Michael Lewis, Lazard Capital Markets
2012 is here, and with it comes big changes for the Federal IT industry. WashingtonExec gave local executives the opportunity to share their thoughts on where they see the government contracting industry headed.
Michael Lewis, Director at Lazard Capital Markets, gave his and his company’s point of view regarding this year’s government contracting market; including the areas of IT, intelligence, and healthcare.
Michael Lewis: 2012 may be the inflection point within the government contracting community as industry moves to a budgetary environment focused on austerity and savings. In our view, the firms that will likely show the most success will be those that realign strategies, costs, overhead and, most importantly, commitments to the customer. If managed correctly, those companies that can see through the nearer-term uncertainty of budget austerity should be the most successful meandering through this next phase within the industry.
Within the IT sub-segment, we expect there will be winners and losers. We believe those companies most closely positioned and operating at the “mission” will be more insulated from significant contract cuts. However, firms providing less critical services out at the periphery will likely face contraction within their IT portfolios as government customers look to cut non-mission-essential spending from agency budgets. We do anticipate further risks to overall federal IT budgets, but the winners should remain those companies that provide higher-end expertise not available from the federal employee workforce. At Lazard Capital Markets, we focus on the intelligence, surveillance and reconnaissance IT markets, including technologies aligned with multi-intelligence capabilities that can be leveraged across multiple end-users. In our view, these are some of the more highly coveted areas within IT; companies operating within those sub-verticals should continue to do well.
Industry consolidation will be opportunistic, in our view, but should remain brisk as we progress through 2012. While we do not expect merger activity among the larger prime contractors, we do anticipate ongoing consolidation within the mid- and small companies operating in the space, with a primary driver to M&A activity being market share growth. In a tightening budgetary environment, holding onto current market share and winning take-away contracts are critical to success, in our opinion. We believe companies must take market share; otherwise, business contraction appears inevitable. Regarding top acquisition prospects, we continue to view cyber security, health IT, energy and infrastructure protection, multi-INT, and fused sensor suites as the most sought after opportunities within the IT market.
Furthermore, as management teams evaluate portfolios and corporate positioning, we expect additional non-core operation divestitures to continue. We have already noted some companies embracing this strategy and expect smaller firms that have been historically active in M&A may also view portions of their businesses as non-core.
Uncertainty has surely prevailed within industry over the last 12 months. Budget concerns, continuing resolutions, protests, and contract delays (to name a few) have all made operating in the IT space difficult. On a positive note, for the first time in a few years, we have a defense bill approved in a more timely manner, which provides industry two elements vacant relative to this time last year – visibility and clarity. We believe for the rest of GFY’12, industry will have better visibility into funding and clarity into contract commitments. Further, managements should be able to more accurately forecast their businesses since contracting offices are now fully funded through year-end. As such, industry should note a more even-keel contracting environment, and we think some contracts that have been constantly delayed could move to award; in our view, a win/win for all parties involved.
