Tough times breed innovation, even in M&A

If there is a silver lining in today’s gloomy budget environment, it’s that tough times breed innovation.

Government customers don’t have the same level of resource, but the world is still a dangerous place, so their mission hasn’t changed.

It’s a worn-out cliché, but it still applies – they have to do more with less. Enter the innovative contractor, who can bring new technologies or commercial solutions or a new process to bear that can save money or increase efficiency.

There are plenty of opportunities for those contractors in today’s market and those are the companies that make the most tempting takeover targets for other companies in the market.

Innovation was a recurring theme during a panel on mergers and acquisitions at the Fairfax County, Va., Chamber of Commerce Government Contractor Symposium earlier this week.

The panel was led by John Song of the investment bank Houlihan Lokey, and it had two private equity representatives: Michael Lustabader with Arlington Capital Partners, and Mark Spoto of Razor’s Edge Ventures, as well as two executives from active buyers: Fred Funk, co-founder and vice president of KEYW Corp., and Peter Schuster, vice president of mergers and acquisitions at Science Applications International Corp.

The threats in today’s world are more significant and diverse, and at the same time, the government faces budget cuts. “And that causes disruption,” Spoto said. “It is an enormous opportunity for innovators today.”

How that translates into M&A is that buyers track what the government’s pain points are, and invest in companies that are delivering against those pain points.

For example, SAIC has invested in technologies that can deliver real-time analysis of data being collected by unmanned aerial vehicles, Schuster said. Another area of investment has been health care.

“We look at companies working where the government has a high priority,” he said.

For KEYW, that has meant looking at areas such as how to deliver data securely to mobile devices, and the impact of data analytics, Funk said.

But investing purely in technology is high risk, he said. Of the 16 deals KEYW had closed since it was founded in 2008, only two were technology driven; the rest were for services, he said.

Lustabader said Arlington Capital spends time talking to government customers to validate what technologies they are using, and what they need.

“You can get caught up in the trends, so we try to stay close to the customers and we like to invest in management teams, not technologies,” he said.

While a lot of companies are investing currently in cyber, mobile, cloud and analytics, what’s next on the horizon?

Funk offered the most surprising answer: Batteries. “That’s a real outlier, but it’s a big issue,” he said.

Lustabader said that there is more to come from mobile, analytics, the cloud, etc. “Those waves are still building and haven’t come to shore yet,” he said.

Spoto’s crystal ball is looking at high performance computing. “There are some amazing advancements on the horizon,” he said.

A second area he’s watching is software. “Everything being done today by hardware will be done by software soon. And that’s very disruptive,” he said.

Pattern recognition is going to move beyond military and intelligence applications, Schuster said. Also, keep an eye out for real-time pattern recognition.

Good stuff, and also another reason why M&A is important. Even if an individual deal is a yawner, few areas highlight trends and priorities quicker than where merger and acquisition dollars are being spent.