New breed of M&A players heat up

Private equity groups and companies looking to make deals in the homeland security and government contracting market are about to face a new competitor.

Special purpose acquisition vehicles, known as SPACs, have started popping up as alternative financing vehicles in the public sector. SPACs are companies that have no operations but that go public with the intention of acquiring a company with the proceeds of an initial public offering. Large institutional investors, such as hedge funds, usually buy shares of SPACs.

In the public sector, these buyers are interested particularly in defense, information technology and homeland security firms in the federal, state and local governments.

Already, two SPACs, Fortress America Acquisitions Corp. and Federal Services Acquisition Corp., have gone public. If one of these two completes a deal in the next year, more SPACS likely will emerge, said William Mutryn, a partner at law firm Holland & Knight LLP. Mutryn said that between five and 10 new SPACs will enter the federal sector in the next year.


The appearance of SPACs in the government sector means that competition with private equity groups and strategic buyers in the government market will become tighter as SPACs go head to head with them to acquire companies.

Private equity groups have been in the federal market since the mid-to-late 1990s, said Paul Serotkin, president of Minuteman Ventures LLC, a Burlington, Mass., investment bank that provides merger and acquisition services. In the strategic buyer arena, companies such as Anteon International Corp., SI International Inc. and SRA International Inc. will face some pressure from SPACs.

"SPACS are going to compete directly with the private equity groups, and both of them are going to compete with the strategic buyers for acquisition candidates," said Mutryn, who specializes in mergers and acquisitions and corporate finance. "Competition between the three could sometimes result in a bidding war for the best company and probably increase valuations."

SPACs are part of a trend of alternative financing options in the homeland security and federal contractor markets. Reverse mergers, in which a private company becomes public by acquiring a publicly traded company, also are being used to a lesser extent. Together, these alternative financing options mean more buyers for government contractors in the $30 million to $100 million revenue range, Mutryn said.

SPACs themselves are nothing new. They've been in other industries, such as health care, logistics, media, retail and telecommunications for a couple of decades.

"The IPO market has been up and down and has not been really robust, so SPACs become a fairly safe haven in which institutional investors can invest and enjoy the liquidity of the public markets, which is what hedge funds like to do," said Harvey Weiss, chief executive officer of Fortress America Acquisition.

As of Oct. 13, 20 SPAC IPOs across all industries had raised nearly $1.2 billion, according to an article in the Oct. 18 issue of Red Herring magazine. That figure had increased since 2004, when 11 SPAC IPOs raised $475 million. The average capital raised in 2005 was $60 million, up from $40 million in 2004, the article said.

Fortress America Acquisition, which went public in July, raised $42 million in its IPO. The company is looking at about five candidates in the homeland security market, said Thomas McMillen, chairman of the company and a former Maryland congressman. He declined to name the companies they are pursuing.

In October, Federal Services Acquisition raised $126 million through its IPO. The New York company was founded by Joel Jacks, chairman and CEO, and Peter Schulte, the company's president and secretary as well as managing partner at private equity firm CM Equity Partners. Another key officer, Edward Bersoff, vice chairman and director, founded BTG Inc., a government contractor that went public in the 1990s and was sold in 2001 to Titan Corp. And director Arthur Money was assistant secretary of defense for command, control, communications and intelligence from 1996 to 2001.

Both Fortress America and Federal Services Acquisition expect to make their first acquisitions in 2006.

In most cases, SPACs must acquire companies with fair market value of at least 80 percent of the SPAC's net assets. Once a target is identified, shareholders vote to approve the deal and the SPAC acquires the target. If SPACs fail to make an acquisition within a certain period, they must refund shareholders' money.

As publicly traded companies, SPACs offer more transparency than do private equity groups. They must comply with certain Securities and Exchange Commission rules, and they must file financial statements and announcements of material events with SEC. Private equity groups are private entities, and their investments are less transparent.

SPACs are drawn to the government market because of its expected growth, industry officials said. Most SPAC managers have great expertise in the government sector. McMillen in the 1990s was involved in two SPACs that focused on the retail sector.

Four other SPACs: Alpha Security Group Corp., Argyle Security Acquisition Corp., Good Harbor Partners Acquisition Corp. and Vector Intersect Security Acquisition Corp., have filed security registrations with SEC but have not had IPOs. All are focused on the homeland security market.

At Federal Services Acquisition, the company's principals, excluding Money, have invested in and run large federal companies, Bersoff said. The federal government contractor sector is "a very exciting market ...We know the field, we know the market and it seems like a very attractive investment for us," he said.

SPACs also benefit the companies they acquire, industry professionals said. Company managers often are allowed to keep running the company the way they see fit and can maintain its corporate identity. They also get more liquidity than they would with a private equity group. The deal works well for company CEOs who don't want to risk their capital; they get an instant public platform and can use SPAC money to make other acquisitions, Serotkin said.

As another investment vehicle seeking a finite group of companies, SPACs could keep company valuations in the federal sector high, Serotkin said. "If anything, it's going to hold up even longer the pretty robust pricing for sellers in the federal sector," he said.

SPACs are the next generation of financial buyers in the government M&A arena, Holland & Knight's Mutryn said.

"It's a little too early to tell exactly how prominent a role they'll play," Mutryn said. "Early indications are they will play a substantial role, judging by the folks backing [Fortress America and Federal Services] and by the amount of money they raised."

Staff Writer Roseanne Gerin can be reached at

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