New IPOs hold great promise for services sector

The recent announcement of two industry initial public offerings—Booz Allen Hamilton Inc. and KEYW Corp.— is exciting news for the government services market. If successful, the IPOs will infuse capital and expand investor interest in the sector. The IPOs will also re-stock the publicly traded government services sector depleted by recent company sales, including the likes of Stanley Inc. and DynCorp. Booz Allen and KEYW represent two very different, but compelling case studies on why companies choose to go public and what company attributes contribute to IPO success. Examining these offerings in the context of the other industry IPOs since 2000 provides useful perspective.

Booz Allen is the classic example of the qualities you’d look for in an IPO candidate: a proven management team, historical track record for growth and solid financial performance, and strong brand recognition. The company was acquired in 2008 by Carlyle and management in a leverage buyout of the federal business. The $300 million offering target will fund repayment of debt incurred in the 2008 transaction. The Booz Allen IPO, like most, will not provide immediate liquidity to shareholders, but will provide a source of capital and liquidity going forward.

KEYW is a much different example in almost every way. The company is very young and relatively small ($116 million in pro forma revenue for calendar 2009), yet it operates in an attractive area of the market: cybersecurity services for the intelligence community. The company has grown rapidly through seven acquisitions, including most recently The Analysis Group and Insight Information Technology.

KEYW’s target capital raise of $100 million will be used to repay existing debt and for general working capital purposes, including potential additional acquisitions. In addition, the offering gives the company the ability to provide employees with public equity compensation components, an important tool for recruiting and retention of key employees. The appeal of this company to the public equity markets includes its proven management team (formerly at Essex Corp.), growth profile, its track record for finding and executing acquisitions, and its market positioning in the rapidly growing cyber and intelligence space.

Over the past 10 years there have been 15 government services IPOs , raising an aggregate of more than $2.5 billion in company proceeds and over $1 billion in capital for selling shareholders. Six IPOs occurred in 2002 during the post-Sept. 11 launch of the war on terrorism and national security ramp-up, with five offerings in 2006 at the peak of defense spending expectations and public market pricing.

Private equity was a significant shareholder in nine of the 15 industry IPOs of the past 10 years. Most of those private equity-backed companies had grown through a series of acquisitions before the IPO. Notably, all of the private equity-backed companies except ICF International Inc. and QinetiQ Group plc subsequently were sold, providing liquidity to all shareholders at a premium to the publicly traded stock price.

While an IPO can be an excellent choice for some, it’s not a viable alternative for the majority of companies. An IPO is generally not considered to be a liquidity event. Proceeds generally fund debt repayment and/or acquisitions. Where the primary objective is to fund acquisitions, demonstrable historical success by the company or its management team is very important. Providing a sound foundation for a vibrant post-IPO market is also critical, including significant institutional ownership, sufficient size (market capitalization), and ample analyst coverage. Once public, management will need to focus on quarterly financial performance and aspire to consistent annual earnings growth of 10 percent to 15 percent or more.

The current IPO interest in Booz Allen and KEYW is likely a function of the attributes of these companies that lend themselves to IPO success rather than a function of broader IPO market exuberance. Notwithstanding lower market multiples today relative to the 2002 to 2006 period, these two IPOs can provide enhanced access to capital, liquidity and motivational tools for management and employees, perhaps offset by the challenges of short-term earnings focus and public investor scrutiny. One thing is for sure, with the success of the Booz Allen and KEYW IPOs, others likely will follow.