Consolidation Shrinks Infotech Services Field
BDM's recent acquisitions are the latest signs of fundamental restructuring in the IT services business
P> Merger-mania continued last week in the professional services and systems integration industry as BDM International Inc., McLean, Va., announced its $18.5 million acquisition of three information technology services companies.
The companies -- CW Systems Inc., IG Systems Inc. and Melco Systems Inc. -- will form the core of a new IT Services Group based in Houston, which will focus on expanding commercial, state and local business. Together, the companies add $35 million in annual revenues to the $900 million in annual revenues BDM already generates.
But the acquisition reflects a more dramatic repositioning in the professional services industry. A clutch of companies -- most based in the Washington area or with significant operations here -- are using acquisitions to expand from their traditional base of federal government business into state and local markets and Internet services -- especially the building and designing of corporate chunks of Internet real estate known as "Intranets." Many of these companies had early government contracts to manage advanced communication systems for defense and intelligence agencies. Accordingly, they are positioning themselves as leaders in applying information technologies to large commercial organizations.
The top players include BDM; Science Applications International Corp., La Jolla, Calif.; American Management Systems, Fairfax, Va.; CACI International Inc., Arlington, Va.; EDS Corp., Plano, Texas; Lockheed Martin/Loral, Bethesda, Md.; Litton Industries, Woodland Hills, Calif.; DynCorp, Reston, Va.; Computer Sciences Corp., El Segundo, Calif.; and BTG Inc., Vienna, Va.
Together, many of these companies have been responsible for scores of acquisitions over the last two years, and acquisition specialists say conditions are ripe for more consolidation.
"This whole area is a hotbed of technical talent," says Jim Duggan, one of three partners for the investment banking company Boles & Co., Reston, Va. "This is talent developed and paid for by the federal government, and it can be imported into booming commercial markets. This is a services economy, so services is where it's at."
A number of converging factors are fueling this consolidation. Professional services and systems integration companies have few chances to sell stock to the public because many on Wall Street see them as government-only contractors.
But William Rabin, managing director at J.P. Morgan Securities Inc., says services are the safest way to play the technology market. In fact, he estimates long-term growth of 18 percent for the services market, which will generate more than $200 billion by 2000.
Nevertheless, unlike product companies, "services companies will always be undervalued [by Wall Street] because their assets can walk away," says Michael Daniels, senior manager for SAIC's Technology Applications Sector.
So the principals of smaller companies are eager to gain liquidity the only way they can -- by being acquired.
This is particularly true because the government budget crisis has caused cash-flow problems at many of the smaller companies. In addition, companies looking to exit the Small Business Administration's embattled 8(a) contracting program see being acquired as an attractive strategy for exiting the program.
For the acquirers, these smaller firms provide precious and relatively cheap engineering and technical talent -- the core asset of professional services and systems integration companies.
All this adds up to a buyer's market.
Among other things, the recent spate of acquisitions suggests it is easier to expand through acquisition than through internally generated growth. DynCorp, for instance, has used acquisitions to expand from defense to civilian agencies. It has built a $300 million information technology services business in just five years.
BTG's acquisition last fall of Concept Automation Inc., Sterling, Va., is part of the company's strategy to move aggressively into commercial and civilian government markets. BTG has grown from $27 million in annual revenues in 1991 to $155 million in 1995.
SAIC last March purchased the Internet engineering firm Network Solutions, Herndon, Va., to move into Internet services. SAIC has been one of the most aggressive acquirers -- quietly making nearly 50 acquisitions over the last several years to build a business with approximately $2 billion in annual revenues and a whopping 5,000 active contracts.
In the meantime, defense contractors are buying their way into the professional services and systems integration business. Litton Industries paid $425 million in cash last December for the professional services and systems integration company PRC Inc., McLean, Va. Last month, Lockheed Martin purchased Loral Corp., New York, N.Y., which had purchased the systems integrator IBM Federal Systems Co., Bethesda, Md., in January 1994.
But these are just the most prominent deals. Acquisitions of smaller professional services companies will continue. Of the 1,100 or so members of the Northern Virginia Technology Council, Duggan believes about 400 are good candidates for acquisition in the next two or three years.
What remains to be seen is how many of the present leaders in the industry are able to gather this talent under one corporate umbrella and survive as independent companies.