DynCorp Tightens Acquisition Strategy

DynCorp Tightens Acquisition Strategy

By Bob Starzynski
Staff Writer

With commercial information technology company prices skyrocketing in the past year, DynCorp has shifted its acquisition strategy to the government sector, where skilled labor can be purchased at a better price.

The change in strategy means the company will make at least one large acquisition by year's end and finally turn its attention to raising capital in the public market.

Paul Lombardi, DynCorp's chief executive officer, told Washington Technology that his company will hit $2.5 billion in revenue by 2001, up from $1.1 billion last year.

To do that, the Reston, Va.-based government contractor must quicken its pace. Its 12 percent revenue growth rate each of the past two years must increase to nearly 25 percent in each of the next four years.

DynCorp's previous strategy was to buy its way into the commercial information technology market. But the company, which traditionally has done everything from systems integration work for government agencies to lower-end facility maintenance work, saw prices for commercial businesses zoom past reasonable levels.

"Organically, we can break $2 billion [by 2001]," Lombardi said. "To get past that, we will have to buy other businesses. [We] will access the public market either by going public or through a reverse merger," where the purchase of a public company would turn DynCorp into a public company. Lombardi would not specify a schedule for a reverse merger or an IPO.

Almost 90 percent of DynCorp's business comes from the federal government, through contracts with the departments of Defense, State, Agriculture, Energy and Justice, the Drug Enforcement Administration and the National Institutes of Health. The rest of the company's business is split between state and local governments and the commercial sector.

While DynCorp, with 16,000 employees, stands to gain much from a public stock market listing, it will have to convince investors the company will continue to grow its high-end IT business and pare back its traditional facilities maintenance work. That work, which includes such low-tech tasks as cleaning services and automotive upkeep, has always been a large part of DynCorp's business.

But since Lombardi took the helm 17 months ago, he has stressed growth in IT and technical outsourcing, which now accounts for two-thirds of DynCorp's overall business.

Like most other government information technology contractors, DynCorp made a strong push into the commercial arena in the past two years, where profit margins are healthier and industry growth is outpacing government work.

Last October, company officials said DynCorp had three acquisitions in its pipeline. Two of those deals never materialized.

In November, Lombardi met with his top lieutenants to evaluate DynCorp's acquisition strategy. The conclusion from that meeting was: Commercial IT companies are selling at too high a premium right now, but there are attractive deals to be found in the government arena.

"I know commercial contractors that have been getting obscene offers," said Tom Meagher, an analyst with Ferris, Baker Watts Inc. in McLean, Va. "It's cheaper to acquire talent through acquisitions than hiring by one-sies and two-sies."

To meet the demand for competent technical workers, companies have been paying higher and higher prices for commercial outfits. Lombardi, among others, thought those prices were too high.

"We did a lot of negotiations with very small companies that were very overpriced," he said.

At the November meeting, most of DynCorp's earlier strategy was kept intact - the $2.5 billion sales goal by 2001, an aggressive and quick approach to business, and a purer focus on information technology and away from the lower-end maintenance work. But Lombardi said that until that meeting, he may have been focusing too much on commercial growth and not enough on federal growth.

While commercial contracts may allow companies to rack up better profit margins and earning potential, government work provides better return on net assets, Lombardi said. The company is not abandoning all efforts in the commercial market, but Lombardi would like that part of the business to grow while prices remain high.

Regardless, DynCorp eventually will turn its attention to Wall Street, leaving behind its life as the third-largest employee-owned technology company in the United States. While Lombardi would not say when the company will go public, he did say it will need public-market equity in the near future.

According to Lombardi's calculation, DynCorp needs to buy a company or companies with $500 million in revenue before the end of 2001. One such acquisition will be made by the end of this year, he said. Those purchases can be financed in part through debt.

But Lombardi does not want to load up too heavily on debt. So the logical move is to either go public or buy a smaller, public IT company and use the acquiree's Wall Street listing as a back-door entrance to the public market.

An IPO "could happen in the next year, but I'm not saying that it is planned for the next year," said Lombardi. "It depends a lot on how the market changes."

The prospect of an IPO has been on Lombardi's radar screen since he took over DynCorp's top spot in February 1997 from Dan Bannister, who remains chairman.

Lombardi declined to comment on the possibility of a divestiture of the facilities maintenance - or technical services - work. But he did say that business is becoming a smaller part of DynCorp's puzzle as the IT business grows.

And, he added, "We have a track record of selling noncore businesses to pay down debt. But that will only happen when we need the proceeds and can get a premium for the business sold."

Wall Street places a higher value on IT companies that do higher-end systems integration work rather than maintenance work or simple reselling of equipment. Furthermore, IT companies with a stronger play in the commercial sector are valued higher than traditional government contractors because of the wider profit margins and explosive growth in the commercial sector.

DynCorp At A Glance
Headquarters:
2000 Edmund Halley Drive
Reston, Va. 22091
Homepage: www.dyncorp.com
Year Founded: 1946
Chairman of the Board: Dan Bannister
CEO: Paul Lombardi
1997 Revenues: $1.1 billion
2001 Estimated Revenues: $2.5 billion

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