Top 5 GovCon M&A Lessons Learned: the Good, the Bad and the Ugly  

John Sutton

John Sutton

John Sutton is the former chief operating officer of KeyW Corp., which closed on its sale to Jacobs Engineering in June 2019.

Introduction

“The quickest way to double your money is to fold it over once and put it back in your pocket.” – Frank Hubbard

The government contracting mergers and acquisitions market continues to sustain high activity and high valuations. The range is increasing from mega-deals such as L3 and Harris and Raytheon and United Technologies, to smaller capability additions such as Perspecta buying KnightPoint and Serco buying Alion’s Navy business. Valuations continue strong as indicated by the recent Jacobs purchase of KeyW at 22.5 X LTM.

1. Buyer Strategy 

“Never invest in a business you cannot understand.” – Warren Buffet

There are recent examples of large, diversified private equity firms buying into GovCon without clear understanding of the sales cycles and business operations. Recent examples of underwhelming results include KKR and GA’s split ownership of TASC and also Ares’ ownership of Sotera.

Meanwhile, private equity firms mainly focused on the aerospace and defense and GovCon space have had great success, as seen with Veritas’ success with Vencore and DynCorp.

Whether large or small, public or private, it is critical the buyer has a strategy for growth, both organic and M&A, if the balance sheet allows. That strategy should address 5 years out with tight fidelity in the next three years. Ensure your 3-year view addresses waterfall, pipeline, priorities, customer strategy and budgets, margin growth and integrated compliant business systems.

Smaller firms should consider a low-profile approach of investing in people or technology partnerships leveraging their equity to create room for investment hires who can be rainmakers inside their firm. A significant cost to entry exists in a purchase of any size, so consider those sunk costs like proposal costs. Too often, bidding doesn’t mean winning.

Also, prepare for intensive and exhausting 24×7 due diligence periods managed by a third party where the buyer must be uncompromising in understanding every program, benefit, contract, expense, obligation, business system, regulatory status, legal issues, etc. The buyer should initially prepare a position on retention of key employees as well as an approach to retain and prosper the muscle mass of employees who deliver the business daily.

While attractive at deal negotiations, earn-outs have traditionally not proven themselves, so buyers and sellers should avoid them. I was once involved in a successful defensive litigation of not paying an earn-out a significant amount to the private equity seller of a commercial firm, where the 3-year court battle distracted the leadership and operational team to a point of no return.

The bottom line as you lead your business is to increase your enterprise value regardless of method whether competed, purchased or simply outperformed.

2. Culture

Peter Drucker said, “Culture eats strategy for breakfast,” whereas I ask, what does culture consume for lunch and dinner? To be clear, a successful business needs both and will achieve great results with a strategy that allows a strong culture to deliver the tactical steps. Strong local cultures can be found at Jacobs and Booz Allen Hamilton, where career growth, customer success, innovation, fun, diversity and upselling are keystones of their success.

Smaller, privately held firms usually evolve into a culture reflective of the founder’s personality and values. Often, that culture is so ingrained, it makes for low probability of a successful integration and subsequent business results. As the buyer, once you have examined the business, it is critical to deeply dive into the people and what makes the company operate and thrive.

In parallel, consider your culture and what is your culture — is it your customer service, is it innovation, is it financial excellence producing double-digit margin and low DSO?

The next three M&A lessons learned; seller strategy, business case and integration, will be published later this month.

Author

Joining KeyW in May 2017, Sutton led the integration of the Sotera Defense acquisition and then harmonized the culture around results, innovation, investments and growth that led to its record 22x trailing EBITDA multiple sale to Jacobs only two years later. Sutton stayed on to lead the successful integration of KeyW into Jacobs Aerospace, Technology and Nuclear business. As they say, this was not Sutton’s first rodeo. He began his career in 1981 as a merchant marine officer serving on U.S. flag ships. Since 1986, Sutton has been a leading player in deals with a total value of $4 billion, i.e. PRC to Litton, GRC to AT&T, McDonald Bradley to ManTech, Global Crossing to Level 3, QinetiQ NA to Veritas, and KeyW to Jacobs.

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