More Bite - Size Deals On Menu, Analysts Say

More Bite - Size Deals On Menu, Analysts Say

By Nick Wakeman
Staff Writer

The megamergers and acquisitions that rocked the federal information technology industry in 1997 have given way to smaller deals as many of the major players digest what they swallowed last year.

Industry consolidation continued apace in the first half of 1998, but with more bite-size deals. One exception is the June 24 acquisition of Austin, Texas-based defense contractor Tracor Inc. by General Electric Co. plc (GEC) of London for $1.4 billion. That purchase marked the only deal involving federal IT companies that exceeded $350 million in 1998.

By contrast, there were five deals worth more than that in 1997, analysts said.

Midrange companies, such as Nichols Research Corp. of Huntsville, Ala., CACI International Inc. of Arlington, Va., and FDC Technologies Inc. of Bethesda, Md., have dominated the acquisition scene in 1998. And systems integrator Nichols is on the verge of buying a defense-related IT company, company executives said.

A plethora of smaller companies, such as Vista Information Technologies Inc. of McLean, Va., and TimeBridge Technologies Inc. of Lanham, Md., are also cutting deals.

One reason megadeals in the federal market have stalled is that companies able to make acquisitions in the $1 billion range already have done so.

"They need time to digest those deals," said Douglas Schmidt, managing director for Legg Mason Inc. in Baltimore. "They probably have a little heartburn."

Another reason for fewer megadeals is there aren't many sizable, pure federal IT services companies left to buy.

And officials at those companies - Nichols, CACI, FDC, Anteon Corp. of Fairfax, Va., DynCorp of Reston, Va., and SRA International Inc. of Fairfax, Va. - aren't in the mood to sell, according to company officials and analysts.

"Look at most of the big government services companies, and there isn't any interest [in being acquired]," said Michael Mruz, chief executive of Nichols.

Analysts clearly don't expect a repeat of last year, which saw such massive deals as the $1 billion purchase of McLean, Va.-based BDM International Inc. by TRW Inc. of Cleveland.

"Almost all the deals are going to be for companies in the $50 million to $250 million range," said Jon Kutler, president of Quarterdeck Investment Partners in Los Angeles.

One trend that won't change any time soon is that commercial companies will fetch top dollar while government companies lag behind.

Richard Leggett, who primarily follows the commercial IT industry for Friedman, Billings, Ramsey & Co. Inc. of Arlington, Va., has seen multiples (a comparison of sales price to revenue) rise from an average of below one times revenue last year to 1.5 times this year for commercial deals.

Meanwhile, among the government deals that Schmidt has followed, the multiples remain just under one times revenue.

He said GEC's purchase of Tracor is considered huge at about 1.1 times revenues, but most sale prices for such government-focused companies remain at 50 percent to 85 percent of annual revenue. GEC is not affiliated with conglomerate General Electric Co. of Fairfield, Conn.

That differential has created an opportunity for commercial companies to increase their valuations at a lower cost by buying a government company rather than a commercial company with the same revenue, Kutler said.

For example, a government company with $10 million in revenues might sell for $6 million, while a commercial company with $10 million sells for $15 million.

Once those government revenues become part of a commercial company's bottom line, the government revenues are generally valued as highly as the commercial revenues by Wall Street because the company is viewed as a commercial rather than a government contractor, Kutler said.

Adding too much government revenue could fuel market perceptions that a company is shifting from a commercial to a government-related concern, he said. If a company wants to keep its commercial valuation, its government business should not rise above 40 percent, Kutler said.

Affiliated Computer Services Inc. of Dallas was successful with this strategy even though it added about $373 million in federal revenues when it bought systems integrator Computer Data Systems Inc. of Rockville, Md., last year, he said. CDSI's sales accounted for 40 percent of Affiliated's 1997 sales of $930 million.

What is driving consolidation in the government market for midrange companies? Niche capabilities that can strengthen their position in the market, according to company officials and analysts.

Some smaller companies are simply trying to take advantage of the consolidation trend to get big quick.

For example, Nichols bought Mnemonic Systems Inc. of Washington in April for $12 million, and announced plans to buy Welkin Associates of Chantilly, Va., one month later for an undisclosed amount.

Welkin had $18.4 million in revenue for its fiscal year that ended March 31. Mnemonic's work is primarily with the Department of Justice, while Welkin is an intelligence contractor that does systems engineering and analysis.

CACI ended 1997 with the purchase of Government Systems Inc. of Wayne, Pa., for $35 million, and signed a deal in May to buy QuesTech Inc. of Falls Church, Va., for $42 million.

Meanwhile, smaller companies like TimeBridge and Vista are practically building themselves from the ground up.

TimeBridge is a $30 million a year spinoff from Sylvest Management Systems Inc. of Greenbelt, Md., now part of FDC. TimeBridge is partnering with Quarterdeck Investment Partners to find acquisitions in the commercial and state and local government markets. In May, TimeBridge bought Orbase Inc. of Denver, a $6 million a year database consulting firm.

Vista began when a group of investors, led by James Duggan, Vista's president, bought General Analytics, McLean, Va., last year. Vista has made four acquisitions in the past year, including the June 22 purchase of the networking integration services unit of Johnson Controls Inc., Milwaukee. That pushed Vista over the $85 million a year mark.

But both Duggan and TimeBridge's president Bill Strang eschew the notion of buying companies just for the sake of getting bigger. Both companies are looking at specific niches such as network services and application development.

"If you don't put a good theme behind [the acquisitions], you won't do well," Schmidt said.

But the big-is-better approach is still a good strategy, Kutler said. Rolling together several slightly related companies into a larger one still creates value because a $250 million company has economies of scale that a $50 million company lacks, he said.

FDC and Anteon are good examples of government-focused companies building themselves quickly through roll-up strategies.

"Plus, there is the whole issue of what happens to you if you don't get bigger," Kutler said. "You won't keep up." n

Selected 1998 IT Acquisitions