Who's your nontraditional buyer?

Acquisition experts Marc Marlin and Kate Troendle continue their four-part series that examines who is driving the resurgence in government market M&A. Here in part three, they look at the "nontraditional" buyers coming into the arena.

(EDITOR'S NOTE: Click here to read the first part of this series focused on private equity and also click here for the second part on public companies)

Next up in our government technology solutions (GTS) buyer series is an assessment of the “nontraditional” buyer, broadly characterized by a buyer that has a more diverse customer base that extends outside of the government sector. This often includes businesses focused on technology products, commercial customers, engineering and construction capabilities, and/or those companies that have special contracting designations, such as is the case with Alaskan Native (ANC) and Tribal corporations.

Recently, sellers have had a heightened interest in the nontraditional buyer. The allure of this buyer group often stems from the perception of premium valuation potential, motivated by the “platform” market entry thesis, higher relative valuations in their core markets that enable them to pay-up (e.g., commercial software companies), and/or contractual advantages when considering the ANCs and tribes (related to continuity of set-asides).

This buyer segment has been increasingly active and has made some big splashes, such as ASGN’s nearly $800 million acquisition of ECS Federal earlier this year, or KBR’s $350 million acquisition of Stinger Ghaffarian Technologies. But the nontraditional group represents a comparatively small segment of buyer activity, representing approximately 11 percent of announced transactions since 2017, down from 20 percent in 2015 and 2016. Of this buyer subset, very few transactions represented the “Silicon Valley” type high flyer platform, as commercial software firms (e.g. Amazon, Microsoft, Salesforce) typically prefer delivery partners and channels to gain access to federal customers.

Moreover, as the GTS public markets continue to flourish, we have seen increased valuation parity across the nontraditional players and GTS buyers. As for the Alaskan Native and Tribal corporations, they have consistently represented the buyer in approximately 2% of all transactions. And outside of ASRC, they have focused on deals smaller then $50 million. While ANCs and Tribal corporations indeed have the inherent advantage of perpetually being able to qualify as a set-aside business, which implies an expanded addressable M&A target market to include predominantly set-aside businesses, they also generally remain highly selective and risk adverse from a valuation perspective, given their mandate to generate highly predictable cash flow for their stakeholders. Moreover, the supply of set-aside companies seeking an ANC or Tribal buyer meaningfully outnumbers demand. As such, the likely value creation strategy for set-aside heavy contractors remains a proactive transition to full-and-open rather than the sale to an ANC or Tribal business.

That said, this nontraditional buyer group does often offer a unique value proposition, albeit valuation, and platform opportunity to keep a seller’s business intact, and/or provide immediate access to new markets or technologies. As a result, these buyers should be seriously considered when GTS business owners are evaluating strategic alternatives.

Next week we will discuss the most active segment of today’s M&A market -- the mid-tier private company acquirer.