The past six months have set the stage for a significant competitive shift in the government technology solutions market, as companies adapt to changing procurement dynamics, budget priorities, and public valuation trends. On the procurement front, contractors are seeing elongated award timelines due to delays in decision-making and longer protest periods, which have weighed on firms' ability to forecast near-term financial results and allocate competing investment resources. Additionally, overall federal IT spending is projected to remain relatively flat over the near-term, while certain areas and capabilities such as intelligence, health, and cybersecurity continue to stand out as key budget priorities.
The combination of more challenging procurement dynamics and a highly selective budget environment have prompted many large government and defense primes to carefully evaluate their portfolios in order to enhance competitiveness, bolster profitability, and focus on core tenets of their businesses.
Key examples include:
- BAE Systems’ announcement in April that it looks to divest its intelligence and security services business (~$1.5 billion in annual revenue);
- CSC’s announcement in May that it is seeking to separate into two independent companies focused on the commercial and public sectors, respectively;
- L-3’s announcement in July of a potential divestiture of its national security solutions unit (~$1.2 billion in revenue), and
- Lockheed Martin’s July announcement of a potential divestiture of its services business (~$6.0 billion in revenue).
Combined with the corporate strategy of publicly-traded primes, private equity firms are also contributing to the competitive shift, as rebounding valuations catalyze potential exit events. Recent commentary from these groups indicate that their portfolio companies could either emerge as publicly-traded firms themselves, or merge within larger government and defense companies through a traditional sale process. Major announcements include a potential sale or initial public offering of Novetta Solutions (Arlington Capital), PAE (Lindsay Goldberg), SRA (Providence Equity), and Vencore (Veritas Capital), all of which are seeking valuations between $650 million and $2.0 billion or more. Last week Salient (Frontenac) and CRGT (Bridge Growth) announced a merger, and Veritas Capital closed on its acquisition of Alion Science & Technology.
With these anticipated events from strategic investors and private equity firms, contractors may likely face a more fragmented market, characterized by greater competition for funding dollars in an environment where organic growth remains a challenge. As a result, we may see a further wave of consolidation activity over the near-term, as firms focus on achieving greater scale, customer access, and capability depth, in order to enhance their competitive positioning and maximize shareholder value.
What does that mean for the mid-size seller? It's a mixed bag. These large investment opportunities are cannibalizing select buyers' attention right now, while certain potential sellers have put buying on hold for the time being. That said, CSC recently announced two deals. To the positive, deal activity in the large-cap end of the market has companies and executives thinking about strategy and positioning, which traditionally has been a strong leading indicator for robust M&A activity for companies of all sizes.