First the Merger, Then the Mess

It wasn't many years ago that Wall Street sharpies were out peddling the idea that professional service firms could smooth out their earnings by maintaining a healthy mix of government and nongovernment business, which tend to move in different cycles. Corporate executives embraced the concept and embarked on an acquisition spree, generating untold fees for Wall Street.

But Wall Street fads are as perishable as a green banana. The same analysts and investment bankers are now out there peddling just the opposite theory -- namely that companies with a mix of commercial and government business are too complex for analysts and investors to value and that great "value" can be unlocked by selling off one business or the other. And once again executives are anxious to embrace any strategy that can deliver a short-term bump to their share prices.

That is the only explanation you really need to understand the rumored $10 billion bid for Computer Sciences Corp. by Lockheed Martin Corp. and a group of private equity funds. Lockheed would take the government contracting business, which this year will account for a third of CSC revenue, while the private guys would take the commercial business, where growth and profit margins are both under pressure.

You can be pretty sure the winners from such a transaction will be the private equity guys and the investment bankers, plus CSC's top executives, who no doubt are already busy negotiating the enhanced pay packages, or "golden parachutes," that will set them up for life. And you can be equally confident that the losers will include the taxpayers, CSC's employees and Lockheed's shareholders, all of whom are about to be fed a heaping helping of corporate malarkey.

Another loser will be the local economy. Although its headquarters is in San Diego, CSC is one of the largest employers in the Washington area, with 11,000 workers. Busting up the company is likely not only to reduce that number, but also to rob the region of a leading corporate citizen, a distinctive corporate culture and a growing and profitable enterprise that could be one of the "winners" in the coming industry consolidation.

If you want a preview of what is likely to happen to CSC if this deal goes through, consider General Dynamics' takeover of Veridian. In the two years since it was announced, key personnel and contracts have been lost as Veridian has been disassembled and shipped off in parts to various GD divisions. It is impossible from its opaque financial reports to determine if GD got its money's worth for the $1.5 billion purchase price. But the local economy surely has not benefited from the loss of a hard-charging company with a distinctive, entrepreneurial corporate culture.

Lockheed's interest in CSC, like GD's in Veridian, comes from a realization that the traditional military hardware business probably will decline in the future under intense budget pressures. Even in shrinking industries, however, executives cannot face the prospect of telling Wall Street that they can't deliver double-digit earnings increases in perpetuity. The only alternative is for them to drag their companies into other lines of business, usually through overpriced acquisitions.

Lockheed has less than a stellar record in this regard: Even today, Lockheed executives are likely to begin twitching uncontrollably at the mere mention of the world "telecom." Nonetheless, the Bethesda-based giant has managed to become the biggest player in the growing government information technology market, which now accounts for a disproportionate share of Lockheed's earnings growth.

But with the number of contractors willing and able to handle the government's mega-contracts now down to half a dozen, allowing two of them to merge will significantly reduce competition and drive up prices. And that's particularly true in an industry in which frequent teaming arrangements invite informal collusion and generate lots of competition-reducing conflicts of interest. Government contracting officers should be lining up outside the Federal Trade Commission to oppose a Lockheed-CSC hookup.

Nor is there any imperative for CSC to put itself on the block. This is a fine (if somewhat stodgy) company, formidable competitor and valued collaborator that has recently stumbled after years of steady, double-digit growth in revenues and earnings. On the commercial side, it has lost two big commercial outsourcing contracts while competition from India is squeezing its margins. In the government area, CSC is still smarting from poor execution of its big computer contract with the Internal Revenue Service, a dip in the flow of new contracts, and the sudden departure this summer of the head of its federal business. Before this week, its share price was down 6 percent this year.

These are the kinds of challenges that all companies face at some point. Good managers and directors figure out how to work through and overcome them. Lousy ones panic, cave in to the pressures from Wall Street and grab at any offer that appears to quickly enhance shareholder value.

Steven Pearlstein is a columnist for the Washington Post, parent company of Washington Technology. This column first appeared in the Washington Post Oct. 28. More of his columns are available at the Washington Post's Web site. Pearlstein can be reached at pearlsteins@washpost.com.

© 2005 The Washington Post Company

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