M&A

Inside NCI's $283M deal to go private

Company entertained multiple suitors before going with PE firm H.I.G. Capital

NCI Inc. was not the only midsized government services contractor to feel scale pressures amid the market’s significant consolidation over the last two years. Like other companies its size it seemingly faced a choice: combine with another player and bulk up or sell itself outright.

Reston, Va.-based NCI chose the latter option and actively searched for a buyer in early 2016 as part of its examination of strategic alternatives, according to July 17 regulatory filings with the Securities and Exchange Commission. NCI agreed earlier this month to be acquired by private equity firm H.I.G. Capital for $283 million, or $20 per share.

These latest filings from NCI include both details of its efforts to find an acquirer and the place it found itself in as a midsized contractor. NCI’s search for a path through that heavy consolidation period dates back to July 2015, when the contractor first told investors it would examine strategic alternatives for itself.

The company has struggled to find organic growth in recent years as 2016 revenue shrunk to $322.4 million from the 2015 figure of $333.1 million. Sales for 2015 did increase 4 percent but mainly on its acquisition of fellow government IT company Compusearch. Revenue in 2014 totaled $317 million, down from 2012 sales of $368.4 million.

Midsized contractors such as NCI face pressures on many fronts: the resources of large contractors with at least $1 billion in annual sales to bid on any contract, who have also made their own acquisitions to bulk up in a market that rewards scale. Calendar year 2015 featured 80 major deals and the following year showed 70 major transactions in government services.

On the other end are small businesses that can receive contract awards through various set-aside programs. For those in the middle, they are ineligible for small business programs and acquisition targets are hard to find because of the deals being made by larger contractors.

In light of that, NCI’s board viewed the company as “facing scale issues in bidding and winning larger procurement contracts,” the July 17 regulatory filings say.

The final sale price of NCI is roughly 16 percent higher than H.I.G.’s original offer of approximately $244 million, or $18 per share, first proposed by H.I.G. on March 8 during initial negotiations, the filings say. H.I.G. returned to NCI with the $20 per share offer on May 16.

H.I.G. approached NCI at various points in late 2016 and January 2017 over the possibility of a transaction but there were no formal communications between both parties during that time. NCI did not engage in discussions due to an October 2016 change in CEO and the January 2017 discovery of the embezzlement by former controller Jon Frank, the filings say.

Investigations by the Justice Department and SEC are ongoing, as is a separate civil fraud investigation by the U.S. Attorney’s Office for the Eastern District of Virginia to determine the embezzlement’s impact on NCI’s government contracts, according to the SEC filings.

NCI's initial search for a buyer prior to the management change and embezzlement discovery saw the contractor reach out to 33 parties in total, 17 of which showed initial interest. Four of those 17 moved forward, including an unnamed private equity firm that conducted due diligence and valued NCI at $18.50 per share, or almost $262 million.

That unnamed firm is a “significant investor” in aerospace, defense and government services business and withdrew from the talks due to regulatory concerns regarding another of its portfolio company in those markets, the filings say.

But the firm returned with a $20-per-share offer for NCI in April 2017 and attended a management presentation with NCI's leaders in May but subsequently withdrew over concerns regarding contracts up for recompete, the filings say.

Excluding H.I.G., NCI had five other potential suitors that expressed some interest in acquiring the company in either 2016 or 2017. Three of them were private equity firms including the one described in the 2016 buyer search.

One of those five was an unnamed “leading provider of IT services to the U.S. government in Reston, Virginia” that sought to discuss how a purchase of NCI would play into the former's own acquisition strategy, the filings say.

That Reston-based contractor also showed interest in acquiring NCI for between $18 and $20 per share but also withdrew in part over estimates of potential synergies being “lower than anticipated,” according to the filings.

An unidentified engineering services contractor contacted NCI management in April 2017 to indicate interest in an acquisition and later proposed a deal for between $200 million and $235 million, or $14.06 and $16.08 per share. The unnamed engineering company withdrew from further talks shortly thereafter, the filings say.

A second private equity firm discussed with NCI a possible $16-per-share deal but ended discussions after determining the contractor was a competitor of another portfolio company. That firm focuses on “founder-backed companies,” the filings say.

A third private equity firm that invests in government services companies showed interest in buying NCI for $275 million, or $19 per share. That firm also later withdrew over concerns regarding NCI's contracts up for recompete in 2017 and 2018, the filings say.

The filings indicated NCI's disclosure of that proposal to H.I.G. spurred the eventual offer that was later accepted.

Also of note, founder and chairman Charles Narang will make $92 million from the sale after he tenders all of his shares in favor of the deal as he has agreed to do, according to the filings. Narang holds 34 percent of NCI’s stock and 84 percent of the voting shares.

That stake gave Narang control over the entire board of directors roster, shareholder votes and any potential transactions involving NCI’s acquisitions or efforts to sell itself, that annual filing says.

Narang retired from the CEO post in October 2015 and was succeeded by then-president Brian Clark. One year later, Clark abruptly resigned from the chief executive role and was succeeded by current CEO Paul Dillahay.

The July 17 filing from NCI makes no reference to any pressure on Clark to step down or any disagreement between him, the board or Narang.

To be exact, Narang holds 4.5 million Class B shares and 117,659 shares of Class A common stock. Dillahay holds 1 percent of Class A stock, Chief Financial Officer Lucas Narel owns 2.8 percent and General Council Michele Capello owns 1.7 percent.

A sale of all shares by the above NCI executives would give Dillahay $425,060, Narel $454,620 and Capello $69,540. They are also eligible for bonuses pending the deal’s closure with Dillahay slated to collect $300,000, while Narel and Capello could make an additional $100,000.

About the Author

Ross Wilkers is a senior staff writer for Washington Technology. He can be reached at rwilkers@washingtontechnology.com. Follow him on Twitter: @rosswilkers. Also find and connect with him on LinkedIn.

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