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By Nick Wakeman

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Nick Wakeman

Engility may be at crossroads on report of possible sale

Engility Corp. apparently is reaching a crossroads, six years after it opened for business and three years after its combination with TASC.

Reuters reported Wednesday that Engility is looking at a sale of itself. But analysts are skeptical, saying that the company’s struggles with revenue growth and high percentage of cost-plus contracts might deter suitors.

Reuters cited CACI International and Science Applications International Corp. as those that have shown interest.

Engility declined to comment on the Reuters report. “It’s Engility's policy not to respond to rumors and speculations,” a spokesman said.

With the increase in merger-and-acquisition activity and more companies looking for scale, it is easy to see why Engility is in the rumor mill with its size at nearly $2 billion in annual revenue and high-end systems engineering skills.

A combination of SAIC and Engility would create a $6.5 billion-revenue company and SAIC ($4.5 billion in sales) would triple its intelligence portfolio along with bringing together similar technical services portfolios, Bloomberg Intelligence federal market analyst James Bach wrote in a note for clients Thursday.

CACI at $4.3 billion in revenue currently would be of a similar scale if it were to combine with Engility. But CACI's technology-oriented solutions "portfolio doesn't align well with (Engility's) market strategy," Bach noted.

And in a Wednesday note for investors, Vertical Research Partners analyst Krishna Sinha pointed out Engility’s portfolio mix has 67 percent of revenue coming from cost-plus contracts compared to 50 percent for CACI and 45 percent for SAIC.

The trend today is for companies to increase their fixed-price work because it can lead to higher profitability. CACI cited that as a reason behind its effort to top General Dynamics' bid for CSRA, which SAIC also made an offer for. So purchasing Engility would be a move in the opposite direction.

For this reason and more, a sale of Engility in the near-term could be a challenge for the typical strategic buyers. So I don’t expect a company above Engility on the Top 100 to be the likely buyer.

But there are companies such as KBR, Parsons Corp. and Huntington Ingalls Industries that are making acquisitions to build out their services businesses. Obviously, I have no idea if any of those companies have looked at Engility. I’m just using them as examples of types of buyers.

But when I look at Engility, I’m not sure I see a company quite ready for a sale. They need to win contracts and show revenue growth. Sales went down 7 percent last year and are poised to keep declining this year.

The company "has not experienced a single quarter of year-to-year organic growth" since it spun off from L3 Technologies in 2012, Technology Business Research analyst Joey Cresta wrote in a note for clients Thursday.

Private equity firms KKR and General Atlantic own almost 48 percent of Engility shares, so they’ll want a premium as well. The end of February marked the third anniversary of when Engility combined with TASC in 2015, which was owned by KKR and General Atlantic.

In addition to shares in Engility, the firms also control four of the 11 Engility board seats. But the third anniversary is a milestone because they could not sell any of their stake in Engility for three years.

Now they can sell shares but they are limited in what they can do for three more years, according to regulatory filings. Shares in Engility closed 10 percent higher to $35 Thursday, but the stock was at around $42 when the TASC combination closed three years ago.

Having said that though, Engility leadership doesn’t expect pressure from KKR and General Atlantic.

“I don't speak for KKR and GA. But we are not bumping up against any fund requirements,” CEO Lynn Dugle said in a March 1 investor call.

She added that she expects them to stay invested in the company “as we get on that trajectory of growth, and don’t anticipate any large movements on their part in the near-term.”

That use of “near-term” is significant to me. So yes, Engility could be an acquisition target but don’t expect it in 2018. That’s my bold prediction.

Posted by Nick Wakeman on Jul 12, 2018 at 1:14 PM

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