Political, regulatory winds batter M&A

As we look forward to 2009 and beyond, political and regulatory factors are affecting both organic growth and merger and acquisition activity for government contractors.

Many large, long-term indefinite-delivery, indefinite-quantity procurements are being protested. This has had a chilling effect on the government's acquisition initiatives and the industry's expected return on investment.

Specifically, the government's acquisition strategy for long-term IDIQs is being scrutinized and analyzed to eliminate the possibility of protest, resulting in protracted procurements.

Industry still must pursue these long-term, high-ceiling efforts and spend resources with the knowledge that the likely outcome is that all or most will win if there is a protest. A number of large IDIQ contracts, such as the General Services Administration's Alliant contract, have a long list of awardees. Other large IDIQ contracts that are near award are likely to follow the same pattern.

The delays and costs involved in bidding on mega IDIQ contracts are resulting in no privileged competitive sanctuary, depressed bottom lines and organic growth, and therefore, a reduction in M&A activity. Moreover, because of the large number of awardees on contracts, buyers are not as motivated to acquire companies that have so-called licenses to hunt.

All indications are that there will be a stalemate after Sept. 30 with agency leaders leaving and others focusing on transition to a new administration. The result will likely be a delay in awarding new contracts and task orders — further affecting organic growth and backlog — which are critical factors in M&A valuations.

Many companies under letters of intent to be acquired in recent months have had to recast downward their 2008 projected numbers because of various factors. Thus, some transactions have not gone forward and some have been repriced.

The biggest factor on the horizon is the impact of the record federal deficit this year on government programs and outsourcing partially because of the federal takeover of financial institutions such as Fannie Mae and Freddie Mac. The next administration and Congress will have to make difficult spending decisions that will affect programs and contractors.

A further concern to some buyers, especially commercial companies looking to acquire a federal platform, is increased congressional oversight of contractors.

Other regulatory issues affecting M&A and capital market activity for government contractors are the Small Business Administration recertification requirement on the sale of a company and more stringent enforcement of rules governing organizational conflicts of interest.

Buyers are carefully scrutinizing target companies to determine the effect of those rules and recertification on the transition of the business base of the target company.

However, some bright spots remain for government M&A and capital market activity. Because of the continued and accelerated retirement of federal officials and employees and the transition to a new administration, the government will have to outsource more acquisition support functions to government contractors that have both institutional knowledge and the requisite skill sets.

I anticipate more pure-play build-ups in this area because of increased outsourcing and organizational conflict-of-interest issues.

Other areas of government spending that will continue to be outsourced to government contractors are areas perceived as being high national priorities.

They include homeland security, intelligence, other defense and national security requirements, logistics, government and military health care, and nation-building activities.

Contractors with those capabilities and contract vehicles will be desirable acquisition targets.