PErspective in Government Contracting

November 2016

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A feature examining the role of private equity in the government contracting space.

Government agencies are increasing their investments in cloud computing, especially for web hosting, backup support and collaboration. A recent MeriTalk report, titled “Destination Cloud: The Federal and SLED Cloud Journey,” found that 82 percent of public sector cloud adopters plan to increase investment in cloud computing platforms in 2017, and there will be a twofold increase in the use of cloud platforms over the next five years.

This opens up opportunities for PE firms with an eye on the government contracting sector. Apollo Global Management will acquire Rackspace, which provides cloud-computing services to both enterprises and governments, in a take-private deal valued at $4.3 billion set to close by the end of this year. This represents a 38 percent premium to the company’s stock price before rumors of a deal began to circulate, but is well under the firm’s peak market value in 2013, according to Bloomberg. The deal follows Rackspace’s inability to compete with its larger-scale web-hosting competitors Amazon, Google and Microsoft, and will enable it to focus on long-term growth and enhancing its product offerings, Bloomberg reports.

While cloud spending is up, security remains a top concern, and cyber attacks from foreign states and illegal hacker groups continue to grab headlines. As agencies grapple with how to store and transfer sensitive data, they are increasingly turning to private cloud solutions. Department approaches can vary—the DOD prefers to build applications for the cloud from the ground up, rather than shift existing apps to the cloud, whereas the Department of Commerce assesses the suitability of each tool for the cloud on a case-by-case basis, FedTech Magazine reports.

Even with a private cloud, shared hosting facilities, jurisdictional hazards and leased telephone lines mean the risks of leaks and intrusions cannot be completely mitigated. Cloud Constellation—a startup that secured series A funding in March 2016—believes the answer is a neutral space-based cloud storage network, relying on satellites rather than terrestrial lines to deliver mission-critical data.

Given the severity of the security challenge, cybersecurity remains a hot area for PE investment, especially as technology companies divest their government-focused cyber tech divisions. Intel, for example, is refocusing on its bread-and-butter chip-making business, in part to take advantage of the rise of the Internet of Things. The firm will spin off its cybersecurity arm into a new joint venture with PE firm TPG in a deal worth $4.2 billion, expected to close in Q2 2017, Bloomberg reports. Using funds from its TPG Partners VII fund, TPG will take a majority stake in the new firm, which will be called McAfee, after its trademark security software.
With multiple small vendors providing highly specialized cyber solutions in a fragmented marketplace, Bloomberg reports the cybersecurity space may be due for a shakeup, and TPG may seek add-on acquisitions as they build the McAfee cybersecurity business. This could also mean broader consolidation in the cyber sector, which will be of interest to other PE firms.

Future PErspectives: What’s Next for Government Contracting Investors

PE firms focused on the defense and aerospace sector are showing increased interest in investing in mid-tier firms with highly specialized technologies after an extended wait-and-see period, according to National Defense Magazine. In September, Acorn Growth Companies bought advanced aircraft technology provider Raisbeck Engineering, and JF Leman acquired The Oldenburg Group’s mining and defense units for undisclosed sums. Trident Maritime Systems, a portfolio company of J.F. Lehman, also acquired Callenberg Technology Group from Wilhelmsen Maritime Services. Companies are increasingly evaluating the separate values for their government and commercial businesses, which will present attractive carve-out opportunities for PE firms going forward.
Sources: Bloomberg, ExecutiveBiz, Federal Times, FedTech, GovCon Wire, Investopedia, J.F. Lehman & Company, Milwaukee Business Journal, National Defense Magazine, PE Hub

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