WashingtonExec 2013 Government Contracting Outlook Series:
The new year brings big changes for the Federal IT industry, and WashingtonExec is back with its Government Contracting Industry Outlook Series.
We are giving local executives the opportunity to share their thoughts on where they see our industry headed this year and beyond. Leaders were asked a series of questions focused on cloud computing, healthcare IT, defense, mobility, and more.
Jean Stack, Managing Director of Aerospace, Defense, and Government Group at Houlihan Lokey, spoke with us about her predictions for 2013:
“The coming year will be an active one for M&A in government contracting. Many of the same realities that contributed to strong deal flow in 2012 (minus the race to beat capital gains tax increases) are back again for 2013. Those factors include slow to no organic growth, an abundance of built up capital available to support acquisition strategies and the strategic drive to re-position through portfolio shaping initiatives.
From a timing perspective, deal activity will be relatively slow in the first half of 2013, increasing significantly in the back half of the year. The slow first half really just reflects a break from the aggressive pace of acquisitions that closed pre-year end 2012. That said, January 2013 M&A should be strong – reflecting spill-over deal volume from year end. As we enter 2013, buyers are reaffirming strategies and targeting areas of acquisition interest, and sellers are assessing timeline given budgetary challenges, award delays and sequestration on the horizon.
Last year was generally a tough one to be a seller, and many transactions that went to market ultimately did not close. Company performance – particularly growth – didn’t manifest as anticipated. In addition, buyers were very cautious on valuation, so some sellers chose not to transact at current market pricing. Hopefully, we’ll see some budget clarity in 2013, and with that, an increased pace of contract awards and hopefully some meaningful organic growth. Until we see more robust industry growth prospects, it’s unlikely that we’ll see any meaningful and sustained resurgence in M&A multiples.
With regards to deal composition, we expect to see still more divestitures in 2013 as companies shed non-core or OCI’d assets. At the same time, larger industry players will diversify into adjacent highly regulated markets (energy/environment, health IT, finance, commercial aerospace) or into high growth, tangential commercial areas (cyber, big data, cloud). Selling companies that participate in these markets will drive strong valuation multiples.
We expect small and mid-tier government services companies to be among the most active acquirers of government contracting firms. These firms have accumulated cash and have support from an active lending community to make strategic add-on acquisitions. More than 75% of deal activity in the space is sub $50mm in transaction value – making acquisitions very meaningful to mid-tier players and critical to adding capabilities, customer relationships and contract vehicles. With current valuation trends and healthy skepticism from Wall Street about near-term industry strength turning some public companies conservative, these smaller firms can be successful in acquiring highly strategic assets to complement their existing platforms.
In addition to M&A from strategic players, we’ll also see a resurgence of private equity (PE) deals of all sizes. There is a long track record of success for PE participation in the industry, and in 2013, private equity will be better able to compete with strategic buyers on valuation with financing markets continuing to be supportive.
Despite broad federal market challenges, there are plenty of reasons to be optimistic about the future for this industry. Organic and inorganic growth strategies will fuel rebuilding and rebranding. Growth and valuation will be driven by efficient execution as well as agility and innovation. I look forward to seeing how this truly resilient industry responds to this latest set of challenges.”