Consolidation helps grow a mature market

From a detailed review of the merger and acquisition and public capital market activity of government technology services (GTS) companies for the past three years, one must conclude that this industry has matured. It also is clear that consolidation and M&A activity will continue for the foreseeable future to be a major driver of growth and shareholder value.

In the GTS industry, there were 300 reported M&A transactions from 2005 to 2007. About 180 different buyers acquired at least one company during that period, and 120 buyers made two or more acquisitions. Some of the most active buyers and the number of acquisitions each made, were:

For the larger publicly traded GTS companies, acquisitions have become a key component of growth, especially to supplement declining organic growth in recent years.

Also, with past performance as a big factor in contract awards, contractors must acquire past-performance credentials to land new customers. Acquisitions have become a core competency for these companies. Nine of the 10 publicly traded GTS companies acquired 44 companies during the past three years.

In addition, those companies that during this period experienced greater growth and profitability primarily from acquisitions achieved much higher valuations from the public markets.

Excluding SAIC because of size and MTC because of the control premium from its pending acquisition by BAE Systems, there is almost a direct correlation between valuation and earnings before interest tax, depreciation and amortization growth. The three GTS companies with the highest valuation metrics (enterprise value/EBITDA) are expecting the highest EBITDA growth from 2007 to 2008: Stanley Inc., ManTech International Corp. and NCI Inc. All three expect growth in 2008 from 2007 acquisitions.

The buying power of the nine publicly traded GTS companies is about $3.8 billion.

Expanding the list to the top 20 most active buyers of GTS companies — primarily by adding defense platform companies — the buying power of serial acquirers is more than $80 billion. CACI, which has been the most active and consistent buyer of GTS companies during the past 10 years, has made 25 acquisitions.

The other two major categories of active buyers of GTS companies in recent years are private-equity groups and foreign buyers.

More than 50 private-equity groups have purchased at least one GTS company. The 25 top private-equity buyers of GTS companies have more than $180 billion of capital under management.

As a result of favorable exchange rates and a focus on the largest military budget in the world, foreign buyers have become active acquirers. On a combined basis, BAE Systems plc, QinetiQ Group plc, Cobham plc, Ultra Electronics Holdings plc and VT Group plc have acquired more than $6 billion in revenue in recent years.

During this same three-year period, seven of the 13 publicly traded GTS companies were acquired.

There were three initial public offerings of GTS companies in this time period — SAIC, ICF and Stanley — resulting in nine publicly traded GTS companies today versus 13 in 2005.

The limited supply of large government services firms has resulted in a frenzied pace for acquisitions involving platform-sized companies or those with at least $100 million in revenue. But the core competency in M&A among serial acquirers of GTS companies has resulted in robust interest in GTS companies of all sizes.