Private equity finds plenty to like in the government market

As the government market has improved, more private equity groups have stepped in with greater confidence that their M&A investments will pay off.

A pair of current themes across the government contracting landscape includes a fast-changing technology landscape for agencies and expectations of a new growth period for the sector, especially in the defense and security domain.

Couple those with a volatile global geopolitical picture and healthy capital markets and that gives private equity firms confidence with their investments in the contracting sector, according to Tysons-based investment bank KippsDeSanto. They advise on mergers and acquisitions in aerospace, defense and government IT.

Last year saw a renewed push by private equity firms into government contracting as 42 out of the 102 announced deals last year had their involvement, KippsDeSanto found in its analysis.

That was above the activity of 2012 at 39 transactions and 40 percent over the average of 30 deals for 2012-2016. Sequestration budget cuts took place in 2013 and fears over those affected deal flow shortly before and for years afterward.

But fast forward to 2017 again 12 out of 19 transactions greater than $100 million in enterprise value then had a private equity group involved, KippsDeSanto found.

Underlying these trends is the business model contractors that investors find to be reliable and stable over the long-term -- through the multitude of contract awards from agencies -- despite the current ongoing budget uncertainty.

“You have visibility into programs and trends and historical and future data that you do not have in other industries,” KippsDeSanto co-founder and managing director Kevin DeSanto told me. “There is a massive pipeline of opportunities that companies can build around and chase with multiple at bats and opportunities to grow these businesses.”

Along with that continual flow of contracting opportunities is the financial resources contractors must put in to operate the business. DeSanto cited the fact that government services contractors mostly require fewer capital expenditures to operate and have meaningful cash flow.

Also worth watching is the concept of a private equity firm acquiring a contractor that can then be used as a platform to make additional deals. An example of that is H.I.G. Capital: the Miami-based group that first bought NCI Inc. in August of last year and made a second deal for Whitney, Bradley & Brown three months later.

In fact, NCI CEO Paul Dillahay previewed that approach by H.I.G. in an interview with me in October after his company’s deal closed. With additional capital from H.I.G., he said the firm views NCI as the “platform from which they want to go and make more” deals.

“When these businesses achieve a certain critical mass and achieve some level of scale, you dilute the risk and then enhance the types of opportunities you can go after and become more attractive to potential strategic buyers,” DeSanto told me.

Perhaps ECS Federal is a more recent example of that kind of success story based on the late January announcement that it would be acquired by IT staffing company On Assignment for $775 million.

On Assignment sees ECS Federal becoming a $1 billion-revenue platform by 2021 through organic growth and more acquisitions, which ECS is no stranger to. ECS more recently acquired InfoReliance early last year and made two deals in 2015.

ECS expected to record $586 million in sales for 2017. It also has footprints in key IT areas like cybersecurity and modernization with a diverse set of customers across defense, civilian and classified customers.

And perhaps past history is an inspiration for private equity firms in the space. “There have been a lot of success stories over time with private equity firms making a living in this space or even just certain situations where groups have had one-offs in the space,” DeSanto said.