Outsourcing draws buyers' interest in CSC, ACS

Outsourcing is the engine that is driving the interest behind a pair of acquisitions that are rumored to be in the works in the government IT space.

Hewlett Packard Co. and a group of private equity groups led by the Blackstone Group are the latest suitors looking to buyout Computer Sciences Corp., according to the Wall Street Journal.

Blackstone also is leading a group that wants to buy Affiliated Computer Services Inc. for $8 billion. The Journal reported that a deal could be announced next week.

Spokesman for the companies involved declined to comment for this story.

The impact on the government market is unclear at this stage as it appears that if both deals are consummated, CSC and ACS would continue to operate as independent companies.

In the CSC deal, HP would hold a minority stake in CSC with an option to buy the rest.

HP, which was flogged for buying Compaq Computers Inc. in 2002, likely is still gun shy about taking on such a large deal by itself.

The apparent structure of the acquisition with Blackstone would let HP "quickly establish a strategic relationship with CSC that, if successful, could later result in their full outright ownership of the business," said Bob Kipps, an investment banker with Houlihan, Lokey, Howard & Zukin.

"While a fairly difficult deal to structure , it could allow HP to essentially rent the car for a while before owning it," he said.

Private equity groups are drawn to CSC and ACS because the outsourcing business they play in generates strong cash flow. That cash flow makes using debt as part of the purchase very attractive, said Charles Chappell with the investment bank Minuteman Ventures.

For example, if half of the purchase for an outsourcing company is financed with debt, the cash flow over the next five or six years could pay that debt off. Meanwhile, the company continues to grow and when at the end of that five-or-six-year period, the private equity group sells the company it reaps a greater return for its original investment because that debt is paid off, Chappell said.

"There are big returns here, but there are also big risks," he said.

Lockheed Martin Corp. and several private equity groups pursued CSC in November but that deal fell apart. Lockheed Martin wanted to take CSC government business?about $4.7 billion of the company's $14.1 billion in 2005 revenue?while the equity groups would take the commercial business.

CSC ranks No. 4 on Washington Technology's 2005 Top 100 list, while ACS ranks No. 51 on the list.

Although the break up of CSC is not a given, splitting up the company is a possibility with any deal, Kipps said.