Today’s 2012 federal IT outlook comes from Bill Loomis, Managing Director of Stifel Nicolaus.
“Over the next decade we believe the government IT market will show dramatic change, driven by much tighter budgets, little or no reduction in the mission of federal agencies, and technology trends. Gone are the five year, enterprise systems costing hundreds of millions and here to stay are more incrementally developed, agile, mission focused systems utilizing secure clouds, advanced analytics, mobile and social networks. Budget reductions will be both a blessing and a curse to this change, by making government more receptive to changes in how they do business, but slowing significant changes near-term due to uncertainty and a lack of future guidance created by the budget debates and political posturing.
Despite the urgent need for the government to reduce spending (both mandatory and discretionary), there will be little reductions in GFY12 and GFY13. An OMB memo indicates the President’s GFY13 DoD budget will not include sequestration reductions and show growth of about 2% per year (on base budget) going forward. We think this budget is not a surprise as the budget is in line with the total spending ceiling put into law in August with the Budget Control Act of 2011 (BCA), and the President has deferred to Congress on any budget reductions beyond the BCA ceiling. We believe this could be a short-term positive for Fed IT contractors, particularly given GFY12 budgets are approaching completion as I write this, and the President’s GFY13 budget announcement next February likely to defer material cuts. These two events could give government customers some feeling of improved visibility (which could help increase the pace of awards), and give investors increased confidence as well.
Unfortunately, the confidence will likely not be sustained beyond the short-term. As many reports from economists and budget experts have shown, significant reductions in government spending have to happen soon as the current path is unsustainable in any scenario without significant spending reductions. As a result, even if budget reductions are deferred for a year, we think they will be revisited out of necessity following the elections. Over the next year, we expect increasing pricing pressure and likely some earnings disappointments from companies in the industry, creating long-term buying opportunities. We believe company valuations generally in the federal services stocks will continue to be under pressure (despite periodic rallies) and begin a more sustained move higher post elections. We believe the drivers will be improved budget visibility (even though we expect them to be down modestly), better margin stability after most higher margin contracts have by then been recompeted at lower margins, and an emerging investment theme of using IT to downsize government and improve efficiency, similar to the 1990s. We believe the current technology trends including cloud computing, more incremental software development, increased use of mobile apps and social media will help government reduce its workforce through efficiency and allow more self service.”
Loomis is scheduled to speak more about this topic at the Fairfax Chamber of Commerce GovCon Symposium in February. Find more details here.
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William Loomis is a managing director at Stifel Nicolaus. He can be reached at wrloomis@stifel.com. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. Stifel Nicolaus does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For additional information and current disclosures for the companies discussed herein, please go to the research page at Stifel.com.