Are CSC, GD the next candidates for spin-offs?

The last three years, the government market has seen several spinoffs of businesses by large government contractors.

Lockheed Martin spun off PAE and its enterprise integration group (now known as the SI Organization).

Northrop Grumman sold off TASC. L-3 Communications spun off Engility, and ITT created Exelis.

More recently, Science Applications International Corp. spun off SAIC and then renamed itself Leidos.

And finally, Exelis is planning to spin off its mission systems group.

Up until the SAIC split, the main driver was organizational conflicts of interest because work in one part of the business would exclude another part of the business from bidding on related work.

While that was an issue with SAIC, there also was a valuation factor that didn’t get much play with the earlier spin-offs.

According to a presentation by Brian Gesuale, senior research analyst with the investment bank Raymond James, SAIC and Leidos, which completed their split at the end of September, are worth more separate than they were together. And that’s a real motivator for companies looking at executing their own split.

At the end of 2012, SAIC had $10.95 billion in revenue and a share price of $11.81, Gesuale said Thursday at Raymond James’ 13th annual Government Services and Technology Summit.

Post-spin off, the companies have combined revenues of $9.86 billion and a combined share price of $16.34.

That higher valuation wouldn’t be possible with the companies were still under the same roof, Gesuale said.

For that reason, Gesuale and others think more spinoffs will happen because the splits can create significant value for shareholders.

After 20 years of consolidation, many large businesses have become generalists, but the current market rewards specialization. So, spin-offs can aid the shift in that direction as well, he said.

The big question in my mind is who are the likely candidates to have a spin-off?

Other than smaller divestitures, Lockheed and Northrop have probably done what they are going to do, but General Dynamics on the other hand hasn’t participated in this trend yet.

If they were to spin off their information systems business, would that create enough shareholder value to be worth it? Maybe.

You have to think there is some value that could be unlocked because it is a nearly $10 billion business.

Another company that comes to mind is Computer Sciences Corp. Mike Lawrie, the CEO, has shown little fear of making aggressive moves to reshape the business.

Spinning off CSC’s public sector business, which represents 36 percent of the company’s $15 billion in revenue, would be a dramatic change for the company.

But at the same time, you can make a strong argument that a government services business and a commercial services business don’t really fit together. There might be overlap in technology offerings, but the way the two markets buy is very different.

A CSC without its government business would function just as well, and vice versa.

It’s interesting to me that we have a market that is both ripe for spin-offs as well as more consolidation, particularly around the pure services players, where there is just too much capacity.

How the two trends interact, and the kind of opportunities they create will be worth watching.