Lockheed to sell bulk of IT business

That Lockheed Martin is buying Sikorsky Aircraft for $9 billion isn’t a huge surprise. After all, over the last 20 years, Lockheed has earned a reputation for making bold moves and positioning itself for growth in the market.

So, given that context, it also shouldn’t be surprising that Lockheed Martin also announced today that it has kicked off the process of divesting the bulk of its IT business, either through a spin-off or an outright sale.

Lockheed Chairman and CEO Marillyn Hewson echoed what I’ve heard other executives say about the federal IT services market – it is highly competitive and the customer is extremely cost conscious.

“We have a proud legacy of being a world leader as an IT services provider,” Hewson said in a call with analysts. “However, market dynamics and trends have led us to believe these businesses may achieve greater growth … by operating outside of Lockheed Martin.”

Specifically, the company is looking to divest five major components of its Information Systems & Global Solutions business:

• Air traffic management
• Technical services
• Government/Enterprise IT
• Commercial cyber
• Government health care IT

It is also looking to divest the technical services business that falls under its Mission & Fire Control sector.

All told, these businesses have more than $6 billion in annual revenue and have profit margins in the mid-7 percent range.

The company is keeping mission IT and services, energy solutions and space and space services that are part of IS&GS. Those business will be absorbed into other Lockheed Martin sectors. IS&GS will go away.

Hewson also emphasized that while it is divesting its commercial cyber business, it is keeping its government cyber business.

“We are not exiting the cyber business. That is important, and we bring value to it,” she said.

But the other parts of the IT business face a market that has changed in recent years of sequestration, budget cuts, LPTA contracts and other factors that have made customers very cost conscious.

“It is increasingly difficult for us to be competitive under our standard business model,” Hewson said.

By separating these businesses from the rest of Lockheed, they’ll have their own business structure that will help the company to compete and grow, she said.

“These businesses need to have as cost-effective a structure as possible to survive in today’s market,” Lockheed Martin Chief Financial Officer Bruce Tanner said.

“We believe these are strong businesses with strong performance and strong programs,” Hewson said.

Hewson said that Lockheed Martin has been ranked as the No. 1 IT contractor in the market for 21 years. [A reference to the Washington Technology Top 100, even though she didn't mention us by name.]

“We think it is a premier asset, and if we can stand it up as a standalone company or find the right buyer for it, that will be the best thing for that business,” she said.

The company also has continued to invest in the IT business. As recently as October, the company acquired Systems Made Simple to bolster its health IT business and that business is now part of the divestiture plan.

But customer behavior has been hard to predict, Tanner said.

“As we went through different SMS competitions, we saw different acts by customers than we expected,” he said, such as breaking out parts of contracts and other twists.

The company has come to the conclusion that it couldn’t compete in the IT sector and create value for customers and employees if the businesses remained with Lockheed.

A divestiture is the best way to “create value and give employees the best chance of growth,” Tanner said.

“All of the business is extremely prices sensitive,” Hewson said. “We may be performing at the top of the heap, but if someone comes in at a lower price, our customer will move.”

Lockheed will likely know by the end of 2015 what it will do with the businesses. The company will reap more cash through a sale as opposed to a spinout, Tanner said.

But the company may do different things with different parts. It isn’t wedded to the idea that all the businesses will have to stay together.

While I’m not sure Lockheed was planning from the start to announce the acquisition of Sikorsky and the divestiture of the IT businesses on the same day, but the two moves send a definite message about where Lockheed sees its future.

In a way, the two portfolio shaping moves signal that Lockheed wants to make sure it remains in a strong position in the parts of the market that are higher margin and have longer sight lines into priorities and programs. It also wants to make sure that it is in markets where it can differentiate itself with its technology and not with pricing.

That’s why it is staying in the mission IT business and the government cybersecurity business because it can leverage investments in technology into advantages as it competes for programs.

The rest of the IT business should make a crown jewel for a company that has the right cost structure to make it competitive in a market driven by price.

One part of the divestiture plan that sticks out to me is the air traffic management business, where Lockheed has been one of the FAA’s largest contractors and has played a major role in creating the building blocks for the Next Generation Air Transportation System.

Lockheed has multiple products and it is a large international market. So if one piece will be sold separately from the others, my first bet would be on the air traffic management business. The commercial cyber business also is a likely candidate to be sold on its own.

And while a spinoff is a possibility, the fact that Lockheed isn’t announcing that as a plan from the start indicates to me that they feel confident they can find either find another company, a private equity partner or some combination to buy its IT businesses.

Whatever happens, we’ve entered the final chapter of Lockheed’s IT story and a new story is about to begin.