Is M&A activity at a crossroads?
- By Ross Wilkers
- Feb 06, 2019
The aerospace, defense and government services group at investment bank Houlihan Lokey is raising the question over whether merger-and-acquisition activity in the market has already hit its peak.
Why? According to their new report “At a Crossroads,” last year saw a collision of positive forces such as stable defense budgets and a Republican-led Congress that wanted to fund the Trump administration’s goal of boosting military funding. Low cost of available debt also helped create an optimistic picture of the market.
But this year is different and the market is now at a crossroads in their eyes. “The current political climate has thrown proverbial cold water on the industry’s otherwise positive outlook,” wrote the McLean, Virginia-based group.
So either positive trends like favorable budgets, company operating performances and the capital environment could win the day -- or the political climate of shutdowns and political disagreements over spending will drive the outlook.
Consider that many once-closed civilian agencies are still catching up from being shut down for five weeks and may have to shutter their doors again if their funding expires Feb. 15.
The specter of a shutdown is just one near-term piece of political uncertainty the Houlihan Lokey team points out. There is also a possible return of 2011 Budget Control Act sequestration budget caps when the government’s 2020 fiscal year begins Oct. 1 and the fact that Congress is divided for another two years.
Valuations of publicly-traded government technology and services companies peaked in September and fell over the last three months, according to the analysis.
Deal volume in that subset of the market was down 19 percent last year from 2017 levels on two factors: an overall supply-and-demand imbalance, and businesses deciding to slow down their exit plans in order to see if their pipeline pursuits will translate to growth in 2019.
Part of the reason for that volume decline is how large publicly-traded companies collectively no longer dominate the buyer landscape. Those traditional buyers closed only 5 out of the 69 deals in the IT and services market last year, or 7 percent, compared to 10-12 five years ago.
That drop is not for lack of trying, according to the analysis, given that many of those traditional buyers have said acquisitions are their preferred capital method. CACI International may be the most visible example of that and is putting nearly $1 billion toward its acquisitions of LGS Innovations and Mastodon Design announced last week.
So-called “non-traditional strategic buyers” are increasingly coming into the fold. Under that umbrella are Parsons Corp. in its acquisition of OGSystems, Huntington Ingalls Industries in its deals for G2 and Fulcrum, and Vectrus in its buy of Sentel Corp. Plus, ASGN Inc. entered the government IT market when it acquired ECS Federal last year.
Private equity firms drove half of deal activity last year in the sector, either through new platform investments or add-on acquisitions for existing platforms.
There are 65-PE backed government technology and services companies versus 32 in 2008, according to the Houlihan Lokey analysis. And 29 percent of those are considered long in their investment periods, either five years or more.
Decisions on whether to exit their investments or stay in will be a main driver of deal activity this year, the analysis says.
Ross Wilkers is a senior staff writer for Washington Technology. He can be reached at firstname.lastname@example.org. Follow him on Twitter: @rosswilkers. Also find and connect with him on LinkedIn.