M&A activity set to rebound

John Allen is co-head of the defense and government services group at BB&T Capital Markets Windsor Group. 

The defense and government services sector experienced tremendous uncertainty in recent years. First, there was the global financial crisis that brought the economy to a halt. Coinciding with the onset of the crisis, the 2008 elections created significant uncertainty for the government contracting community. Such turmoil undoubtedly resulted in a reduction of merger and acquisition activity among defense and government services companies. With normalcy returning to the marketplace, diminishing uncertainty is leading to an improving environment for merger and acquisition activity.

The greatest overhang on M&A activity for defense and government services companies was the broader economic situation. Even the best-positioned companies and boldest executives were hesitant to enter the acquisition arena when the stock market was in a free-fall and credit was frozen. Although still off historic highs, the stock market has staged an impressive comeback during the past 12 months, removing one albatross from the necks of eager deal-makers. Credit, particularly of a senior variety, is still not consistently available. Yet strong companies are finding an ample supply of capital in a variety of forms. This is highlighted by ManTech International Corp.’s recent $200 million high-yield bond offering and ICF International Inc.’s $90 million secondary equity offering at the end of 2009. Momentum in the equity markets and the unfreezing of capital provide a solid foundation for resurgence in deal activity.

A changing of the political guard at the same time the economy appeared on the brink of collapse further stifled M&A activity. In the early days of the Obama administration, myriad issues concerning government contractors quickly entered the political debate. Discussions about the elimination of weapons platforms, government insourcing, and procurement reform dominated headlines and created tremendous uncertainty for contractors. The passage of time has resulted in greater clarity or consensus regarding the political initiatives of great importance to the contractor community. Several consistent and positive themes are starting to emerge. 

• Prospects remain bright for federal information technology spending. History has shown that in tight budget environments IT spending can increase as the government looks for ways to do more with less, as occurred during the Clinton administration. Given this tendency, it is no surprise that research firm Input Inc. recently announced that the federal IT market is expected to grow at a 5.4 percent annual rate to a total of $111.9 billion by 2015. Input also projected that cybersecurity spending will grow at a compound annual growth rate of 8 percent, reaching $12 billion by 2015.
• Preventing and deterring future conflicts is a primary strategic objective in the Quadrennial Defense Review. Companies that provide services in support of this objective will be in high demand. For example, Lockheed Martin Corp. built a sizable business in this area through its acquisitions of PAE and Eagle Group. Cerberus Capital Management LP's recently announced plan to acquire DynCorp International is indicative of sustained interest in international peacekeeping, nation-building, and other soft-power activities.
• Insourcing isn’t as easy as it sounds. It is a monumental task for the federal government to recruit a workforce with the talent and expertise to meet its growing and increasingly complex technical needs. Take into consideration the well-publicized fact that a large portion of the federal workforce is eligible for retirement in the coming years, and it seems increasingly unlikely that the federal government can mount an insourcing campaign that matches its rhetoric.

Defense and government services companies showed great resiliency in dealing with tremendous uncertainty during the past few years. Company executives in the sector demonstrated wise stewardship as they slowed merger and acquisition programs to wait for uncertainty to diminish. As the economy continues to stabilize and clarity concerning budget priorities returns, the pace of merger and acquisition activity in the defense and government services sector will accelerate.