Contractors jockey for position on spending priorities

Reflecting on 2009, it proved to be a tough year for federal services companies. The industry as a whole struggled with delayed program starts (as a result of a contracting pause due to a change in administration), increased protest activity, insourcing initiatives, and an understaffed and inexperienced acquisition workforce.

Walt Havenstein, chief executive officer of SAIC, described the 2009 contracting environment as “increased oversight with an anti-contractor undercurrent.” Despite these challenges, the government services industry sees new opportunities emerging — many of which have been outlined in the 2010 Quadrennial Defense Review (QDR).

Spending increases are expected for the priority markets outlined in the 2010 QDR and proposed in President Barack Obama’s fiscal 2011 budget. The 2010 QDR, described as “truly a wartime QDR” by Defense Secretary Robert Gates, contains four primary objectives:

• Prevail in today’s wars; prevent and deter conflict.
• Prepare to defeat adversaries.
• Succeed in a wide range of contingencies.
• Preserve the all-volunteer force.

To accomplish these objectives, the QDR describes a number of priorities, including the necessity to provide our troops with the critical resources needed to be effective (advanced intelligence surveillance and reconnaissance and cyber capabilities), improving the ability to detect roadside bombs, increasing the number of special operations forces, and greater combat air patrols by unmanned aerial vehicles.

These priorities are reflected in the president’s proposed fiscal 2011 budget with increased procurement dollars and overseas contingency operations spending on reset, security, intelligence and IED defeat. George Pederson, CEO of ManTech International Corp., said Obama’s fiscal 2011 budget “makes a clear commitment to national security” with increased funding to support “vital missions such as intelligence, surveillance, reconnaissance, communications, and logistics and sustainment.”

Strategically, companies have been vying for position to be in front of these priorities. Cybersecurity was a major theme for 2009 and continuing into 2010, representing 14 transactions in the space. New and emerging players have entered the cyber domain through acquisitions – Harris Corp.’s acquisition of Crucial Security, ICF International Inc.’s acquisition of Jacob & Sundstrom, and Cobham plc’s acquisition of Argotek are a few examples. Addressing the demands of today’s wars, we witnessed SAIC’s acquisition of SET (for counter-improvised explosive device technology) as well as ManTech’s purchase of STI International (for command, control, communications, computers, intelligence, surveillance and reconnaissance).

Such merger-and-acquisition activity demonstrates companies’ renewed commitment to making investments in growth. Michael Laphen, CEO and president of CSC, said “We’re back in acquisition mode.” That statement is true of many of the public government services companies. In the first two months of 2010, SAIC completed four acquisitions, while SRA International Inc., ManTech, DynCorp International LLC, and CACI International Inc. have each closed one acquisition. Improving capital markets have contributed to the ability to be more aggressive on acquisition opportunities. Notably, ICF completed a secondary offing in December 2009, Stanley filed a shelf registration in January 2010, and ManTech amended its credit facilities to include a $550 million unsecured debt basket, all to assist in acquisition financing.

How companies are positioned in the market affects perspectives on growth in 2010 and 2011. CSC and DRC expect organic growth in the mid-single digits. SRA, CACI and Stanley Inc. described expectations of increased organic growth in the mid-to-high single digits. NCI Information Systems Inc. and ManTech both anticipate growth of 10 percent-plus looking ahead. Notably, ManTech anticipates 2010 growth in its cyber business in excess of 40 percent, and executives plan to invest more heavily in cyber research and development initiatives. In their recent analyst calls, most of the services companies commented that they will increase spending in bid and proposal activities to better enable them to win prime positions on large indefinite-delivery, indefinite-quantity vehicles. Companies' growth perspectives tie back to how they are positioned relative to federal spending priorities, such as those listed in QDR and others such as health information technology, environmental initiatives and intelligence.

No one believes that the threat to national security is going away. However, the budget deficit and the mounting federal debt will continue to place significant pressure on defense and civilian agency discretionary spending. There is no doubt that federal spending constraints will have an impact on the government services market. Company positioning in the current market environment is critical to a successful growth strategy. Accessing the capital markets to take advantage acquisition opportunities, investing in business development to access large contract vehicles, and building capabilities that include technology and/or products are key elements to successful growth in the long term.