Leidos makes product play in $1.65B Dynetics deal

The biggest tech contractor in the federal market is set to get bigger.

Reston, Virginia-based Leidos said Tuesday it will acquire employee-owned technical services and hardware provider Dynetics for $1.65 billion in cash to gain more of a foothold in technology areas such as hypersonics, space and weapons systems.

The deal also extends Leidos further into an area it has increasingly talked about and bid more work in: products. Whereas Leidos' merger with the former Lockheed Martin IS&GS business three years ago was focused on services and building more scale there.

As CEO Roger Krone told investors Tuesday: “an increase in product mix to better balance the portfolio of services and solutions was something that we aspired to"

Leidos has bid on an increasing amount of that type of work as that piece of the business has grown organically. "The opportunity to combine with Dynetics, who already has a nice portfolio of products, fits well with that strategy," Krone said.

The Defense Department has identified seven key emerging technology priorities and Krone said Dynetics has capabilities in five of those areas: hypersonics, space, weapons systems, directed energy, artificial intelligence and microelectronics..

“Dynetics also brings proven capabilities in rapid prototyping, agile systems integration and production, threat analysis and emulation, and contract (research and development),” he said.

The prototyping and production piece of Dynetics comes into play when considering the Leidos Innovation Center, which is the company's internal research-and-development and technology incubation organization.

For instance, the LINC is one of four contractors working on a program for the Missile Defense Agency to develop space sensors that can track hypersonics and ballistic missiles. Dynetics for its part is also involved in sensors, autonomy and sensor signal processing technologies.

Leidos' vast IT services business that includes IS&GS may not see much synergies from Dynetics, executives said. But the LINC and R&D-focused government customers are where those synergies are more likely to be found, Chief Financial Officer Jim Reagan said.

“Think about programs at DARPA (Defense Advanced Research Projects Agency) where they have hardware and manufacturing capabilities that when you combine them with our services offerings on our more technology-focused businesses that’s a great synergy opportunity,” Reagan said. “Also think of space programs where again the engineering and high-end tech opportunities that we see there are really going to spring from the technological capabilities that Dynetics brings to us.”

Both companies expect the transaction to close in the first quarter of 2020, after which Dynetics will operate as a subsidiary and continue to be led by CEO David King.

Dynetics is headquartered in Huntsville, Alabama -- a key location Leidos wanted to expand in given the presence of both the Army and NASA in that city for rocket propulsion research.

Other agencies that Krone said Leidos will have increased access to in Huntsville include DARPA, Defense Intelligence Agency and Special Operations Command.

“The FBI is also increasing its presence in Huntsville and our expanded footprint in this region will position us well to meet their growing needs,” Krone said. “Increased penetration with these customers will help grow the opportunity space for customers which have seen a surge in funding in recent years due to alignment with the prioritized mission and technology sectors.”

Dynetics will add 2,300 employees: of which 1,000 are engineers and 1,000 are technical specialists with 94 percent of all direct staff cleared. Leidos currently has 34,000 employees.

Leidos expects the deal to add nearly $1 billion in annualized revenue for 2020 and $110 million in adjusted earnings before interest, taxes, depreciation and amortization expenses. The addition of Dynetics will pus Leidos' annual revenue to close to $12 billion.

The deal values Dynetics at a forward EBITDA multiple of 12.6 times when adjusting for a nearly $265 million tax benefit Leidos gains from the acquisition.

It was only last month that Reagan gave investors a glimpse at what his company is seeing in the M&A landscape: sellers looking to fetch high multiples in a market with more optimism than in years past.

From the sound of things, Dynetics appears to be worth the price for Leidos.

“When we thought about the valuation for us that multiple works really well given the historical growth rate of the biz as well as what the backlog and the quality of the backlog and pipeline for that business is,” Reagan said. “They really are in the fast current of what our customers’ priorities are and we expect them to really be accretive to the overall growth rate of the combined business going forward.”

Baird is serving as exclusive financial adviser to Leidos.  Skadden, Arps, Slate, Meagher & Flom LLP is serving as legal adviser for Leidos in connection with the transaction.

Jefferies LLC is serving as exclusive financial adviser to Dynetics and King & Spalding LLP is serving as legal adviser in connection with the transaction. Dynetics retained Grant Thornton LLP as accounting adviser and Avascent for strategic industry advisory services.