Engility-TASC deal gets a warm welcome

The overnight reviews are in, and it looks Engility’s planned $1.1 billion acquisition of TASC is a hit.

At least when you look at the reaction on Wall Street, where Engility’s stock (trading under the EGL ticker) were up nearly 12 percent on the news that company had signed an agreement to buy TASC from General Atlantic and Kohlberg Kravis Roberts & Co., its private equity owners.

The acquisition fits the strategy Engility has followed since it was spun out of L-3 Communications in 2012.

“When we look at the marketplace for government services we know there has to be consolidation, and there is a decision to be made to be a consolidator or be consolidated, and we want to be a consolidator,” said Tony Smeraglinolo, Engility’s president and CEO.

A good acquisition for Engility is a company that can bring new customers, new capabilities and scale.

“You saw a foreshadowing of that with our acquisition last year of Dynamics Research Corp., which helped up pivot away from the Defense Department, brought us higher capabilities and moved us into the federal civilian space,” he said.

The $120 million DRC deal closed in January.

“When you look at TASC, it does all that with exclamation points,” Smeraglinolo said.

TASC’s strengths lie in the intelligence community where it is well-known as a systems engineering and professional services provider. Some of its capabilities include intelligence analysis, space systems architecture analysis, cyber forensics and cybersecurity, ISR operations, geospatial intelligence and secure cloud computing and mobile applications.

The company brings with it $1.1 billion in revenue and 4,000 employees.

And scale is critical to be competitive in the government services market because of the focus on cost and efficiency.

With the deal, Engility’s infrastructure costs – back office functions such as human resources, accounting and IT – will only go up incrementally, while the company’s revenue will nearly double to $2.5 billion annually.

“We’ve always been good at finding and delivering good people quickly,” Smeraglinolo said. And with the added scale of TASC, the value to the customer gets enhanced. “Now what we are able to do is provide the same great people wherever and whenever they are needed at even more attractive price points,” he said.

Applying Engility’s cost structure to TASC will help the business be more competitive. “To get their high quality people to be more cost-competitive is going to be very attractive to customers,” said Craig Reed, Engility’s senior vice president, strategy and corporate development. “That will improve their ability to win work in the future.”

There is very little overlap of customers and capabilities between the two companies, so there also are growth opportunities, for example, by bringing TASC's capabilities onto the large task order contracts that Engility holds and TASC doesn’t, including the Homeland Security Department's EAGLE II contract and the GSA Alliant contract.

They also are exploring areas where neither company bid as a prime in the past, but the combination should allow them to,” Reed said.

So, that’s the argument from the Engility point of view, but what about TASC? The company was spun out of Northrop Grumman in 2009 with great promise. But it has struggled to compete in a market that values low price above all else.

Revenue dropped from $1.6 billion in 2009 to $1.1 billion this year. Most of that can be attributed to a handful of lost contracts.

But the losses aren’t a reflection of TASC’s capabilities, Smeraglinolo said. “The losses don’t indicate a systematic problem with the way the company performed,” he said. “It doesn’t reflect the company’s ability going forward to compete.”

I contacted KKR and General Atlantic for comment on whether they considered TASC a good investment, but neither returned my phone calls.

But interestingly, the two private equity groups are not walking away from TASC. The deal is a stock transaction, and they will end up owning 51 percent of Engility going forward. Because of the way the deal is structured, they’ll only have 30 percent of the voting shares.

“It’s obvious the TASC investment did not work out for them,” said Larry Davis, a partner with the investment bank Aronson Capital Partners. “With that said, this transaction combined with continued strong execution by the Engility management team can still provide KKR/GA with a successful outcome.”

Another plus is that KKR and General Atlantic are known as strategic and patient investors, Davis said. “As significant owners of the business, they will be highly motivated to enhance shareholder value,” he said.

Kevin McCormick, a managing director with the investment bank Raymond James, held a similar view.

“It wasn’t a home run, but they bought TASC at the peak of the market, so retaining some ownership should allow them to recover that investment,” he said.

McCormick said that Booz Allen Hamilton’s relationship with The Carlyle Group is similar, where the private equity group holds a large stake in the company.

“Booz has done well and I don’t see [private equity] ownership being a hangover for the company,” he said.

A final question that may take some more time for me to ferret out is whether there were other potential buyers.

Smeraglinolo declined to comment on the process, but more information will come out when the company files its proxy statement in a few weeks.

He did tell me that as Engility looked for acquisition targets, TASC quickly rose to the top because of its size, customers and capabilities.

The company will continue to go to market with TASC's name, but everything else will be fully integrated.

TASC CEO John Hynes will become chief operating officer of Engility, and four more directors will be added to Engility’s board, bringing the total to 11. Edward Boykin, chairman of Engility and Peter A. Marino, chairman of TASC, will be co-chairmen of the combined company.

Given TASC’s size and the makeup of the board, the acquisition almost seems like more of a merger of equals than one company swallowing up another.

Smeraglinolo described it as transformational. And it probably is. Engility was ranked at No. 30 on the 2014 Top 100 and TASC at No. 54. The combination will likely push them into the Top 20.

So perhaps this isn't an end for TASC as much as it is a new beginning for a company that traces its roots back to 1966.

In any case, the proof will be in the pudding and will depend on how Engility applies its cost structure to TASC, and how that translates into contract wins.

The deal is expected to close in the first quarter of 2015.