Windows of opportunity

Booz Allen’s deal with Carlyle captures the top spot for 2008 acquisitions.

As Ralph Shrader led Booz Allen Hamilton Inc. through the first years of the 21st century, he knew fundamental changes were needed at the 94-year-old company.

Booz Allen, which was built on a partnership model as a commercial management consulting firm, saw its government business expand exponentially after the collapse in the late 1990s and the terrorist attacks in 2001. Although the double-digit growth was welcome, it complicated the structure and culture of the company.

“What you had was a firm that had grown up as a commercial strategic consulting firm that became a giant government technology consulting firm,” said Shrader, Booz Allen’s chairman and chief executive officer.

The government side of the business had 100 partners and 18,000 employees, while the commercial side had 200 partners and 2,000 employees. Three-quarters of the revenue and profits came from the government side. “Yet the business was still dominated by the commercial model,” Shrader said. “It was a fundamental instability, and at some point, I knew it had to be dealt with.”

After spending a couple of years examining alternatives, the leaders of the government and commercial sides decided the best course was to spin off the commercial business by forging a deal with Carlyle Group. In essence, the private equity firm paid more than $2.5 billion for the commercial partners’ share of Booz Allen. The commercial partners then formed their own consulting firm, now called Booz and Co.

The transaction, which was completed July 31, was one of 88 such deals in the government market in 2008, and a panel of merger and acquisition experts picked it as the best overall deal.

The panel evaluated all the deals that closed in 2008 in the government services market and picked the top ones in various categories, which included choosing dealmaker of the year, best private equity deal and best deal involving a foreign buyer.

Investment bank Houlihan Lokey compiled the list of transactions for Washington Technology. The total was 88 – 11 fewer deals than were recorded in 2007.

According to Houlihan Lokey’s analysis, buyers are concentrating on key market niches, such as training and logistics, program management, environmental work, cybersecurity, health care, and command and control. Access to contract vehicles was another important motivating factor for acquisitions in 2008.

A new player emerges
Several companies on the list, including ManTech International Inc., QinetiQ plc and BAE Systems Inc., made multiple acquisitions last year.

And Boeing Co., which hadn’t made a government technology-related acquisition since buying Frontier Systems Inc. in 2004, jumped back into the game in a big way by racking up five publicly announced acquisitions.

The company’s Integrated Defense Systems division acquired Tapestry Solutions and Federal Software Group for their military logistics and supply chain capabilities. Boeing brought in Digital Receiver Technology and Ravenwing to bolster its intelligence work. And the Insitu acquisition feeds into Boeing’s strategy for supplying unmanned aerial vehicles.

“We really upped our M&A efforts,” said William Bonadio, vice president of strategic development at Boeing Integrated Defense Systems. “We see it as an important part of our portfolio for strengthening our capabilities.”

The M&A plan is part of a strategy Boeing formulated nearly two years ago when it looked at its core capabilities and evaluated adjacent markets that it could move into, he said.

The company wants to acquire new capabilities to support current customers while also using acquisitions to gain access to new customers, Bonadio said.

“Boeing has taken a very thoughtful, disciplined and strategic approach to making acquisitions,” said Jean Stack, senior vice president in Houlihan Lokey’s government group. The firm represented Insitu in its sale to Boeing.

Boeing’s acquisitions have focused on companies whose products or services are central to customers’ missions, she added.

An eye on the niches
Boeing and other large buyers often are not focused on a single blockbuster deal. A more common strategy is to look for new technologies or customers.

For example, Computer Sciences Corp. acquired Log.Sec in part because of its record of growth and its strong customer relationships, said James Sheaffer, president of CSC’s North American public sector division. In addition, Log.Sec is part of the logistics and training sector, which is expected to grow significantly.

CSC will also consider making acquisitions in other high-growth areas, including health care, identity management, training and simulation, cybersecurity, and information technology infrastructure, Sheaffer said.

A third factor in the Log.Sec acquisition is the approaching impact of base realignment and closure activities, he said. CSC has a strong presence at military facilities in Morristown, N.J., but that work will be moving to the Aberdeen Proving Ground in Maryland, where CSC doesn’t have much of a presence, he said.
“We needed someone who knew how to operate in that community,” Sheaffer added.

Game-changing deal
Although large companies can use acquisitions to build capabilities or gain access to customers, a successful deal can have an even bigger impact on smaller businesses.

For example, NetStar-1 saw its revenue nearly double when it acquired Aviel Systems in April. NetStar-1 had about $100 million in revenue, and Aviel brought another $70 million, said Bill Strang, NetStar-1’s president and CEO.

But beyond revenue, the acquisition added a new line of business for the company, he said.
NetStar-1 now goes to market as an IT and management consulting company. The majority of the management consulting work –- which includes program management, acquisition support, and budget and financial analysis –- came from Aviel.

“We needed a broader customer base, and Aviel brought us some customers and some technology that we didn’t have,” Strang said.

Aviel also fit another important criterion: It grows organically without the help of government contracts set aside for small businesses, he said. The company expects to hit $200 million in annual revenue in 2009.

“You really have to maintain the organic growth because that is where you get the bang for your buck,” Strang said.

Know your buyer
As crucial as it is for buyers to pick the right acquisition target, it is equally important for sellers to find the right buyer.

As Shrader and his team at Booz Allen weighed their options, selling the company to a so-called strategic buyer –- an established company –- was the least attractive option, he said.

Because of Booz Allen’s size –- it had about $4 billion in annual revenue –- the buyer would have to be quite large.

“The challenge for a strategic buyer is the fact that Booz Allen is a very unique business with a very strong culture and a unique operating model,” Shrader said.

Much of the value of the company is derived from the strength of that model, he added.

A strategic buyer would need to figure out how to integrate Booz Allen into its own operations, and that integration would most likely destroy the value of the acquired company, he said.

That led Booz Allen to go with a financial investor and thereby retain its culture and operating model, Shrader said.

The two organizations, with Credit Suisse as Booz Allen’s outside adviser, began working on the deal at the beginning of 2008 and closed it July 31. Despite the tough credit market, “we had an oversubscription from people who wanted to participate in the financing and funding [of] the deal,” Shrader said.

Bob Kipps, managing director of investment bank KippsDeSanto, said that oversubscription was “remarkable and a huge testament to both firms’ reputations.”

The right window of opportunity opened for the deal, and Booz Allen moved forward, Shrader said. A delay into September could have made the deal much harder to close as the credit markets collapsed.

“I’m glad we got it done when we did,” he said.