Government Contracting M&A Updatemacpamedia.org/media/downloads/2013GVC/Davis_PPT1pp.pdf ·...
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Aronson Capital PartnersI N V E S T M E N T B A N K I N G
Government Contracting M&A Update September 23, 2013
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Agenda
I. Introduction to Aronson Capital Partners
II. Federal Market Trends & M&A Landscape
III. M&A Nuts & Bolts: Building Shareholder Value & Exit Strategies
Aronson Capital Partners
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Larry DavisPartner & Founder(301) 231‐[email protected]
Over 25 years of transactional experience in middle‐market M&A, divestitures, and financings; having completed more than 40 transactions involving defense and government services companies
15 years operational experience as VP of Finance at DynCorp, acquiring 15 federal IT companies
Selected notable transactions include sale of: ‒ TexelTek to TASC ‒ Atlantic Coast Telesys to SAIC ‒ AEPCO to VT Group plc‒ Capital City Technologies to Ernst & Young
Holds a B.S. in Accounting from University of Maryland and is a founding member of the MCCC Government Contracting Network and Board Member of Hearts and Homes for Youth
Introduction to Presenter
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Full‐Service Investment Banking Capabilities
MERGERS & ACQUISITIONS
Sell‐Side M&A Buy‐Side M&A Management & Leveraged Buyouts Divestitures Asset Sales
CORPORATEFINANCE
Recapitalizations and Restructurings Common and Preferred Equity Raises Mezzanine Capital Raises Debt Capital Raises Majority and Minority Private Equity Investments
FINANCIALADVISORY
Internal Capital Transaction Advisory Independent Corporate Valuations Fairness Opinions ESOP Valuations Strategic Alternatives Assessments
ACP is a full service investment bank with the domain expertise, industry relationships, and corporate finance experience to complete a tailored transaction to fit shareholders’ objectivesACP is a full service investment bank with the domain expertise, industry relationships, and
corporate finance experience to complete a tailored transaction to fit shareholders’ objectives
Aronson Capital Partners
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Agenda
I. Introduction to Aronson Capital Partners
II. Federal Market Trends & M&A Landscape
III. M&A Nuts & Bolts: Building Shareholder Value & Exit Strategies
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Federal IT Market: Component Market Size & Growth Rates ($ in billions)
Government Services Market HeadwindsTrends Federal IT spending is forecasted to decline by a 1.4% CAGR from 2012 – 2017, from $121.7B to $113.3B.
Contract award activity is weak due to budget, federal acquisition issues and more protests; new procurements are taking a back seat to sequestration planning.
Delayed procurements will lead to depressed backlogs and stagnant revenue.
Fewer awards, continued award delays, and further pressure on growth and margins will likely result in underperformance of contractors relative to the market over the next year.
Feasibility and cost effectiveness reviews of major IT programs have already led to IT program cuts.
Intensified competition, tighter pricing and narrower margins as low price technically acceptable (“LPTA”) procurements reign.
Source: INPUT
Federal IT Market: Customer Segment Growth Rates (2012 – 2017)
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Priority Markets: Sizing and Forecast
$4.8
$2.8$2.4
$6.9
$3.9$3.5
$‐
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
$7.0
Defense CAGR: 7.6% Civilian CAGR: 7.0% Intel CAGR: 8.2%
2012 2017
Cyber Security Customer Segments(S in billions)
$1.9 $1.8
$1.2
$2.8 $2.6
$1.8
$‐
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
Defense CAGR: 7.6% Civilian CAGR: 7.0% Intel CAGR: 8.2%
2012 2017
Big DataCustomer Segments($ in billions)
352 484 811 1,073 1,372 1,368294 339
509747
1,248 1,336
88145
270
513
499 477
$‐
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
2012 2013 2014 2015 2016 2017Software CAGR: 31% Infrastructure CAGR: 35% Platform CAGR: 40%
Cloud Computing Service Types($ in millions)
$1.6$1.4 $1.5
$2.1$1.8
$2.6
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
VA DoD HHS
2011 2016
CAGR 5.6% CAGR 5.8% CAGR 11.5%
Health ITCustomer Segments($ in billions)
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Government Services Index Performance and Valuations Though organic growth outlooks remain
relatively flat, the market has become more optimistic over the past six months — The threat of large‐scale budget cuts and
contract cancellations has largely passed
— For many companies, flat is the new normal
Profit margins remain under pressure as LCTA acquisitions are becoming more commonplace— Many contractors, both incumbents and new
bidders, are willing to significantly reduce margins in order to gain access to steady revenue within desirable budget areas
M&A Impact: — The budget has begun to stabilize and overall
acquisition risk perception has been reduced, and we expect to see an up‐tick in the number of deals over the next 6 months
— Acquisitions are increasingly driven by strategic imperative rather than simply building mass
— Because of this, there has been an increase in smaller deals (<$100M) with leading companies in niche markets that a larger buyer hopes to leverage into large scale prime efforts through its existing relationships and scale
Mid‐Tier Index: Active Tickers ‐ BAH, CACI, CUB, DRCO, EGL, ICFI, KEYW, MANT, NCIT, SAI; Inactive Tickers – GTEC, SRX, SXETier‐1 Index: BA, GD, HRS, LLL, LMT, NOC, RTN Source: Cap IQ
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1
3
4
5
6
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Impact (Peak / Trough) Tier‐1Mid‐Tier
1. Peak (Q2’10) 7.5x 9.2x
2. Insourcing (Q3’10) 5.6x 6.3x
3. Recovery (Q1’11) 6.4x 8.5x
4. Cont. Rsltn. (Q3’11) 4.8x 5.5x
5. Recovery (Q2’12) 6.1x 6.6x
6. Sequestration (Q4’12) 5.5x 4.6x
7. Recovery (Current) 7.7x 7.3x
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Comparable Public Company Valuations
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Software Engineering & Development
The 80/20 PhenomenonDue to a challenging budgetary environment and precise acquisition criteria, 80% of the prospective
buyer universe is pursuing the same 20% of the acquisition targets
Prospective Buyer UniverseProspective Buyer Universe
All Private Equity
Targets’ Focus:Targets’ Focus:
80% of buyers are pursuing 20% of acquisition targets
80% of buyers are pursuing 20% of acquisition targets
Big Data Analytics
Healthcare IT
Cyber Services & Technologies
Cloud Computing
C4ISR
Technical Assistance
Cost Estimating
Program Management
IT Infrastructure
Value Added Resellers
Advisory & Assistance Services
Acquisition Support
Program Portfolio
Management
Grants Management
International Assistance
Financial Management
IT Integration
OCONUS Language Translation
Facilities Management
IT Compliance
Business Process
Engineering
Knowledge Management
:Primary Target Markets
:Secondary Target Markets
Data Visualization
Engineering Services
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Current Deal Environment Observations Buyers are very active but highly focused
– Buyers are actively seeking acquisition opportunities for a variety of reasons, including repositioning their capabilities to complement organic growth, and to achieve Wall Street earnings estimates
– Acquisition criteria has become more precise – smaller number of available targets that “check all of the boxes”
– Increased flexibility – willingness to prioritize capability expertise / customer depth over size
Despite budgetary uncertainty, 2012 was an active year for M&A
– The total number of transactions is comparable to previous years
– However, the number of marketed companies that did not close has increased significantly
Credit markets are loosening
– There is a need to deploy a sizeable amount of both private equity and traditional bank capital
– Much more reasonable leverage characteristics (i.e. Debt / EBITDA)
Valuations are deal specific
– Value uncertainty depending on buyer universe and company characteristics
– Continued perception of downward pressure on valuation
– Structured transactions (i.e. contingent payment) were prevalent
Buyer Universe (2012 Deals)Source: InfoBase; Aronson research
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Priority Markets: M&A Trends and Key Competencies
Big Data
Business / Actionable Intelligence Predictive Analytics
Extract, Transform, and Load Geospatial Analysis Visualization Unstructured / Structured Data Data Warehousing Real‐Time Analytics
Priority Market Deals as a Percentage of Total Federal M&A Activity
Cloud Computing
System Architecture & Development Application Programming Interface Everything as a Service Data Warehousing System Implementation & Sustainment Virtual Desktop Infrastructures Secure Remote Access Thin Client Management
Healthcare IT
EHR Management Federal Health Exchange
Medical and Vital Records Fraud, Waste, and Abuse Prevention
Medicaid Management Health Informatics
Record Location Services & Patient Tracking Hardware Maintenance & System Implementation
Cyber Security
Intrusion Prevention / Detection Systems Real‐Time Situational Awareness Identity Extraction / Attribution Computer Network Attack / Defense Vulnerability and Prevention Testing Computer Network Exploitation Deep Packet Inspection Malware Analysis
Leading‐Edge Enabling Technologies
Advanced Data Fusion Geospatial Visualization Predictive Analytics Data Discovery Secure Mobile
Technologies Cloud Computing
(Hadoop, MongoDB)
9383
63
85 79 83
11%
18%25%
36%43% 46%
0%
20%
40%
60%
020406080100
2007 2008 2009 2010 2011 2012Federal M&A Transactions % Cyber/Big Data/Cloud/Health IT
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Continued Private Equity Interest in Gov’t Services
Aston Capital
Edgewater
LLR
Halifax
Providence
Ares
Veritas
Frontenac
GA & KKR
Snow Phipps
Court Square
GTCR
Riordan Lewis
Metalmark
New Mountain
Veritas
Carlyle Group
DC Capital
Excellere
Covant
RadiantBlue
Haystax
Paragon
XL Associates
SRA
Sotera
The SI
Salient
TASC
Acentia
Wyle
Six3
Secure MS
Schafer
Camber
CRGT
Booz Allen
Kaseman
ASI Gov’t
ATSolutions
SponsorSponsor PlatformPlatform 2008 2009
ICOR
2011 2012 2013
Acceligence Trancite Logic Innovative Technology
2010
Frontline
Sallyport PMSI
Partial IPO ARINC DSES
Johnston McLamb CIBER Federal Guident
i2s Veritas Analytics EADS DS3 Novonics
Asychrony Kimball Consulting
SDI Corp.
WareOnEarth
Sim‐G Technologies
BIT Systems
HardingSecurity
Novii Design
CAS
NetStar‐1 Assets Peace Technology 2020
TexelTek
CommandInfo
DatalineESS Division
ATS Corp.
Morgan Franklin Assets
Potomac Fusion
Software Process Tech.
ALON
Platform Acquisition Add‐On Exit FlexPointDigital Sandbox
PhaseOneApplied CommunicationSciences
(still seeking platform)
LIST
Ticom Geomatics
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P/E – Growth Buyers
P/E firms see growth opportunities and are
buying in priority markets at valuations that rival
strategics
Private Buyers
6x 8x 11x+7x 9x
9x
Substantial revenue dependent on set‐aside awards or recompete
Undistinguished services Targets in non‐priority markets Lower margins, pass‐through costs Predominantly subcontractor work
5x
Federal Sector General Valuation Framework
Customer base in “priority” markets Distinguished workforce with key
discriminators (clearances, education) Strong technical capabilities with greater
growth prospects Above average profitability
Pure‐play firms focused on priority markets
Patented IP or niche technologies Majority of prime, full & open contracts Industry leading profitability & growth Targets with scale
11x+
8x
6x
5x
Valuation Criteria
7x
P/E – Value Buyers
3x
Valuations limited due to financing constraints – lack of equity and
reduced leverage ability
BuyerGroups
The “80” The “20”
4x
10x
4x 10x
P/E – Growth BuyersStrategic Buyers
Valuations are most attractive but acquisition criteria is exacting and extremely selective; target must fill a strategic priority
P/E – Value Buyers
Valuations are at a 10 year low and there is a significant activity amongst value buyers, acquiring / bolting on non‐priority market targets for 5x – 8x
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M&A Market Summary
PUBLIC VALUATIONS
ARE DOWN
Public company valuations are down from their historic highs due to:
PRIORITY MARKETS
REMAIN ACTIVE
However, there remains strong interest from federal buyers in hot market segments as companies try to re‐align themselves with budgetary priorities expected to experience continued growth:
STRATEGIC
VALUATIONS
Scarcity of attractive targets that fulfill evolving and exacting acquisition criteria results in proliferation of the “80/20 rule”
The recent “flight to quality” has caused M&A valuations to remain high in priority markets despite plummeting public company valuations
LIQUIDITY ANDMARKET TIMING
Strategic buyers carefully managed capital during the recession and currently have strong balance sheets with ample dry powder and favorable lending terms
Once the current market uncertainty declines after the overall impact of sequestration becomes clearer, exit timing for targets will likely be company specific based on backlog, revenue visibility and the timing of major pipeline opportunities
— Slowing contract activity, funding and growth outlook
— Sequestration risk and general uncertainty
— Cloud Computing
— Big Data / Analytics
— Healthcare IT
— Virtualization
— Budget reductions: exposure to budget areas susceptible to cuts
— Delayed and canceled procurements
— Cyber Security
— C4ISR
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Agenda
I. Introduction to Aronson Capital Partners
II. Federal Market Trends & M&A Landscape
III. M&A Nuts & Bolts: Building Shareholder Value & Exit Strategies
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Key contracts are a primary driver of acquisition valuation
Develop a suite of contract vehicles in both a prime and subcontractor role (Schedules,GWACS, BPAs, etc.)‒ Minimize reliance on a single contract
‒ Establish a variety of customer relationships that can help to win prime awards
Strategically utilize set aside awards to help position the business for F&O competitions‒ Establish the customer relationships that will become critical in the conversion to a F&O
contract
‒ Generate relevant past performance in a prime role; acquire key talent and qualifications
‒ Use the cash flow from set aside awards to generate investment dollars and build theinfrastructure and business development capabilities necessary to pursue F&O awards
Deliver technology‐driven solutions to the customer‒ Solve difficult problems; align with the mission
‒ Commodity‐type staffing services are harder to transition to F&O contracts once set aside statusis lost, and are also more susceptible to downsizing /budget cuts
‒ Develop a transition plan for set aside contracts
‒ Customer intimacy is key
Target Focus: Contract Mix
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Revenue visibility is a primary buyer focus during diligence
The future cash flow potential of a business is the basis for valuation; well developedreporting capabilities can enhance shareholder value during the sale process
Up‐to‐date backlog reporting provides management with a useful forecasting tool andprovides insight into near‐term revenue and profitability‒ Tracking backlog over time can be beneficial to sellers, as historically strong backlogs support
higher valuations
‒ Contract backlog is the foundation of reliable forecasting
Current business development pipeline reports that capture the company’s salespipeline are necessary to support projections‒ A robust yet realistic pipeline heightens the upside potential of an investment for buyers, driving
higher valuations
Sellers and their advisors need to consider upcoming recompetes when determining theoptimal time to start a sale process
Maintain a “contract waterfall” as part of the annual planning process
Target Focus: Revenue Visibility
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Contract Waterfall Example
XYZ, Inc.
Contract Waterfall Example
2012 2013 2014 2015 2016
Revenue:
Contract Backlog $16.0 $12.0 $8.0 $4.0 $0.0
Renewals/Extensions 2.0 6.0 10.0 14.0 18.0
New Business (Factored):
Proposal in Evaluation 1.0 1.5 2.0 2.0 2.0
Proposal in Process 1.0 1.5 2.0 2.0 2.0
Pre‐RFP Planning 0.0 1.0 1.0 2.0 3.0
Exploratory 0.0 0.0 1.0 2.0 3.0
Total Revenue $20.0 $22.0 $24.0 $26.0 $28.0
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Flow Through Entity Benefits
Flow through entities (S Corp, LLC) provide significant tax advantages at the time of sale
However, S‐Corp election must be made early on in order for buyers to realize these tax savings and for sellers to achieve a higher valuation
Target Focus: Tax IssuesCompany A (S‐Corp)
Company B (C‐Corp)
Revenue $20M $20M
EBITDA $2M $2M
Calculated EnterpriseValue (@ 8.0x EBITDA) $16M $16M
Net Book Value $4M $4M
Tax Savings to Buyer (1) $3M $0
Final Valuation $19M $16M
(1) Assumes 35% tax rate and 5% discount rate over 15 years
Valuation 19% higher for Company AValuation 19% higher for Company A
Other Tax Considerations
Buyers perform substantial diligence surrounding a target’s tax position looking for any potential exposures post‐closing, such as: ‒ Employees vs. Independent contractors (1099s) classification
‒ International tax liabilities
‒ Aggressive tax positions
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Strategic Positioning Companies that focus on specialized or niche service offerings command a valuation premium
One mile deep is generally better than one mile wide
Intellectual Property Patents and other forms of IP drive higher valuations
Create barriers to entry
Corporate Infrastructure Sufficient to Support Growth Budgeting and planning processes
DCAA approved accounting systems
Government contracting compliance
Business development
Strategic pricing capability
Management Team Most buyers want management to stay with the business for a period of 1‐3 years after sale
Balance Sheet Efficiency Working capital / collection cycle / billing
Other Key Value Drivers
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Overview of Strategic AlternativesAlternative Overview Pros Cons
Sale to Strategic Buyer
Transaction for 100% of the Company’s outstanding stock
with a strategic buyer
Maximizes valuation and liquidity to existing shareholders
Management team and employees may be subject to integration (e.g., new benefits, policies, reporting structure, etc.)
Company borrows senior debt and receives an equity
investment from a P/E firm, providing partial liquidity for
existing shareholders
Provides some near‐term liquidity while allowing for participation in future growth (“second bite of the apple”)
Valuations tend to be lower than strategic sale; requires continued involvement post‐transaction
ESOP
Shareholders sell equity to a trust and receive partial liquidity; trust is funded
through combination of senior debt and seller‐financed notes
Preserves business autonomy, facilitates mgmt. equity participation; allows liquidity when strategic or P/E buyer can’t be found
Some liquidity remains tied up in long term seller notes; requires a large employee base to be effective
The Company continues as a lifestyle business and does not pursue any other strategic
alternatives
The Company can continue to bid on SBSA procurements and the shareholders benefit from the strong cash flow generation
No near term liquidity, and income is subject to ordinary tax rates; shareholders do not diversify their assets (no chips off the table)
StrategicAcquisition
The Company makes a small acquisition to diversify revenue stream, add capabilities or
customers, and propel growth
Ideal for rapidly growing companies with strong cash flow generation and balance sheets, minimizing need for additional leverage
No near term liquidity; existing shareholders put more money into the business and bear future execution risk
ShareholderLiquidity
ShareholderInvestment