PErspective in Government Contracting - Summer 2017

August 2017

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A feature examining the role of private equity in the government contracting space.
 
Despite major budget cuts, proposed legislative shifts and unfilled federal government positions, the outlook for government contractors has been optimistic. Earlier this year, private equity activity for the government contracting industry was looking up. According to a Washington Technology report, a post-Trump bump boosted sector valuations, averaging 11x forward earnings before interest, tax, depreciation and amortization (EBITDA).

Today, the mood in Washington remains positive as contractors—especially in the aerospace and defense industries—predict growth, federal government spending and budgets will be in their favor. According to Bloomberg Government, many contractors who were taking a “wait and see” attitude prior to the November elections are now leaning into an “invest and grow” mentality in areas like infrastructure and technology.

As contractors are actively investing more in technology, expect strategic IT deals to play a major role in the year ahead. We’ve already seen top contractors making big moves in the deal space this year. Lockheed Martin recently divested its Information Systems & Global Services business to Leidos, which resulted in Lockheed slipping from number one in Washington Technology’s Top 100 to number two. Leidos assumed the top spot post‑transaction.

Companies lower on Washington Technology’s list are also making moves in cyber, IT and cloud technologies through strategic hires and partnerships. Other notable deals in the space this year include the merger of HPE’s enterprise services business with Computer Sciences Corp. to create DXC Technology. DXC will aim to “modernize and digitize outdated government processes.”

We continue to see many large and mid-sized government contractors consider carving out non-strategic business lines. Their boards and senior leaders are reassessing their portfolio of capabilities and customers to focus the company’s resources on areas of expertise and growth. Financial buyers and smaller government contractors have shown great interest in these discarded businesses as they possess or have access to senior leadership to run the carve-outs though are keen to fully understand the stand-alone abilities of the carve-out businesses and the areas of investments needed.

Overall, we are currently experiencing a seller’s market for government contracting M&A. Investment bankers are very active with robust auctions for small and mid-sized government contractors with unrestricted contracts and a healthy pipeline to capture higher valuations. While we are seeing smaller government contractors with set-aside revenue completing transactions, the market of buyers for these businesses is shrinking as buyers see the risk of the set-aside work not continuing post-transaction, which then produces a lower valuation, or no transaction at all. 

Sources: Washington Technology, Bloomberg Government