Sparking an international buying spree

Market Watch | Financial views of a competitive environment

Merger and acquisition activity involving both domestic and international transactions is likely to increase substantially in the near term with companies being acquired that perform international services related to nation-building.

Just as the major defense platform companies acquired government information technology companies to follow budgetary dollars, a similar acquisition spree will involve government contractors operating internationally. A comparison between the 2001 and 2006 Quadrennial Defense Review (QDR) reports and the subsequent budget trends within the Defense Department and broader international affairs community reflects this budgetary shift.

The 2001 QDR report focused largely on transforming warfighting capabilities and emphasized our nation's ability, and right, to flex its military muscle if necessary to protect U.S. security interests. The 2006 report, however, recognized that pure military power is only one component of a broad strategy to achieve U.S. and global security.

A quick review of the language that was emphasized highlights the significant difference in tone and focus between the two reports. For example, the 2006 report collectively referenced the words humanitarian and reconstruction in the context of relief and assistance 45 times whereas the 2001 report did not make a single reference to those words. In addition, the 2006 report used the word interagency 47 times, while the 2001 report used it only once. The 2006 report clearly portrayed a different paradigm for the military.

The authors of the two reports viewed DOD's mission through two entirely different lenses. With the 2001 report being issued less than 20 days after the tragic attacks of Sept. 11, 2001, the committee had no real ability to contemplate or even comprehend DOD's new global and expanded mission.

Indeed, the 2001 report was issued at a time when DOD believed we could win the war on terrorism quickly and decisively. In contrast, the first chapter of the 2006 report is titled "Fighting the Long War." Moreover, the 2006 QDR recognized stability, security, transition and reconstruction (SSTR) as a governmentwide mission of increasing importance and identified military support to SSTR as a core mission for the first time in U.S. military history.

SSTR by definition is global in nature and requires a new set of disciplines that have long been the domain of the State Department and the U.S. Agency for International Development. In the 2006 QDR, DOD recognized the strategic importance of working with these and other organizations to achieve our global objectives. DOD funding for SSTR and civil affairs has increased significantly.

In addition, the 2008 budget request for State and USAID is $36.2 billion. This represents a growth rate of 21 percent compared to the 2007 estimated expenditure of $29.9 billion. Within the 2008 budget request is a request for $4.4 billion in aid to Africa, representing a 54 percent increase compared to the 2007 expenditures.

A recent large M&A transaction to capitalize on this budgetary growth is the acquisition of Pacific Architects and Engineers Inc. in late 2006 by Lockheed Martin Corp. for what analysts estimated was $700 million. PAE is a global U.S. government contractor providing a wide range of humanitarian, peacekeeping missions and nation-building in countries that are or could become threats through an economic, political or humanitarian crisis.

Lockheed Martin has established PAE as a separate business unit focused on international services.

Another transaction earlier this month further illustrates increased merger and acquisition activity involving international services related to "nation building." On Oct. 2, Tetra Tech Inc. acquired ARD Inc., a provider of consulting and technical services for international aid agencies, which has annual revenues of $110 million.

We anticipate a number of other acquisitions in this market during the next year as acquirers seek to follow the budgetary dollars. Companies looking to make such acquisitions should not underestimate the challenges they face. The serious barriers to entry in this space include language skills, global footprint, technical skills and recruitment of in-country employees.

About the Author

Rick Knop is senior managing director and head of international banking investment at BB&T Capital Markets, of Reston, Va.

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