Will this marriage last?

Wall Street embraced the federal IT sector in 2002, but some worry that stock prices may be overblown

Joseph Kampf wasn't about to compete with the promises of six-figure salaries, nor with BMWs or assistants who'd pick up dry cleaning or wash cars.

So Kampf, president and chief executive officer of Anteon International Corp., waved goodbye to one of every five employees, mostly young techies who couldn't bear to turn those things down.

That was the late 1990s, when Anteon's conservative mahogany desks and bland beige walls were out of vogue with Foozball tables and open-air ceilings. When dot-coms declared they'd deliver a new Internet world on an investor-funded platter. And business plans began with a dream and ended in billion-dollar portfolios.

Now, however, it's government information technology companies such as Anteon that are riding high. Having outlived the dot-coms, they are seeing stock prices soar ever higher in a depressed market, as formally dismissive Wall Street analysts clamor for a piece of the action. Today, in fact, Fairfax, Va.-based Anteon is followed by 11 analysts and 160 investing institutions, and Kampf said he's welcoming back former employees who have ditched their get-rich-quick dreams and returned to Anteon's suit-and-tie traditions.

But Wall Street's sudden embrace of government contractors makes some industry observers wonder: Could the valuations of these one-time corporate stepchildren be climbing higher than their worth? And what happens when the commercial sector returns to health? Will these government IT companies be relegated once again to behind-the-scenes territory?

"Right now, it's the only place where something's going on," said Gretchen Guandolo, vice president of Updata Capital in Reston, Va., regarding the government sector. "That's not going to last."

But Jerry Grossman, managing director at investment bank Houlihan Lokey Howard & Zukin in McLean, Va., said he expects the companies to remain viable investments.

"Could demand be pushing the price higher than the fundamentals? Maybe," Grossman said. "But it's nothing like the tech bubble. That was pricing with a lot of air underneath. Here, we're talking about good, performing companies. This is not a concept. This is old-fashioned, real business."

COMMERCIAL MARKET SIRENS

During the tech boom, Kampf and his colleagues saw valuations that would mystify mathematicians.

"It seemed awfully odd that a company such as MicroStrategy had a CEO who was thirty-something and worth $13 billion," Kampf said. "It did one-fourth the revenue we did and had no profitability."

J.P. "Jack" London, chairman and CEO of CACI International Inc., Arlington, Va., said analysts, investors and even board members were constantly asking him the same question: Why isn't CACI moving into the commercial sector?

It's no wonder they asked. In the last five years of the 1990s, CACI's shares never scaled $24, mere pocket change -- and only 6 percent -- of MicroStrategy Inc.'s stunning $359.24 high.

Government contractors were seen as passe, and their executives as out of step with New Economy business leadership. They had to lean on contacts to land interviews with investors.

Ironically, they were expanding -- at rates of anywhere from 25 percent to 35 percent a year -- but their margins were deemed too skinny and their growth, too slow.

"People did not buy stocks based on revenue growth. People looked at balance sheets," said Cynthia Houlton, an analyst with RBC Capital Markets, New York. Government contractors didn't use "the greatest buzzwords and coolest PowerPoint presentations."

Some government contractors made modest attempts at entering the commercial market. In 2000, CACI created an e-commerce division that London dismantled about eight months later because he said it focused more on raising money than delivering product, a familiar refrain today. Veridian Corp. of Arlington, Va., launched one venture but terminated it before going public last year.

SRA International Inc. spun off five companies, four with commercial partners, all at a total investment of about $5 million, or 1 percent of its revenue. The Fairfax, Va., company sold or phased them all out by last June.

ManTech International Corp., also based in Fairfax, Va., sold all but one of its international commercial ventures.

They could see, or as London said, "could smell it, feel it coming out of my pores," that the boom would quickly go bust.

The younger crew of CEOs "were all engineers. They were all computer scientists," said Harris Miller, president of the Information Technology Association of America of Arlington, Va. "They never took a history course. They forgot the economy has its highs and lows. They'd only seen the highs."

Still, government IT executives said they could see how that headiness spread.

"You're 25 years old. You don't have a family. You have an engineering degree and an idea," said Ernst Volgenau, president and CEO of SRA, the company he founded 24 years ago. "What have you got to lose?"

But executives a generation older than the twenty-something dot-commers, such as George Pedersen, ManTech's chairman, president and CEO, have seen enough business cycles -- from IBM's commercial rise to President Reagan's defense increases -- to understand the ebb and flow of public-sector and private-sector spending.

"Fortunately," Pedersen said, "the market proved us right."

ON THE RISE ... AND GROWING?

With the collapse of the commercial IT market in 2000, coupled with a dramatic boost in defense and homeland security spending following the Sept. 11 terrorist attacks, government stocks have become bargain shopping for investors.

Last year, finding themselves on the courting end of the investment community, government contractors experienced the best public market of this sector in history. With seven defense-related initial public offerings last year, the government sector raked in more than $830 million in what was otherwise a poor IPO showing.

While sliding from highs posted last summer and fall, the share prices of defense giants Lockheed Martin Corp. and Northrop Grumman Corp. have still held a good portion of their gains since rising after the Sept. 11 terrorist attacks. Lockheed Martin closed Jan. 7 at $58.50 a share, compared to $38.32 Sept. 10, 2001, while Northrop Grumman closed at $100.43, up from a Sept. 10 price of $81.94. Since its public offering last May, SRA's share price skyrocketed to $29.36 Jan. 7, a 63 percent upswing from its original IPO price of $18.

Their rapid rise has caused concern that the prices of some companies could be too high to sustain, especially when the commercial sector returns to normal. Then, "the government sector, by default, is not going to be interesting," Guandolo said. "There will be more [investment] choices."

"The multiples over the last 12 months won't be sustained over the next 12 months," said Edward Bersoff, managing director of Quarterdeck Investment Partners LLC, a research firm based in Los Angeles. "2003 will be the turning point."

But Grossman argued that these companies' solid foundations will keep them strong. "These pricing levels have reason behind them. It's not wishful thinking," he said.

Regardless of when commercial business picks up, Kampf is confident that the government IT sector has demonstrated long-term staying power. "In the future we won't have all the limelight. We won't dominate Wall Street. But we will have a healthy place," he said.

Veridian's CEO David Langstaff agreed. "We are in this for the long term. I'm not going to over-promise. It's not a 100-yard dash. We've been in this for 50 years," he said. *

Government Computer News Staff Writer Vandana Sinha can be reached at vsinha@postnewsweektech.com

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