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By Nick Wakeman

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Nick Wakeman

Did DXC foreshadow government divestiture?

Will they or won’t they has been a common question since DXC Technologies was created through the April merger of Computer Sciences Corp. and HPE Enterprise Services. And the question is often followed by when?

That question involves DXC’s U.S. public sector business, which came into the new entity from HPE.

It is a sizable business -- No. 10 on the Washington Technology 2017 Top 100 with $3.2 billion in prime contracts.

Much of the speculation is driven by the fact that the former CSC had already spun out its government business because it didn’t fit with CEO Mike Lawrie’s growth strategy. The prevailing wisdom is that he didn’t really want HPE's public sector business either.

But now he has it and is limited in his ability to spin it off because of the tax-free structure of the CSC-HPES merger.

I haven’t been able to confirm details, but a so-called "Reverse Morris Trust" transaction was used to create DXC through a tax-free merger for shareholders of CSC and HPE.

Under that structure, DXC cannot make a major divestiture. What I haven’t been able to confirm is how long that restriction stays in place.

But once that restriction is lifted, look for DXC to make some kind of move.

Lawrie said as much during a presentation to investors at the Citi 2017 Global Technology Conference on Sept. 8.

He was asked about how the government business was segmented at DXC and Lawrie said he had done much the same at CSC before that business was spun out to create CSRA.

“We’ve kept it much more self-contained in terms of financial systems, reporting systems and all of those things. Down the road, we would have flexibility to do whatever we felt would drive the most shareholder value,” he said.

Lawrie said they like the government business. It generates lots of cash and the U.S. government pays it bills. But he also described it as having “some minor growth capabilities.”

He said he is keeping the business segmented so that “down the road” the company could move on an opportunity to “monetize that asset.” He used the expression "down the road" twice in his 167-word response, according to a transcript.

I reached out to DXC for comment and a spokesman said that at the Citi conference, "Lawrie reiterated what he has said on multiple occasions, that all options are on the table for this business. Further, he has also said that he likes its growth potential both now and in the future."

So it might be speculative on my part, but I think we'll see history repeat itself. DXC looks to be interested in shopping the government property. It is merely a matter of timing and then the right opportunity.

At more than $3 billion in scale, it would need to be another sizable business to make a traditional acquisition. Or a private equity player could by the business and create a standalone business.

But it doesn’t have to be a traditional acquisition as recent history is teaching us.

I wouldn’t discount the possibility of another Reverse Morris Trust, which also was used to create CSRA two years ago and when Leidos acquired Lockheed Martin’s IT business.

The “seller's” shareholders retain a significant position in the new entity. When DXC was created, HPE shareholders received 50.1 percent of the stock in the new company. Likewise with Lockheed Martin and Leidos. Lockheed shareholders received a 50.5 percent stake in Leidos.

A Reverse Morris Trust would widen the universe of buyers by making it possible for a smaller business to move for DXC's government unit. DXC shareholders would get the majority of shares in a new entity. And of course, it would be tax free.

But for now this will all have to wait until the restriction on a divestiture is lifted. My guess would be 2019 at the earliest before we see a deal.

Posted by Nick Wakeman on Sep 14, 2017 at 1:26 PM


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