Market Watch: Titan and Veridian deals ? Indicators or outliers in federal IT

Jerry Grossman

Lockheed Martin Corp.'s acquisition of Titan Corp. is the second
"big bang" of the summer, the first being General Dynamics Corp.'s purchase of Veridian Corp. The Titan transaction value of about $2.4 billion, including debt of nearly $600 million, is seen as very aggressive by many industry observers, relative to the expected fiscal 2003 performance of Titan.

Specifically, the transaction value will be about 1.4 times projected 2003 revenue and more than 17 times projected 2003 earnings before interest, tax, depreciation and amortization.

In the Veridian acquisition, General Dynamics paid about $1.5 billion in transaction value, including about $270 million in debt, or 1.3 times projected revenue and nearly 14 times projected EBITDA.

Each of these deals has additional considerations, such as tax benefits and working capital surpluses. But the critical questions are what do these large deals tell us about the shape of the federal IT sector, and are the valuations applicable to other federal IT companies, public or private.

As in other transactions, large and small alike, there are many individual attributes and issues, which are factored into transaction structure and valuation.

However, with those caveats, there are some implications to be drawn. First, these valuations are not broadly indicative of enterprise valuations for most other federal IT companies. Relative to the shape of the federal IT sector, these deals underline the increasingly large size of many procurements and the broad base of critical technical competencies and domain knowledge needed to successfully win them.

Both Veridian and Titan have attributes that few other "pure play" federal IT companies can match. Very few companies have their size, concentration in priority markets, technical competencies and long-running relationships with customers.

Both companies have large numbers of "cleared" personnel, essential for work with intelligence agencies and certain elements of the departments of Defense, Energy and others. It would take years to build a cadre of cleared professionals. Building, therefore, is not an option where the market opportunity is urgent and significant.

Also, technical competencies in command and control, network-centric warfare, missile defense and homeland security are critical to positioning large aerospace primes, such as Lockheed Martin and General Dynamics, in those priority sectors. Successful positioning requires that they have a professional services element big enough to handle major implementations, including program management, system architecture, programming and integration, deployment and support.

Strategically, there is a case to be made for both of these deals from an opportunity-cost or defensive perspective. That is, can a major player expect to stay abreast of industry growth opportunities without having the types of capabilities of Veridian, Titan and a few others? The option to paying a premium valuation may be many missed opportunities on major procurements, lack of business growth and diminished market valuations. After all, equity market pricing is based substantially on growth expectations, so paying a price above most other transactions to sustain or increase growth can be very rationally defended.

The Veridian and Titan pricing multiples are well above most recent deals, excepting certain transactions involving sales of companies serving intelligence agencies and selected priority customers. The revenue multiples are 30 percent to 50 percent above the norm for federal IT deals, while the enterprise value to EBITDA multiples are 50 percent to 100 percent above the typical transaction.

However, for a strong federal IT performer with 15 percent to 20 percent long-term earnings growth, 8 percent to 10 percent EBITDA margins and industry normal capital requirements, these transaction prices can be reconciled with solid valuation analysis.

Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va. He can be reached at jgrossman@hlhz.com.

About the Author

Jerry Grossman is managing director at Houlihan Lokey Howard and Zukin.

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