Consolidators rule

<@VM>NO DEAL?YET<@VM>20 YEARS, 20 DEALS

Pursuing an acquisition "really depends on finding a company that logistically makes sense for us, if we go through a whole year and we don't see one, then we just won't do one." ? Alion's Bahman Atefi

"The valuation of our business kept going up," said Apogen's Paul Leslie. "When the offers came in, they were just too hard for us to turn away and say we're not interested."

Rick Steele

By Nick Wakeman and Ethan Butterfield

When Frank Lanza first looked at Titan Corp. two years before Lockheed Martin Corp.'s failed 2004 attempt to buy the San Diego company, he was not impressed.

"I didn't like Titan. I didn't like what they were doing, I didn't like their strategy," said Lanza, chairman and CEO of L-3 Communications Inc.

After Lockheed's deal fell through, Lanza took a second look.

"They had changed dramatically in structure, and they had gotten big time into the intel world, which we are in big time, too," he said.

Titan's revenue had grown from about $1 billion to $2.5 billion. "But they had one big wart," Lanza said: an ongoing investigation into allegations that some Titan officials used bribery to win foreign business.

But Lanza had a remedy. He went to Titan's board, gave them a price and offered to help settle the Foreign Corrupt Practices Act allegations.

"If we could do that, we at L-3 could make a tremendous acquisition," he said.

Attorneys for Titan and L-3 worked with the government on the problem, while another L-3 team handled the usual due diligence activities. When the two companies announced the deal in June, a plan was in place to settle the allegations, and Lanza had his tremendous acquisition for $2.6 billion.

The transaction captured the attention of a panel of merger and acquisitions experts who called the acquisition the biggest deal of 2005. The panelists reviewed a list compiled for Washington Technology by Houlihan Lokey Howard & Zukin of 100 government services acquisitions that closed during 2005.

Although the L-3-Titan deal was the largest of last year, size wasn't a deciding factor for the panel. Titan's long history ? Gene Ray founded the company in 1981 ? and its reputation as an aggressive acquirer on its own helped make its acquisition noteworthy.

The deal also helped L-3 of New York grow its government services business to more than $3 billion, making it a major IT player to complement its communications products and solutions business.

But L-3 wasn't a shoe-in as the top deal. Other contenders include Nortel Network Corp.'s acquisitions of PEC Solutions Inc., and QinetiQ Group Plc.'s pickup of Apogen Technologies Inc., the No. 2 and 3 deals of the year, respectively.

The 2005 deals reflect several trends at work in today's U.S. government market ? most notably, it is the largest and most attractive in the world. A range of buyers from foreign-owned companies, such as Nortel and QinetiQ, to private equity groups, such as Veritas Capital Fund LP, and small companies, such as Indus Corp., are making deals. Veritas acquired parts of DynCorp, and Indus made a pair of deals signaling that it is a consolidator.

The 100 deals in 2005 lag the 106 transactions that closed in 2004, but are still well ahead of 2003's 82 deals.

What these companies buy shines a spotlight on the fastest growing segments of the government market and where companies are investing for future growth.

Lanza saw 5,000 Titan employees with security clearances ? hot commodities for any company doing defense and intelligence work.

[IMGCAP(2)]QinetiQ of Farnborough, U.K., needed Apogen to create a U.S. IT division to go after the American defense and civilian market. "The scale and scope of U.S. federal and defense budgets are significantly higher, compared to British or European budgets," said Apogen CEO Paul Leslie.

SRA International Inc.'s acquisitions brought the Fairfax, Va., company new capabilities in consulting, enterprise resource planning and customer relationship management as well as in intelligence, surveillance and recognizance systems, markets the company wanted to expand into quickly.

"There are some businesses that you just can't grow one person at a time," said Renato DiPentima, president and CEO of SRA. "You can't get the critical mass fast enough, and you don't have the credibility."

The market next door

Nortel Networks of Brampton, Ontario, had a U.S. government business before it acquired Fairfax, Va.-based PEC Systems for $425 million. But as a foreign company, it was hobbled.

For each sale it made to a defense or intelligence agency, the Canadian company needed its customer to write a "Compelling Letter of Need" to let it buy products and services from Nortel.

"That's doable, and we did that, but it's very limiting," said Chuck Saffell, CEO of Nortel Government Solutions Inc.

Nortel was one of nine foreign buyers of U.S. companies in 2005. Other major deals include QinetiQ's $288 million acquisition of Apogen, and the $215 million acquisition by Serco Group Plc. of Hampshire, U.K., of Vienna, Va.-based RCI Holdings Inc.

"Part of the rationale behind the acquisition was to create a U.S. entity with all the access to the federal market that any other U.S. company would have," Saffell said.

Nortel Government Solutions of Fairfax is now free to compete and partner just as any U.S. federal contractor does.

"That agility in the marketplace has been a big plus," he said. "We can be a prime, and we can be a better partner to our traditional channel partners."

Saffell declined to comment on specific contracts the company is pursuing, but he did say Nortel would play a bigger role, both as a prime and a sub, in the chase for all the major, multiple-award, task order contracts that are in the works.

"2006 is a very interesting year," he said. "There are lots of very large contracts out, and we are participating in those in a much more robust way, even more than PEC would have."

With about $250 million in annual revenue, PEC was a midsize player, but as part of Nortel, the U.S. subsidiary has access to the resources of a $10 billion-a-year company, he said.

"We can reach back and tap expertise from across all of Nortel," he said.

A year ago, Apogen was picked as a Top 10 dealmaker when it was created through the merger of ITS Services Inc. and Science and Engineering Inc. The two companies merged with the backing of Arlington Capital Partners LP, an equity investment group.

The group's strategy was to hold the company for about five years, then have an initial public offering of stock to recoup its investment.

But the sizzling M&A market altered those plans, Apogen's Leslie said.

"The valuation of our business kept going up," he said. "Then when the offers came in, they were just too hard for us to turn away and say we're not interested."

QinetiQ, which in 2004 acquired two other companies in the government market, paid $288 million for Apogen. The company made about $225 million in revenue providing IT services to Defense and Homeland Security department clients.

For QinetiQ, the deal completed the company's plan to create three distinct lines of government business in the United States. The acquisition of Foster Miller Inc. brought it high-end technology capabilities; Westar Aerospace and Defense Group Inc. brought systems engineering and customer support; and Apogen brought IT.

For now, the companies operate independently of each other, but with QinetiQ holding an IPO in England, that structure could change, Leslie said.

"For QinetiQ to really leverage the value of all of its acquisitions, over some period of time we'll need to integrate and re-brand the company into QinetiQ North America," he said.

The hunt for hot tech

Alion Science and Technology Corp. of McLean, Va., is at once one of the newest and oldest players on the M&A list.

The company was founded in 2002 as a spinoff by the Illinois Institute of Technology, which got its start in 1890.

Through organic growth and acquisitions ? it closed three deals in 2005 ? the company grew its annual revenue from $275 million in 2004 to about $400 million. Employee-owned Alion focuses on industrial engineering, modeling and simulation applications, transportation systems and wireless communications systems, primarily for defense customers.

The company's acquisition strategy focuses on three types of companies: those with roughly $10 million in revenue and unique technology or intellectual property; those in the $20 million to $40 million range that would help diversify Alion's client base, and those with intellectual property and market presence that would significantly improve Alion's business offerings.

Alion's acquisition of John J. McMullen Associates Inc. falls into the last category. The company brought with it about $100 million in revenue and capabilities in naval architecture, maritime engineering and program management for the Navy, which is also a new customer for Alion.

"Except for the large companies like Northrop Grumman Corp., Raytheon Co. and General Dynamics Corp. that own shipyards, after that, JJMA is the largest naval architecture and marine engineering company in the country," said Bahman Atefi, Alion president and CEO.

Alion also bought Carmel Applied Technologies Inc. for its 3-D visualization capabilities, and ManTech Environmental Technology Inc. for its health sciences, chemical and biological defense and counterterrorism skills.

With a few more acquisitions in 2006, the company could hit $500 million by the end of the year, Atefi said.

"It really depends on finding a company that logistically makes sense for us," he said. "If we go through a whole year and we don't see one, then we just won't do one."

Feed the growth engine

For most of its 28-year history, SRA avoided acquisitions. Then the company went public in 2002 and closed its first. A second deal followed in 2003 and a third in 2004.

The company must have liked the experience, because in 2005, it closed three acquisitions and firmly established its credentials as a consolidator.

But don't expect the systems integrator to rely on acquisitions as its growth engine.

In 2005, SRA grew by 43 percent, to $881.8 million, but its growth from acquisitions was just 5 percent, SRA's DiPentima said.

"We think of acquisitions as the secret sauce, not the main ingredient," he said.

The crux of SRA's acquisition strategy is to find companies that are about to leap to the next level, not companies that need to be fixed or turned around, DiPentima said.

Most of the companies SRA has acquired were not for sale. SRA pursued Galaxy Scientific Corp., one of its 2005 acquisitions, for three years before its owner agreed to sell.

"We look for who is the best, and we go after them. We woo them," DiPentima said.

The key to wooing is showing the company that being part of SRA will help it grow even faster than it could on its own, he said.

"We want good, healthy, robust companies that are on the cusp of taking their next big steps," he said. "To do that, they have to invest in infrastructure, business development and get on more contracts."

SRA, which is on several large task order contracts and has a strong bid and proposal operation, will give them those capabilities, DiPentima said.

The gain for SRA is access either to new customers or new capabilities that will support current customers, he said.

"We look at: Do we think our customers are going there, and what offerings do we have or need to have to continue to be a robust grower?" he said.

Editor Nick Wakeman can be reached at nwakeman@postnewsweektech.com. Staff Writer Ethan Butterfield can be reached at ebutterfield@postnewsweektech.com.By Ethan Butterfield

In any hot mergers and acquisition market, you need sellers to go along with the buyers. The government market has an abundance of small businesses, the most frequent acquisition targets.

But not all small companies are destined to be gobbled up.

When Indus Corp. of Vienna, Va., in 2003 graduated from the 8(a) small-business program, founder Shiv Krishnan was determined that the company, which provides enterprise management services and Web applications to civilian agencies, would remain independent. He set revenue targets, and this summer reached the second of those by acquiring Aaron B. Floyd Enterprises Inc. and the government network services business of Halifax Corp., both in Alexandria, Va. The deals helped land Indus in the No. 10 spot on the Top 10 deals of 2005.

The transactions pushed Indus to $100 million in annual revenue, a size Krishnan said positions the company for goal No. 3: $250 million in annual revenue in the next three to five years.

"At the $250 million level, we will become a significant player in the mid-size market," he said.

Indus is already of a size and stature that attracts would-be suitors, but Krishnan said he has no problem resisting their advances.

"There's no compelling argument for us to fold Indus into another large company at this stage," he said.

At $250 million in revenue, however, Indus will be even more valuable to buyers and possibly even to the public markets, Krishnan said.

"Once we reach that size, we'll have multiple opportunities open to us," he said.

Meanwhile, he's looking at more acquisitions, mostly in the $5 million to $10 million range. But a bigger deal ? $40 million to $50 million ? could happen by the end of 2006, he said. The focus is on finding companies that will build Indus' capabilities and customer base.

"What separates the winners from the losers is that the winners focus on specific opportunities and tell a very compelling story to the customers," Krishnan said. "The losers look at every opportunity and think that in a $100 billion market, they should be able to get any contract. That's not a strategy that will survive."Mergers and acquisitions have been a major part of the government IT landscape since before Washington Technology's founding in 1986. Here's a look at 20 of the deals and dealmakers of the past two decades that helped create today's market.

1986: Emhart Corp. acquires Planning Research Corp. In 1988, Emhart acquires Advanced Technology Inc. In 1991, Black and Decker Corp. acquires Emhart and merges Planning Research and Advanced Technology to form PRC Inc.

1988: DynCorp goes private through a buyout that includes equity backing, management and an employee stock ownership plan.

1988: Ford Aerospace & Communications Corp. acquires BDM International Inc. Two years later, Ford Aerospace is sold to Loral Corp. BDM's management and the Carlyle Group spin it off as an independent company. In 1998, TRW Inc. acquires BDM.

1994: Loral Corp. acquires IBM Federal Services.

1995: Litton Industries Inc. acquires PRC from Black and Decker. In 1998, Litton acquires TASC Inc.

1996: Anteon International Corp. is created and begins a decade of steady acquisitions.

1996: Lockheed Martin Corp. acquires Loral.

1997: Northrop Grumman Corp. acquires Logicon Inc.

1997: Affiliated Computer Services Inc. acquires Computer Data Systems Inc. and enters the federal market. In 2003, Lockheed Martin and ACS swap government units: Lockheed takes most of ACS' federal work, and ACS takes control of Lockheed's state and local business.

1998: General Electric Co. plc acquires Tracor Inc. In 1999, GEC, now called Marconi Electronic Systems plc, merges with British Aerospace Ltd. to create BAE Systems plc.

1999: General Dynamics Corp. acquires three government IT and communications divisions from GTE Corp. DynCorp acquires the fourth unit.

1999: Veridian Corp. is formed through the acquisitions of MRJ Technology Solutions Inc., ERIM International Inc. and Trident Data Systems Inc.

2001: Northrop Grumman acquires Litton Industries.

2001: Titan Corp. acquires BTG Inc.

2002: DigitalNet Inc.formed with the acquisition of Getronics U.S. government business.

2003: General Dynamicsacquires Veridian.

2003: Northrop Grumman acquires TRW.

2003: Computer Sciences Corp. acquires DynCorp. In 2005, CSC sells off part of DynCorp to Veritas Capital Fund LLC, which plans to make DynCorp a publicly traded company.

2004: BAE Systems acquires DigitalNet.

2004: CACI International Inc. and CGI Group Inc. execute a complex deal that splits American Management Systems Inc. into two pieces. The defense business goes to CACI, and CGI takes the rest.

2005: L-3 Communications Inc. acquires Titan.

Pending: General Dynamics plans to acquire Anteon International Corp. by the end of June.

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