The conditions that made 2010 a stellar year for mergers and acquisitions promise to do the same for 2011.
Jean Stack (Jstack@hl.com) is director of the aerospace, defense and government group at investment bank Houlihan Lokey.
In 2010, merger and acquisition activity in the government services market reached an all-time high, with 102 announced deals worth an aggregate $13.3 billion.
Sellers took advantage of a confluence of favorable factors: low capital gains rates, credit availability, overcapitalized balance sheets, slow organic growth rates and aggressive pricing in priority markets.
The same conditions continue in 2011 as a number of themes have emerged that will dominate the M&A landscape.
1. The re-emergence of big deals. Although Ashton Carter, undersecretary of Defense for acquisition, technology and logistics, said the Defense Department wouldn't allow consolidation among the top tier, he said acquisitions and divestitures were unavoidable in the face of defense spending cuts. Although we witnessed in 2010 a continuation of smaller, focused transactions, with targets such as cyber companies, aggregate deal value increased 42 percent compared to 2009, driven by acquisitions of larger companies such as Stanley, VT Group, and DynCorp. Well-capitalized balance sheets and accommodating debt markets will likely advance that trend in 2011 as companies look to fill the void of slow organic growth.
2. Private equity as a formidable competitor to strategic buyers. As financial market conditions improve, private equity is becoming more competitive with strategic buyers and hence more active in making acquisitions. The number of acquisitions by private-equity platforms in the government services market increased from seven deals in 2009 to 13 in 2010, representing 9 percent and 13 percent of total deals, respectively. In addition, private equity has shown the ability to beat strategic buyers on price, such as Cerberus' acquisition of DynCorp and Veritas’ deal for Lockheed Martin’s EIG business.
3. Fewer OCI-related corporate divestitures. The Weapons Systems Acquisition Reform Act of 2009 prompted government officials and contracting officers to take a stricter stance on organizational conflicts of interest, which propagated corporate divestitures. However, with new regulatory provisions and greater clarity in the rules and mitigation plans, it’s unlikely that we’ll see divestitures of the magnitude of a Northrop Grumman/TASC or Lockheed Martin/EIG in the defense industry. That said, an increasing number of corporate divestitures for strategic reasons are likely, as defense contractors look to shed noncore assets.
4. New growth markets. Intelligence-, cyber-, and command and control-related acquisitions accounted for 40 percent of all transactions in 2010. Although there is little indication that this trend is wavering, new markets are beginning to emerge as areas of growth. In anticipation of the impending drawdown, troops brought stateside will need more training to ensure a high level of readiness. Companies that provide training support services will likely receive increased interest from prospective investors. From a customer standpoint, interest in the Special Operations Command continues to rise. The command has doubled in force size during the past nine years while its budget tripled during the same time period. As its mission continues to expand, its budget is relatively insulated from the cuts the major military branches will likely experience.
5. Continued public-company transactions. During the past year, we witnessed an increase in the acquisition of public companies as pricing from M&A transactions yielded higher valuations than public-market pricing: a 27 percent premium. In 2010, there were six acquisitions of publicly traded defense and government companies compared to one in 2009 and two in 2008.
Trends in mergers and acquisitions continue to evolve in a dynamic market. In a time of budgetary uncertainty, companies use mergers and acquisitions to better position themselves for growth. Companies that are focused in their strategy and optimally take advantage of their financial resources will likely thrive during challenging budgetary times.
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