Deals consolidate IT clout

If General Dynamics Corp.'s proposed acquisition of Anteon International Corp. closes, five companies?Lockheed Martin Corp., Northrop Grumman Corp., Science Applications International Corp., Computer Sciences Corp. and General Dynamics?will control about $21 billion in annual IT contract revenue, nearly one-third of the government's IT budget.

And that's a conservative estimate, based on figures from Washington Technology's 2005 Top 100 list. It doesn't count acquisitions of companies outside the Top 100, nor does it include organic growth by these companies during fiscal 2005. So the real number likely will be higher.

But the number does illustrate several trends in the market over the last several years: Defense companies are relying on IT as one of their growth engines, and no matter how successful a mid-tier company may be, getting to that next level usually involves a sale.

The bar a midsized company must cross to be considered a tier-one company also keeps getting higher. Not too many years ago, the magic number was $1 billion in annual revenue. Today, it is closer to $2 billion and inching higher.

Just based on revenue, the shape of the government IT market looks like an oddly formed inverted pyramid, perhaps drawn by Salvador Dali?wide at the top, sloping quickly down before getting slightly broader at the base. The base is small businesses, which can't counter the large amount of dollars going to the biggest player, but at least have some stability from government programs.

In the middle are those midsized companies that can range anywhere from $100 million to more than $1 billion in revenue. These midsized companies are among the most active acquirers of small, up-and-coming companies, but they also are among the most frequent targets for acquisition.

The midsized companies play a vital role in the M&A ecosystem. They buy the small players. The large companies then buy the midsized companies.

This works as long as there are enough midsized companies making deals. If the middle shrinks too much, M&A activity in this segment of the market could decrease because small companies will not have a viable option when it comes time to sell.

Another effect to watch is the impact on partnering and teaming relationships, as more midsized companies are acquired.

Five companies control one-third of the market, while the government is trying to push more and more work to small businesses that fit into various categories such as 8(a), veteran-owned and HUBZone.

If you are a small or midsized company, and you can't fit into one of these designations, you'll either need to own a desirable customer set or have hard-to-find niche capabilities that go well beyond generic IT services.

Without those characteristics, it'll be a struggle to grow your company, and you'll likely be both an unattractive teammate to a prime and an unwanted acquisition target.