M&A activity may have cooled but conditions are still positive

After a whirlwind 2021 in the government services mergers and acquisitions market, we entered 2022 with a number of questions on what to expect for the year ahead.

As we reflect on the first half of 2022, some of those questions have been answered, while other key themes are emerging and impacting deal activity.

The government services M&A market was incredibly active in 2021. Relatively inexpensive and readily available debt financing, strong balance sheets, anticipation of tax reform around corporate and capital gains rates, and reinvigorated M&A appetite after the initial and thankfully short-lived 2020 pandemic pause in M&A activity led to record setting activity of more than 180 announced transactions.

Second half 2021 M&A activity was especially robust with 104 announced transactions alone. While expectations for 2022 were somewhat tempered, overall sentiment in the marketplace remained abundantly positive, buoyed by considerable dry powder for acquisitions and expectations of continued, moderate economic growth and budgetary support. 

Then came first half 2022, a tale of two interrelated, and in some respects, conflicting deal making stories.  A collective hangover in deal announcements given the fever of the second half of 2021, was met with volatile public markets, another wave of COVID, rising interest rates, conflict in Ukraine that returned conventional warfare and near peer national state threats above the fold, and a 25% year-over-year decline in deal announcements when comparing first half of 2021 to first half of 2022.

However, below the surface stats and news, industry fundamentals, M&A appetite/activity, and dealmaking conditions remain strong.

Though well off the pace of 2021, deal activity is still trending above historical norms

Through June 30, 2022, annualized deal volume of ~120 transactions would be exceeded only by 2020 and 2021 – this, despite a slower start to the year. While public markets have experienced considerable volatility, balance sheets remain strong and budgets remain stable, providing acquirers with plenty of support for their M&A appetites.

As such, deal announcements are expected to accelerate in the second half of 2022, driving full year total announcements ahead of the current pace. 

Geopolitical instability remains front and center

Russia’s invasion of Ukraine caused a brief rally in defense and government public company stock performance in early 2022, though this has tempered in recent weeks, despite the ongoing conflict.

Given the way defense budgets act as a leading indicator for M&A, it will be important to track how much a heightened emphasis on the international threat landscape will reinforce a focus on our national security posture and budget support.

The macro influences are positive for the dealmaking backdrop.

Private equity continues to play an incredibly active role with an increasing impact on dealmaking

Private equity interest in the government services marketplace remains very high – this can be seen in deal volume, as well as fundraising efforts.

Nearly 50% of government services transactions in the first half of 2022 have included private equity (new platforms and portfolio tuck-ins), while fundraising activity for government services and aerospace/defense-focused funds further demonstrates a bullish sentiment on these sectors. 

On the recent fundraising front:

• Arlington Capital Partners submitted an SEC filing for its intent to raise a $3.5 billion Fund VI (April 2022)
• Blue Delta Capital Partners closed its Fund III at $215 million in December 2021 (oversubscribed)
• Enlightenment Capital closed its Fund IV at $540 million in June 2022 (oversubscribed)
• Veritas Capital raised closed its Vantage Fund at $1.8 billion in May 2021 (oversubscribed).

Private equity groups have also increasingly been a “net buyer” in the government services arena, with platform acquisitions and tuck-ins far outpacing exits. Some recent, aggressive roll-up strategies include:

• Arlington-backed Blue Halo has made 10+ acquisitions since 2019
• Arlington-backed Octo has made four acquisitions since 2019, punctuated by the sizable recent acquisition of B3 Group, Inc.
• Carlyle’s roll-up of five businesses since 2021 as part of the Two Six Technologies platform
• Enlightenment Capital-backed Aeyon’s three acquisitions between September 2021 – February 2022
• Godspeed Capital’s recently formed SilverEdge Government Solutions business, comprised of three acquisitions made between December 2021 – February 2022.

Regulators taking a more aggressive posture on consolidation within federal markets

Several recent deals highlight this recent trend and highlight this as an additional consideration for mid-tier and large-scale companies alike. Lockheed Martin’s planned $4B+ acquisition of Aerojet Rocketdyne was ultimately terminated in February 2022 after the Federal Trade Commission sued to block the deal, while L3Harris recently abandoned talks to acquire NSO Group’s surveillance technology following White House concerns.

In June 2022, the Department of Justice filed a civil antitrust lawsuit to block Booz Allen Hamilton’s proposed acquisition of EverWatch, on the grounds it would limit competition at the National Security Agency.

While generally viewed as a more common concern on the product side, the Booz Allen Hamilton/EverWatch lawsuit highlights the need for careful consideration of customer/technology overlap and concentration within service businesses as well. 

Clearly a consideration, but not anticipated to be a hindrance to dealmaking.

The plight of the perceived subscale public company – too big to be small and too small to be big

After rumors of a potential sale of ManTech began intensifying early in 2022, Carlyle announced its intent to acquire the company in May. This represents another recent example of financial sponsor involvement in taking a public company private (e.g., Veritas-backed Peraton acquiring Perspecta, Lindsay Goldberg-backed Amentum acquiring PAE). 

Additionally, Vectrus recently closed its merger with Vertex, creating the publicly listed V2X and furthering a trend of significant growth in median revenue among government services public companies, which has been fueled by other large public acquisitions over the past few years (e.g., Jacobs / KeyW, SAIC / Engility).

The trend of consolidation, scale, and financial horsepower for investment and M&A continues to motivate mega-deals.

Fundamentals still matter

Despite all the various factors influencing government services M&A markets, certain key fundamentals remain paramount. Companies positioned in high growth areas, being built for scale, and with mature growth engines will continue to command considerable interest from potential acquirers.

Coupling these attributes with access to existing indefinite delivery, indefinite quantity contracts (“IDIQs”), blanket purchase agreements (“BPAs”), Other Transaction Agreements (“OTAs”) and task-order based awards is a strong differentiator for sellers, especially when considering ongoing procurement challenges impacting government agencies and competitive tension in a crowded market.

The first half of 2022 has highlighted some of the more qualitative vs. quantitative deal metrics. However, these trends underpin a ripe environment for dealmaking, and a brewing momentum for heightened activity levels in the second half of 2022 that rivals the momentum we saw in 2021.

About the author: Brian Tunney is a director with the investment bank KippsDeSanto & Co. and has nearly 15 years of M&A experience. He is a graduate of the University of Virginia.  He may be reached at btunney@kippsdesanto.com.

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