll. Increases in government spending in defense, homeland security and IT, coupled with outsourcing initiatives, have elevated the industry to star status. Expectations are high. Many companies, particularly those with strong capabilities and customer relationships, will deliver stronger growth over the intermediate term.These factors are bringing new investors to the industry. For the first time in many years, institutional investors are increasing demand for GTS stocks. The limited supply of public companies in the sector has produced a demand/supply imbalance, pushing prices and price-to-earnings ratios to unprecedented levels.Consequently, several midsize industry companies have completed Securities and Exchange Commission filings in advance of initial public offerings, with several more to follow. However, newly public companies will need to accelerate acquisition plans to sustain growth rates implied in their stock values. The result is an increase in the number of buyers seeking companies in the $30 million to $100 million sales range. Companies with revenue of more than $100 million will receive extensive attention from the widest array of strategic and financial buyers.For most executives, a sale of the business is the most probable exit strategy. They must, however, understand several things:? What attributes of their company are most attractive to buyers in the market?? What steps should be taken to increase that appeal? ? What is the best timing for an attempted sale? ? What sale process best fits the priorities and objectives of the company, its shareholders and employees? ? Whose help do they need in this initiative, from analysis and decision-making through execution? An analysis of about 60 GTS transactions since 1998 reveals some insights. Target companies with revenue in excess of $100 million realized transaction values at the median of 91 percent of revenue and 9.6 times earnings before interest, taxes, depreciation and amortization, or EBITDA. Companies with revenue under $100 million realized values of 65 percent of revenue and 6.9 times EBITDA, reflecting discounts of about 28 percent, relative to the larger sellers. So size matters.Sellers in all cash deals received, on average, pricing multiples about 20 percent below stock deals. For companies under $100 million in revenue in all cash deals, the pricing penalty was even greater, relative to stock deals with pricing discounts of over 30 percent on average. Form of consideration matters.Among companies sold, those with EBITDA returns on revenue of 7.5 percent to 10 percent received, on average, almost 60 percent more value for revenue than those sellers delivering 5 percent to 7.5 percent EBITDA margins. Profits matter.Clearly, a company's capabilities mix, contract base, customer relationships, management team and other factors weigh in the selling and pricing process as well. The selling process is complex and usually filled with unexpected occurrences. Hiring good advisers and doing your homework will not only increase your probability of closing a good deal, but will deliver a value 15 percent to 20 percent higher, or more.