Conditions ripe for continued M&A activity

There has been no shortage of mergers and acquisitions in both the hardware and services sides of federal contracting in recent times, but what are the buyers looking for?

It’s a question on the front of minds for industry executives and other observers as the market’s M&A engine has picked up a lot of steam this year.

Just look at Northrop Grumman’s huge space bet with its deal to acquire Orbital ATK. DXC Technology is creating a government services powerhouse in the three-way merger of its U.S. public sector business with Vencore and KeyPoint Government Solutions.

Then there are CSRA’s defense and intelligence IT-focused deals in NES Associates and Praxis Engineering. And ManTech International’s buy of InfoZen for new IT modernization work at civilian agencies.

I’m pondering this as I follow the ongoing round of quarterly earnings reports from GovCon’s largest publicly-traded companies. The defense and aerospace companies reported this week and services contractors will hold their next earnings calls next week. Expect M&A to be a hot topic.

I also had the opportunity Thursday morning to listen to investment bankers and company executives at the annual Morrison & Foerster Federal M&A Outlook in Tysons, Va. There were common themes I heard from the panel with respect to buyers: growth in a new or emerging market, a pressure to get to scale. And of course there is the shareholder value mandate of increasing earnings.

Why the buying spree now? The bankers told us that debt and equity markets are favorable for buyers, which means they can pay more to match the higher valuations GovCon companies have now amid renewed confidence. That presents an opportunity to buy in specific areas or pull off a massive scale play.

Northrop’s move for Orbital eyes the addition of the latter’s “smaller, more agile response capabilities” on the subsystem level with the former’s “very large assets,” as Northrop CEO Wes Bush said Wednesday in his company’s third quarter earnings call. That combination comes amid a “dramatic shift in the way that our architecture of our space assets is being assessed,” he added.

Also look at L3 Technologies’ spree of acquisitions in the unmanned underwater drone area this year. The defense giant bought vehicle maker OceanServer Technology in May and has since bolted on several other companies in that domain. CSRA sees growth in defense and intelligence amid expectations for increased spending there and ManTech wants an increased presence with agencies looking to modernize their IT systems.

Then there is the rush by large services companies to bulk up even further amid a commoditization of some IT and other work performed at lower margins. Almost overnight, DXC is creating a top six services company with its three-way deal. DXC is also seeking to fulfill its shareholder value mandate with the separation or unlocking of the U.S. public sector arm.

Perhaps what General Dynamics Chief Financial Officer Jason Aiken said in their third quarter call Wednesday helps answer the question of what buyers want. General Dynamics spent roughly $3 billion on deals between 2009 and 2013 but has been conservative since with only one deal in 2014 for special operations logistics provider ARMA Global Corp.

That was followed by no buys in 2015, then the acquisition of underwater drone maker Bluefin Robotics in 2016 and the pickup of the former Advatech Pacific cyber product business in May of this year.

“While we've been fairly quiet on this front for the past few years, it doesn't mean that there hasn't been sort of activity under the surface in terms of looking and evaluating things that are out there,” Aiken told investors Wednesday.

“We will continue and will always look at deals that are accretive and are in our core, whether they're large or small," he said. "And in this case, a couple of them happen to come in."