After several years of active deal-making, BAE Systems North America Inc. in 2001 suddenly ran into market conditions that hobbled its mergers and acquisitions strategy.
Contractor valuations rose dramatically, and top-quality, large defense companies for sale were nearly impossible to find. The $5 billion-a-year company wasn't able to meet its objective of growing by 15 percent annually through acquisitions.
"We realized we had to become more aggressive," said Lucy Reilly Fitch, senior vice president of acquisitions and strategy for the American subsidiary of the U.K. defense and aerospace giant. "To reach our goals, we had to change how we did our M&As in North America."
In 2003, BAE reorganized how it evaluated targets, with sector presidents and Fitch's corporate office in Rockville, Md., working more closely together. They also clarified their definition of a strategic acquisition. The company wasn't looking only for defense companies but also for companies that served national security interests, including homeland defense.
"We broadened our aperture," Fitch said.
The result was a deal that wowed an industry.
BAE's October acquisition of DigitalNet Holdings Inc. for $593.2 million was picked by a panel of industry experts as the Big Impact deal of 2004 because it showed that the company could make a big acquisition in its bid to take on other contractors such as Lockheed Martin Corp. and Northrop Grumman Corp. Over the last year, BAE made four government-related acquisitions, strengthening its position among elite systems integrators.
But BAE wasn't the only deal-maker creating an impression. In 2004, 106 acquisitions occurred among government IT services companies, according to research by Washington Technology and investment banking firm Houlihan Lokey Howard & Zukin of McLean, Va.
The number of deals is more than 25 percent higher than 2003's total of 82, and represents a steady climb from just 45 transactions in 2001. The companies making the deals show a wide range of interests in the government market, particularly because of budget growth in homeland security, intelligence, network-centric warfare and outsourcing. Companies making acquisitions are often are trying to get into these markets or, if they're already in, trying to grow to increase their competitiveness.
Contributing to the rising number of transactions are capital equity groups such as Veritas Capital Fund LP, which made its first foray into the government IT services market in 2004 when it acquired McNeil Technologies Inc. These groups are looking to repeat the success of equity-backed ventures such as Anteon International Corp. and SI International Inc., which now are publicly traded and continue to make acquisitions of their own.
Another factor driving M&A growth is the push by foreign companies into this market. In addition to BAE, six other non-U.S. companies bought American firms.
"We wanted to get to a proper scale and get bigger customers, and the biggest customer is right next door," said Claude Séguin, senior vice president of strategic investments of Montreal-based CGI Group Inc. CGI and CACI International Inc. split American Management Systems Inc.'s government business in a complex deal worth $848 million. That deal was tapped as a close second to the BAE-DigitalNet transaction by the panel of industry experts.
One of the strongest trends — and the one that bodes well for the future of the government market — is the vitality of deal-making among small businesses. For example, Dimensions International Inc. nearly doubled its size with its first acquisition when it bought Sentel Corp. in June. The transaction pushed its revenue from $53 million to $100 million, a big first bite.
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"It's eat or be eaten, and we decided we weren't ready to be bought," said Russell Wright, chairman and chief executive officer of Dimensions International of Alexandria, Va., which specializes in information integration, logistics management and air space management support.
But the deal almost didn't happen, even though Sentel was one of the first companies Wright looked at when he began shopping for an acquisition.
"I looked the other way," he said. "Taking on that size acquisition right out of the gate was more aggressive than I wanted to be."
But three months later and after looking at three other targets, Wright agreed to a lunch to discuss Sentel. "Once I met the owner of Sentel [James Garrett] and got an idea of Sentel's culture, I knew we were an ideal fit and it was worth the risk," he said.
The next deal likely will be easier. "At least the bank knows I can pull the trigger," Wright said.
CULTURE COUNTS
A cultural fit also was a driver behind the year's most unusual deal, AMS' joint acquisition by CACI of Arlington, Va., and the CGI Group of Montreal. CACI bought AMS' defense and intelligence business, while CGI acquired the federal civilian, state and local and commercial units.
Donna Morea, president of CGI-AMS and a longtime AMS employee, said that as she learned about CGI during the acquisition, "it was like holding up a mirror" to AMS. Like AMS for most of its 30-year history, CGI is run by its founders, who emphasize customer satisfaction as the measure of success.
"I felt like we were coming home again," she said.
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Becoming a part of CGI brought AMS the ability to go after larger contracts that require a breadth of capabilities, something AMS struggled to do previously, even though it had about $1 billion in revenue. An early sign of the deal's success came when CGI-AMS in November was named one of 12 winners of the Justice Department's $980 million Information Technology Support Services contract, Morea said.
Although the company will have to compete for work, it is one of the few companies on the task order contract that is approved for all service offerings, such as infrastructure management, application management, outsourcing, system integration and business process outsourcing.
"We would not have qualified across all of those dimensions if not for CGI," Morea said.
One big cultural difference between CGI and AMS is the making of acquisitions. The CGI Group has completed 60 since its founding in 1976; AMS completed precious few in its more than 30 years in existence. But that is going to change, according to Morea and Séguin.
"We're not shooting from the hip," Séguin said, "but we are looking to reinforce our base in the United States."
A big target is adding capabilities to pursue more outsourcing work, Séguin said.
CGI-AMS' federal business is between $200 million and $250 million, Morea said. "To be a player, you have to be at least twice that," she said.
The goal is to have $500 million in federal revenue by the end of 2006. "That's a big, audacious goal," she said.
A BUYER AND A SELLER
McNeil Technologies was on both sides of deals last year. In one of the first deals of the year, it acquired Research and Evaluation Associates Inc., a company with about $7.5 million in annual revenue. About seven months later, in July, McNeil pulled off a surprise when it was acquired by Veritas Capital.
Although the value of the deal was not disclosed, Veritas now has a platform company with revenue that was about $75 million in 2004 and is projected to hit $100 million in 2005, not counting any potential acquisitions.
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For James McNeil, who founded the Springfield, Va., company in 1985, the sale to Veritas will let the company grow and make acquisitions while remaining independent.
"We had financed our growth in-house, and we were tapping out our resources," he said. "When you are growing 40 percent to 50 percent a year, it gets a little tough."
Though McNeil had been fielding eight to 10 calls a week from potential suitors -- and had even higher offers -- McNeil said he went with Veritas because it let him and his management team stay in place, and it gives them the resources to continue making deals.
Other deals would have eliminated the name of McNeil and integrated it into a larger company. "I'm not ready to ride out into the sunset, and neither is this management team," McNeil said. "We have a lot of fight left in us and a lot of insight into the marketplace."
With Veritas' backing, McNeil plans to look at companies with intelligence, IT and consulting expertise to complement the work McNeil Technologies does. His targets are in the $50 million to $100 million range. He said he wants to close two deals in 2005.
Since the McNeil purchase, Veritas showed its commitment to the government services field with its planned purchase of DynCorp International LLC from Computer Sciences Corp. for $850 million. The deal, announced in December, is pending.
Although rumor has it that Veritas will combine DynCorp with McNeil Technologies, McNeil said he has not talked to Veritas about that prospect and doesn't expect it to happen.
"We'll work together, I'm sure, but our core businesses are different," he said.
A RESELLER'S TRANSFORMATION
After adopting its third name in six years, Apptis Inc. of Chantilly, Va., is making bold moves to remake itself from a reseller of IT products into a services company.
The company, which started as Intellisys Technology Corp. before becoming PlanetGov in 2000 and Apptis last year, made three deals in 2004 and closed a fourth deal at the start of 2005.
The company always had a strong professional services unit, but it has been overshadowed by the revenue generated by the reseller business, said Brian Nightingale, senior vice president of business management. Nightingale, Apptis CEO Stephen Baldwin and three other Apptis executives bolted from BTG Inc. and acquired Intellisys after BTG sold its reseller business to rival GTSI Corp.
Apptis kicked off its buying spree in November 2003 after New Mountain Capital took an equity stake in Apptis and agreed to back acquisitions. The company is using acquisitions to acquire personnel who have desirable skill sets, such as network and software engineers as well as customers, Nightingale said. For example, at the end of 2003, Apptis acquired General Data Systems, which gave it access to more State Department customers. Acquiring Technology and Management Associates brought Federal Aviation Administration customers.
Apptis made three deals in 2004, and in January completed its purchase of SETA Corp., a McLean, Va., IT services company. Apptis is projecting about $600 million in annual revenue, Nightingale said.
"Our acquisitions over the last 18 months have been to position ourselves as a premier IT services provider," he said.
Although 75 percent of the company's revenue is from product sales, about 75 percent of Apptis' profits are from professional services. "From a bottom-line standpoint, services heavily rule the day," he said.
NO PRESSURE
Before it paid $53.4 million in September for Impact Innovations Group LLC, Dynamics Research Corp. of Andover, Mass., had not done a deal since 2002.
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The deal was aided by a company reorganization earlier in 2004 that defined six solution sets that DRC offers its customers, said William Hoover, company president and chief operating officer.
"I'm a firm believer that an organization's structure follows strategy. You develop the strategy, and then you create the organization to execute that strategy," he said.
With the reorganization, DRC quickly spotted where Impact Innovations Group would fit into the company. "Because we had reorganized, it was not a very complex task to assimilate IIG into the organization," Hoover said.
About half of DRC's revenue comes from acquisition management support, and the rest come from business transformation, business intelligence, case management, infrastructure support and training. IIG brought capabilities in infrastructure support and business intelligence, Hoover said.
DRC also added a new executive, Ellen Glover, to its team through the acquisition. When it reorganized, DRC created a new division -- systems development -- that is the company's largest with between $130 million and $150 million in annual revenue. DRC was searching for a leader for the unit when it began the due diligence process for the IIG acquisition, Hoover said.
Glover, who was the president of IIG's government unit, now leads the systems development division. "It was obvious that Ellen was the ideal candidate," Hoover said.
As for more deals, Hoover said the company will stick to its strategy and not make acquisitions to fuel growth. There is no set goal for growth through acquisitions.
"We are not going to be pressured to make a deal that doesn't make sense for us," he said.
Senior Editor Nick Wakeman can be reached at nwakeman@postnewsweektech.com.
