As government IT spending grows and as projects become more complex, companies are racing to become the big fish in the federal sector.
In recent months, a wave of acquisitions has washed over companies providing government agencies with services such as systems integration and IT consulting. And more gobbling up is in store in what is now a fragmented market, said David Garrity, director of research for the independent firm American Technology Research.
In the next several years, Garrity said he expects to see the number of significant players selling IT services to the government--those pulling in $100 million or more in annual revenue--shrink from about 30 to as few as six. Factors such as larger IT budgets for defense and homeland security, bigger contracts, an aging government IT work force and low interest rates are fueling the merging trend, said Garrity, whose firm doesn't own stocks but sells research to institutional investors.
"There's a lot of consolidation that could happen," he said. "The conditions are ripe."
Another condition encouraging acquisitions is that several IT companies with government contracts went public last year, giving them cash to swallow up competitors.
Fairfax, Va.-based ManTech International launched an initial public offering in February 2002 and then had a secondary offering in December. It bought two government-focused IT firms last year: Aegis Research and CTX. Meanwhile, Fairfax, Va.-based SRA International went public in May and earlier this month said it would snap up Adroit Systems, which concentrates on national security contracts.
Arlington, Va.-based CACI International's stock has traded publicly for more than three decades, but the company raised roughly $150 million in March in another stock offering. After the stock sale, CACI acquired the government solutions division of Condor Technology Solutions, as well as Acton Burnell, an IT company focused on federal government contracts. And during its fourth-quarter earnings report on Jan. 23, CACI said it had signed a letter of intent to acquire the stock of a company that provides IT and training services in support of defense and homeland security initiatives.
Perhaps the highest-profile deal recently was Computer Sciences' decision in December to acquire DynCorp for $950 million in cash, stock and assumed debt.
"We are seizing an opportunity to significantly strengthen our leadership position in the U.S. federal marketplace, augment our capabilities to support the requirements of the new Homeland Security...Department and respond to the federal government's initiative to increase its reliance on service providers," Computer Sciences CEO Van Honeycutt said in a statement.
When the deal is complete, Computer Sciences expects to bring in $6 billion annually from its government business, which will have roughly 38,000 employees. The El Segundo, Calif.-based company reported revenue of $11.4 billion for fiscal 2002, with about $2.9 billion of that derived from its government business.
Garrity of American Technology Research said the DynCorp deal should propel Computer Sciences into the top 10 companies competing for government IT services contracts.
Other major government IT players include defense contractors Lockheed Martin, Boeing and Ratheon, Garrity said. Also gunning for government IT contracts are commercial technology services giants Electronic Data Systems and Accenture.
A heavy hitter in the commercial IT market may want to snap up an entrenched company serving the government sector, Garrity said, because it's not an easy market to crack. For example, marketing techniques and cost-accounting methods differ in government deals as opposed to corporate deals. Garrity said one juicy target may be BearingPoint, which was formerly known as KPMG Consulting and whose public services division accounted for 36 percent of the $748 million in third-quarter revenue. Networking giant Cisco Systems already owns 8 percent of BearingPoint, and an agreement to limit Cisco's ownership in the company ends this month.
Representatives from both Cisco and BearingPoint declined to comment on a possible acquisition.
The government sector has attracted more interest from technology firms amid flagging IT spending by businesses and amid growing government IT budgets in the wake of the terrorist attacks on Sept. 11, 2001. The Bush administration has proposed spending $59.1 billion on information technology in federal fiscal year 2004, a 12.4 percent increase from 2003.
IT outsourcing--when a company takes over another organization's technology tasks such as running a data center--seems to be a particularly plum arena. Market research firm Input projects that federal spending on IT outsourcing services will increase at an annual rate of 18 percent from $6.6 billion in fiscal year 2002 to nearly $15 billion in fiscal year 2007.
One of the factors that may spur outsourcing is the retirement of federal government IT professionals. A federal study from 2001 estimated that 10 percent of federal electronics engineers employed in 1998 would retire by 2006, along with 14 percent of computer specialists, 20 percent of telecommunications employees and 21 percent of electronics technicians.
Another issue that may trigger consolidation among IT services companies is the size of federal contracts. As the government seeks to integrate a host of computer systems within and across departments, the contracts are becoming larger, Garrity said. Those larger contracts, in turn, call for larger companies able to manage mega-projects, he said.
Joseph Kampf, CEO of Fairfax, Va.-based Anteon, agrees. A large federal deal eight to 10 years ago may have been for $50 million, whereas today Uncle Sam might offer a contract worth hundreds of millions of dollars, Kampf said.
The shift to larger federal contracts, Kampf said, has "put pressure on the small companies and even midsize companies to be acquired and be part of a name brand." Anteon intends to become one of those name brands. Kampf said he wants to build the company's annual revenue to $1.5 billion or more to compete with giants such as Northrop Grumman, Lockheed Martin and Computer Sciences. Anteon's revenue in 2001 was $715 million; the company has acquired five companies since 1997.
Garrity sets the bar lower than Kampf. He said companies need to rake in $1 billion annually to show that they are legitimate contenders for the big deals. A $1 billion threshold suggests that a number of companies now serving the federal government are too small--and may be prime candidates for merger activity. For example, ManTech's revenue in 2001 totaled $431 million. SRA International's revenue for the year that ended in June was $361 million. And CACI's revenue for the year that ended in June was $682 million.
ManTech, at least, isn't worried about its size. Vice President Peter LaMontagne said that he does not see a clear trend toward larger federal contracts and that his company has no trouble snagging government work: For 91 percent of its revenues, ManTech is the primary contractor.
Still, ManTech is on the hunt for other companies to add to its ranks. "We continue to have an active acquisition program," LaMontagne said.