MARKET SHARE

Government IT Firms Hold Investors Favor

Bill Loomis

It is surprising how quickly investors can change their views of industries and business models. Stock markets tend to magnify these views on both the upside and the downside, as selling or buying momentum combines with human emotions.

Information technology service stocks have not been as out of favor with investors for more than a decade as they are now. Ironically, the steady, relatively stable, though slower-growth and lower-profit-margin government IT business is becoming favored by investors.

Valuations on many of the once high-flying commercial e-business solutions companies are below the valuations of government IT service firms, such as PEC Solutions Inc., Maximus Inc. and CACI International Inc.

Maximus, a leading state and local business process outsourcing company, reported better-than-expected fourth quarter results. Only a small portion of its revenue is IT-related, and that business has been weak for several quarters, as it has been for many companies in both the government and the commercial IT services space.

Most of Maximus' business is outsourced health and human functions from state governments, an area that has been very strong. Maximus' stock has outperformed the NASDAQ over the past few months, and other companies with long-term outsourcing contracts also have fared well, such as Electronic Data Systems Corp., Computer Sciences Corp. and Affiliated Computer Services Inc.

Despite lackluster revenue growth at the larger outsourcing companies, investors clearly are favoring more business visibility over growth, as evidenced by the fact that stocks of even the leaders in the e-business solutions segment, Sapient Corp. and Diamond Technology Partners Inc., are hitting new lows despite management's indicating support for estimates.

The slowdown has not escaped Europe, either. Highlighting this factor recently on the traditional side, Sema Group, an IT services company in the United Kingdom, issued a profit warning for calendar 2000. Other recent European disappointments include traditional players such as Getronics NV and Cap Gemini, and e-business names Framfab and Icon Medialab, as well as the U.S.' Razorfish Inc. highlighting problems in the third quarter in its Swedish business.

Nearly everyone believes the lower valuations in the IT services industry will spur consolidation. The question is: Who will buy?

Following Hewlett-Packard Co.'s announcement that it missed fiscal fourth quarter earnings expectations, the technology giant announced that it terminated discussions to acquire Pricewaterhouse-Coopers' consulting business, implying that price and retention became issues.

With that unit having trailing-12-months' (TTM) revenue of about $7.6 billion as of June 30, Hewlett-Packard would have paid 2.4 times enterprise value (EV) to TTM revenue at the high end of the discussed $18 billion valuation, and still 2.0 times at the low end of $15 billion.

With large companies like EDS and CSC trading at 1.4 times and 1.3 times EV to TTM revenue, respectively, the range had looked expensive in the current business environment.

The large outsourcing companies and other Big Five consultants could be acquirers of the fallen e-business IT service companies, though the market trends seem to be moving toward the strengths of those big companies, not away from them. Both KPMG and Andersen Consulting (to be renamed Accenture next year) could make acquisitions to better position them for their anticipated initial public offerings next year.

CSC still is trying to close its proposed acquisition of Mynd, making another near-term acquisition unlikely. EDS, IBM Corp. and Affiliated Computer Services could be consolidators, though. As noted before, the European IT services companies are wrestling with their own problems, making significant near-term acquisitions unlikely.

While consolidation in the commercial IT services industry seems to make sense, the uncertainty about the IT spending environment, as well as company-specific issues, likely will limit near-term deals.

Bill Loomis is managing director of the Technology Research Group at Legg Mason Wood Walker Inc., Baltimore. He can be reached at wrloomis@leggmason.com. Legg Mason Wood Walker makes a market in the shares of CACI International and PEC Solutions Inc. Within the past three years it has managed or co-managed an underwriting of Maximus Inc. and PEC Solutions. Electronic Data Systems Corp. is a Legg Mason Select List core holding. Maximus is a Legg Mason Select List compelling idea. This information is based on sources believed to be reliable but is not guaranteed as to completeness or accuracy and is not intended to be an offer to buy or sell any security. Opinions expressed are subject to change. Additional information available on request.

Reader Comments

Please post your comments here. Comments are moderated, so they may not appear immediately after submitting. We will not post comments that we consider abusive or off-topic.

Please type the letters/numbers you see above

What is your e-mail address?

My e-mail address is:

Do you have a password?

Forgot your password? Click here
close

Trending

  • POWER TRAINING: How to engage your customers

    Don't miss our Aug. 2 Washington Technology Power Training session on Mastering Stakeholder Engagement, where you'll learned the critical skills you need to more fully connect with your customers and win more business. Read More

  • PROJECT 38 PODCAST

    In our latest Project 38 Podcast, editor Nick Wakeman interviews Tom Romeo, the leader of Maximus Federal about how it has zoomed up the 2019 Top 100. Read More

contracts DB

Washington Technology Daily

Sign up for our newsletter.

Terms and Privacy Policy consent

I agree to this site's Privacy Policy.