Market Watch: Government services remain in the sweet spot

           
Some analysts and investors anticipate declining growth rates in the
government services sector, with large budget deficits frequently cited as a
barrier to continuing increases in defense and intelligence spending.

           
Although barriers to growth exist, several other factors offer a
rationale for continued organic growth in the 5 percent to 10 percent range. In
any analysis of the industry, it is essential to understand the overall drivers
of growth, as well as the effect of these factors on individual companies. Most
often, well-managed companies can capitalize on the opportunities and mitigate
the risk factors.

           
Four factors likely will contribute to industry revenue growth: continued
expansion of government outsourcing, defense transformation and rapid
implementation of complex technologies, sustainment of older weapons platforms,
and the government's preference for end-to-end solutions.

           
The move toward outsourcing functions appears unlikely to reverse in the
near future and is in line with trends among commercial enterprises. Private
companies and government entities alike are aligning their employee bases to
core competencies while outsourcing other functions. The demographic profile of
government employees implies a continuing need to turn over to service providers
those functions that are not inherently governmental.

           
Fueling increased support services requirements is defense
transformation, an ongoing process directed at better aligning military
strategy, platforms, systems and practices with the evolving threats that our
nation faces. Transformation, like many other government initiatives, also
involves assessing emerging technologies to determine whether to replace or
augment older systems.

           
Reduced funding for new weapons platforms requires replacing outdated
systems in platforms, including avionics, communications, sensors and fire
control systems. Testing, evaluation, installation, training, operations and
maintenance for all of these new systems involve significant services and
support.

           
Government agencies and military units that deploy these new technologies
frequently demand that their contractors deliver total solutions, including all
support services elements.

           
The complexity of these products and systems inclines the government to
want effective training, ongoing support and logistics along with the products.
In many instances, systems must be implemented in the field, outside the

United States

and in war zones. Implementation of these systems requires specialized training
tools, logistics and around-the-clock operational support.

           
A good example is the global communications infrastructure needed for
effective network-centric operations, especially satellite communications for
strategic and tactical operations. Rapidly deployable satellite capabilities
have been delivered to defense units at hundreds of locations around the world,
including many throughout

Afghanistan

and

Iraq

. Satellite terminals and communications electronics are being integrated into
trucks, trailers and other platforms to provide mobility and portability to
small and large military units alike.

           
These systems are being integrated into or connected to secure military
networks, packaged with bandwidth and supported by 24/7 network operations
centers.

           
Government and military users find that outsourcing the operations and
maintenance of new systems is often the most effective means of deploying and
operating the new technologies.

           
Taken together, these factors give well-managed government services
companies the opportunity to position themselves in the sweet spot of government
demand. In that spot, meaningful organic growth becomes more likely.

Jerry Grossman is managing director at Houlihan Lokey
Howard & Zukin in

McLean
,
Va.

He can be reached at jgrossman@hlhz.com.