Market Share | Congress puts 2007 spending bills on fast track

Investors' trepidation about slowing IT budget growth has prompted a drop in stocks of publicly traded federal IT companies. And it's no help that there is weakness in the overall stock market over concerns of rising interest rates and oil prices hurting global economic growth.

Defense and Homeland Security department budgets are the most important for the publicly traded federal IT companies, which, on average, derive 77 percent of their revenue from these budgets.

But in a bit of good news, it looks as though Congress could pass the Defense and DHS fiscal 2007 spending bills by or soon after Sept. 30, the end of the fiscal year.

The House had completed work, and the Senate had cleared the homeland security bill as this article goes to press, adding about $1 billion to the House version.

The Senate passed the fiscal 2007 defense authorization bill, but it still needs to complete work on the 2007 defense spending bill. Defense supplemental spending bills will continue, with the president's request of about $50 billion, as part of the fiscal 2007 defense spending bill. A $60 billion request is likely next spring.

Most civilian agency spending bills will take a back seat to the Defense and Homeland Security bills. As a result, we could see continuing resolutions for most of the civilian agencies until after the November elections.

Tighter defense budgets were a hot topic at the July 11 Army IT Day conference, held by the Armed Forces Communications and Electronics Association. The Army is facing budget pressures, with total funding from Congress coming in from $4 billion to $5 billion lower than the service believes is necessary, prompting delays for some non-warfighting programs.

As one of the Army's senior IT officials put it, IT spending is not stopping, but the tough funding environment is making it more challenging. IT remains critical to the Army's plans, although it will take a back seat to costs of warfighting and deployment if Congress tightens funding.

The soldier remains a priority for the Army, and the cost of equipping an individual soldier has exploded from $7,083 in fiscal 2000 to $25,980 today as a result of improvements in equipment, such as night-vision devices, body armor and communications. Personnel costs comprise 42 percent of the Army budget (30 percent for Navy and 23 percent for Air Force) and are difficult to cut. This puts pressure on other areas, such as IT, when money is tight.

Lt. Gen. David Melcher, Army deputy chief of staff for programs, who spoke at the conference, posed the question: Why is defense spending so low, as a percentage of gross domestic product, given the increasing global threats and responsibility of the United States? It's 3 percent versus 6 percent in the Reagan era, 10 percent during the Vietnam War and 13 percent during the Korean War.

It's a good question, but skyrocketing health care and entitlement programs, such as Medicaid, have been a large part of budget growth, putting pressure on other areas.

Although budget growth has slowed, well-positioned companies can gain market share in this large and still-growing market, driving double-digit earnings per share growth.

Bill Loomis is a managing director at Stifel Nicolaus, which acquired Legg Mason's Capital Markets Group in December 2005. He can be reached at wrloomis@stifel.com. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. For additional information and disclosures for the companies discussed herein, please write to: Stifel Nicolaus, 100 Light St., Baltimore, MD 21202, Attn: Research Department.