In the current climate, some gain a clear edge

Merger and acquisition activity in the government services market was off slightly last year from the pace in 2005 but remained robust relative to historical levels.Altogether, 87 transactions closed in 2006. This issue of Washington Technology contains a summary of government services deals in 2006, including buyer, seller, business base and pricing, where available. A panel of industry advisers selected a top 10 list of noteworthy transactions that reflect industry trends. Although 2006 activity generally reflects the last two or three years, some trends and developments have emerged during the past six months that will impact 2007 deals.The transactions completed in 2006 reflect the wide diversity of buyers that continue to participate in government services M&A. Among the federal information technology companies, Science Applications International Corp. and Alion Science and Technology Corp. were active, having completed four transactions each.Lockheed Martin Corp. and General Dynamics Corp. continued buying services businesses. Lockheed Martin acquired five companies, including Pacific Architects and Engineers Inc., ISX Corp. and Aspen Systems Corp., while General Dynamics purchased Anteon International and FC Business Systems Inc.At about $2.2 billion, the Anteon transaction was the largest deal in the sector, and one that was noteworthy for its size, valuation level and delayed regulatory approval. Ultimately, a segment of Anteon's business was sold to Alion to address government conflict-of-interest concerns.Among the defense electronics companies, EDO Corp. completed two services acquisitions and DataPath Inc. finished one. EADS North America, QinetiQ Group plc and VT Group plc, which are all based in the United Kingdom or Europe, together completed six services acquisitions. Finally, private equity deals involving Golden Gate Capital and Carlyle Group, through Command Information Inc., closed acquisitions.In 2007, certain developments are likely to affect the pace, structure and valuation levels in many M&A transactions. Those developments are:Additionally, the existence of many large agencywide contract vehicles with long terms creates a winner-take-all mind-set for those companies and teams competing, producing more protest actions.Taken together, those factors contribute to increased uncertainty at the company level about the probability and timing of contract awards. Revenue visibility is decreased for company executives, owners and public market investors. For many, those factors suggest a higher likelihood of sluggish organic growth, earnings surprises and greater investment risk.On the buy side, companies lacking organic growth opportunities may intensify their acquisition initiatives, seeking targets with growth components in line with customer priorities.On the sell side, most companies will fall within one of two groupings. One group comprises the high-quality companies with sought-after capabilities, priority market participation, and insignificant set-aside revenues. Those companies will continue to attract strong interest and high-end valuations.The other group is the commonplace majority: small businesses with more common skill sets and significant set-aside revenues facing even greater scrutiny of their preference contracts by prospective buyers.As the recertification requirements become effective, valuations of the preference contracts will incorporate the decreased probability of longer-term contract retention, at least until the industry gains more clarity on the reactions of contracting officials to a loss of small-business credit.Arguably, the pricing pattern for M&A transactions in 2007 could become somewhat bipolar, reflecting strong pricing multiples for the high-quality group and much lower pricing multiples for the commonplace majority.Our insight about those issues will grow as the year unfolds.