BAE bulks up

After DigitalNet deal, company still hungry for more acquisitions<@VM>BAE acquires Alphatech

BAE Systems North America Inc.

Based: Rockville, Md.

What it does: Designs, develops, integrates, manufactures and supports a wide range of advanced aerospace products and intelligent electronic systems for government and commercial customers

President and CEO: Mark Ronald

Employees: Approximately 30,000

2003 revenue: More than $5 billion

Recent acquisitions: DigitalNet Holdings Inc. of Herndon, Va., for $600 million in cash and assumption of almost $93.3 million in debt in October; Alphatech Inc. of Burlington, Mass., for $88.4 million in November

William Shernit, president of BAE Systems Information Technology, said the company's purchase of DigitalNet gives the newly created IT unit the "critical mass" to chase large federal contracts.

Rick Steele

As officials at BAE Systems North America Inc. saw the federal landscape change, they decided to make some aggressive moves. Government agencies were contracting out more of their information technology needs, but they were bundling projects into fewer large contracts.

To compete for those, "you basically have to have a larger critical mass, the business funds, the people and the scope of the past-performance credentials to bid and succeed in that market place," said William Shernit, president of BAE's new IT unit.

The answer for BAE, the U.S. subsidiary of BAE Systems Plc of Farnborough, England, was to make acquisitions and raise the profile of its IT business by creating a distinct unit.

BAE made its first deal in October, buying DigitalNet Holdings Inc. of Herndon, Va., for which it paid $600 million in cash and assumed $93.3 million in debt. The company then combined its Enterprise Systems unit with DigitalNet to create BAE Systems Information Technology.

"This is a complementary merger, which now spans a wider breadth of the federal IT marketplace, and in doing that, we believe it allows us to play strongly into the need for information sharing and horizontal integration," Shernit said.

His unit will offer a suite of managed network services, IT applications and information assurance solutions for the day-to-day activities of federal departments and agencies, including the intelligence community and the Defense, Homeland Security, Justice, State and Treasury departments. It will provide network systems installation, software applications and hardware.

"The DigitalNet acquisition certainly accelerates [BAE's] penetration of the federal IT sector," said Jonathan Skinner, who oversees the business and technology services unit at Adams Harkness, a Boston investment banking firm. "It increases their presence in a sector in which a lot of companies are doing managed network services."

BAE Systems looked at several companies before buying DigitalNet. The combined capabilities of DigitalNet and BAE's Enterprise Systems prompted creation of a single unit instead of two separate but similar, independent operating organizations, Shernit said.

The acquisition moves BAE into the No. 9 spot on Washington Technology's 2004 Top 100, based on the two companies' 2003 IT contracting revenue. BAE ranked No. 12 on the list with nearly $888.9 million in prime contracting IT revenue. With DigitalNet's $255.7 million IT revenue for 2003 pushes BAE Systems total sales to $1.1 billion. DigitalNet was ranked No. 34.

BAE Systems likely will buy more companies to add to its IT unit, Shernit said, especially those that are worth more than $100 million and that will strengthen the company's overall strategy in national security.

"BAE has had its IT business for quite a long time, but it's just not had a quite high enough profile," said Jon Kutler, chairman and chief executive officer of Jeffries Quarterdeck, a Los Angeles merger and acquisition firm for defense-related IT companies.

The creation of the new IT division signals "that BAE intends to use this unit to make further acquisitions and is setting it up to be an integrator of companies," Kutler said.

During the next five years, Shernit expects the unit to grow 10 percent to 15 percent annually in both revenue and profit -- the same double-digit growth achieved during the past five years, he said.

Most of the growth likely will come from areas such as homeland security and defense, as well as from agencies that increasingly continue to contract out IT services.

The IT unit will hire about 1,000 employees during the next several years, Shernit said. Of the unit's more than 4,200 workers, between 85 percent and 90 percent have security clearances, he said. It will pursue a mix of prime and subcontracts from the $5 million-to-$10 million range to the $200 million-to-$500 million range.

"If you waited for the big trains to come along, you might find a lot of business flowing by, so you want to cover that whole market," he said.

At present, the IT unit covers a broad base of government agencies, including the Justice and State departments and the FBI, that need to share information for counterterrorism efforts and among themselves, Shernit said. But he declined to comment on specific contracts the IT unit will pursue.

The IT unit holds about 75 percent of its contracts as the prime, he said.

Although Shernit would not disclose the new IT unit's largest contract, he said its contract mix includes DigitalNet's largest award, the Justice Consolidated Office Network III contract, won in March 2003. DigitalNet was one of five contractors, along with BAE Systems, selected by the Justice Department for a $500 million blanket purchase agreement, according to Input Inc., a Reston, Va., market research firm. The Justice Department was DigitalNet's largest federal customer, Shernit said.

Although Shernit did not name other federal clients whose business he would solicit, he said the IT unit has a strategic consulting practice "that will allow us to better explore new markets and address those on a larger scale basis."

Although companies such as General Dynamics Corp., Lockheed Martin Corp. and Northrop Grumman Corp. have had separate IT divisions for years, Shernit does not believe that BAE Systems' started its own IT unit too late.

"It's like it's never too late to buy a stock that's increasing in value, and never too late to sell a stock that's decreasing in value," he said.

Shernit said the company has been in IT solutions and services for years, but less visibly than the other companies that have provided services to the broader federal IT market.

Staff Writer Roseanne Gerin can be reached at
BAE Systems North America Inc. this month purchased Alphatech Inc., a Burlington, Mass., company that specializes in image and signal processing, multi-intelligence fusion and intelligence systems for the Defense Department and intelligence agencies.

The $88.4 million deal for Alphatech followed on the heels of BAE's October purchase of DigitalNet Holdings Inc.

Alphatech is now part of BAE Systems Advanced Information Technologies, which operates under the company's National Security Solutions unit in San Diego. As part of a reorganization, the National Security Solutions unit, which designs and delivers large-scale information systems solutions, will move to Reston, Va., said William Shernit, president of BAE Systems Information Technology.

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