Yesterday's announcement that technology vendor Bart & Associates has acquired Digital Solutions likely has more to it than the combination of two small businesses to build scale and diversify customer bases.

Bart has been the subject of acquisition rumors since the introduction of DHS's EAGLE contract vehicle. Bart was not a winner, despite the fact that 95% of their business comes from DHS. Also, BART is a key vendor supporting the O&M of CBP's TECS land border entry system. Given that TECS Modernization will likely be a major technology effort coming out soon, Bart needed access to EAGLE, and buyers were interested in BART's expertise and stable of cleared staff. Now that Bart has access to EAGLE through the Digital Solutions acquisition, the stakes just went up.

What a deal

If buyer stock price is the sole measure of a deal's success, Stanley Inc.'s acquisition of Oberon Associates is a runaway. On June 10th, Stanley announced its acquisition of Oberon Associates for $170 million. On that day, Stanley opened at just under $30 a share and closed at $30.61. As I write this post less than two weeks later, Stanley shares are now trading above $35, up roughly 17% since the deal was announced. Not surprisingly, analysts have praised the deal.

Fast growth for seller (and buyer)

Started in 2002, Oberon reported $48.4 million in government revenue for 2007. Per the acquisition press release, Oberon will reach total revenue of about $80 million for 2008.

At the time of its IPO in 2006, Stanley had revenue of about $300 million and its stock started at $13 per share. Stanley is now at over $600 million in revenue with a stock price in the mid-$30s.

Rare breed or endangered species, take your pick

There aren't many mid-cap contractor stocks left. Argon ST, DRC, NCI Information Systems, SI International and Stanley are about all. ManTech and SRA crossed the $1B mark. RS Information Systems (RSIS) and McDonald Bradley (MBI) went with being acquired over an IPO. The number of contractors with revenue between $200 million to $600 million per year couldn't fill a room.

Additional evidence of the rare breed/endangered species: For over three years serial entrepreneur Ken Bajaj and his current venture SystemsNet have been sitting on cash looking for an acquisition. (A deal seems imminent though, as hinted at in recent coverage by TechBisnow)

A decline in the hunted increases competition among the hunters. In an exchange with Marc Marlin, Vice President with KippsDeSanto which represented Oberon in the deal, Marlin said Oberon received "strong interest from a broad universe of suitors". I think this may be an understatement. And with RSIS and MBI, it seemed like there was an article every couple of months musing about who was interested, whether they would be acquired or go public.

M&A value drivers

Marlin summed up the Stanley-Oberon deal: "The transaction reflects many core themes evident in today's M&A environment. Specifically, government services and defense companies (i) well positioned in high-priority, growth markets such as intelligence and national security, (ii) with intellectual capital in emerging technologies such as biometrics in the case of Oberon, and (iii) that exhibit a strong organic growth track-record and prospects, continue to drive premium M&A valuations."

Win-win

As it stands now, the deal appears to be a win-win for everyone involved. The seller is getting a price of more than 2x revenue (historically above-average consideration for a government services firm), the buyer's stock price increased immediately following the announcement, and with no overlap between the two firms the employees will not worry too much about their job security.

John Johnson enlightened attendees at INPUT's State and Local MarketView conference about the General Services Administration's(GSA) Greening of Government. Johnson serves as the Assistant Commissioner for the Integrated Technology Service (ITS) with the Federal Acquisition Service (FAS), and discussed directions that the GSA is taking to infuse green products in the portfolio and foster awareness to 135 federal agencies and 1800 sub bureaus.

What is going green – in a nutshell Johnson stated that collectively as individuals and organizations we must become more mindful and understand how our consumption of products and services impacts the environment. Therefore, we must start with behavior changes to minimize further detrimental effects. This speaks to all of us, not just "tree huggers," as some still believe. Corporations have found that they can build teamwork through corporate social responsibility by promoting "green behaviors," which establishes common goals and reap multifaceted benefits - the intangible asset of boosting employee morale along with hard cash savings of power consumption and paper costs through efficiency practices.

GSA is positioned to drive more effective utilization of technology given the billions of dollars spent through procurement vehicles they negotiate. The groundswell of interest continues as officials are more tuned into the pressing need to improve energy efficiencies. Significant energy consumption is wasted by PC users and much inefficiency can be changed by simply using power saving features. Multiply Johnson's estimate of $75 annually, per pc user over all the units in circulation – that yields tremendous savings of energy and dollars, by merely using power management tools.

It is no secret that most data center operations substantially underutilize hardware processing capability. As our dependency mounts for servers to provide file storage and the power of search engines, changes must be made to minimize the average of 10 to 12 generators that are found in data centers. Less than 10 years ago 6 million servers were in use; today there are approximately 28 million servers, and estimates project the number to rise to 43 million servers by 2010. Not only is there enthusiasm mounting to support to go green, given growing climate concerns, but there are substantial financial savings that can be realized from reducing power consumption in data center operations. Government is now accessing the correct metric to use to measure efficiency, which is most often, Power Use Effectiveness, (PUE). These standards will be adopted by EPA to establish future policy and guidelines and were addressed in an EPA Report to Congress on Server and Data Center Energy Efficiency.

Given over $17 billion of procurements through GSA Schedule 70, Johnson indicated that we can anticipate a greening of the schedule. Currently officials are working with the CIO's within federal agencies to bring this direction forward. The greening of GSA's Schedule 70 may spur additional State and Local procurements through Schedule 70 and cascade widespread green procurements, so stay tuned.

As more focus draws on the need to go green to support mounting environmental issues, vendors must also recognize the importance of deploying practices and building products that minimize power consumption and elicit users to embrace power saving features. Going green is mounting in importance and vendors need to establish practices and not consider them as merely as "a nice thing to do," but rather an important business strategy on all fronts. The Green Business Alliance fosters education and knowledge of how business needs to act. All roles of government and business from IT managers, procurement officials, program managers together with industry, can successfully deploy IT products and operate data centers that are environmentally sound and fiscally responsible.

Harris announced today it is not for sale and that it will continue to grow through acquisitions and organic growth.

Reuters' coverage touches on the "tepid interest" from large defense firms.

We explored the possible buyers, contract portfolio, source of growth, where the lines would be drawn, and other issues surrounding a possible sale in our analysis of the Harris rumor.

Did Harris not get the price they wanted, or was it an inflated rumor based on the everyday acquisition interest contractors show for their peers?

This morning Booz Allen Hamilton announced the split of its commercial and government business, with Carlyle Group buying a majority of the government business for $2.54 billion (roughly 1x federal FY07 prime contract obligations).

This move has been expected for some time. In February 2008, the Washington Post explored the impending breakup.

Why the break-up? According to the Post article, part of the reason has been attributed to the success of the government unit and an imbalance in profit-sharing. The government business has been growing at a faster rate than the commercial practice but profits are split between the two groups and most of the owners are on the commercial side.

Booz Allen's federal contracts

Booz generates over three-quarters of its federal work from defense and homeland security agencies (not including work for non-defense intelligence agencies). Booz's top federal contract, the Operation of the Information Assurance and Technical Analysis Center for the Air Force, brings in over 10% of its federal business and is up for recompete this year. A strong presence in the intelligence community flies below the radar of reported spending.

Like most of the top services vendors, Booz wins positions on many of the largest contract vehicles. On May 1 Booz was one of fourteen awarded a prime contract on DISA's $12.2 billion full and open ENCORE II (along with EDS, just acquired by HP). Booz also holds prime positions on DHS EAGLE, Army's ITES-2S, and Navy's SeaPort-e.

Booz's top customers

Booz's top contracts

Carlyle + Government Contractors

Carlyle Group's long history of investments in government contractors shows a possible new trend with what is now its largest move into services. Most investments have been on the manufacturing side of the aerospace and defense (A&D) market. Below is a representative list of Carlyle's contractor investments, with many of the A&D manufacturer investments left out.

For more information on recent government M&A deals, see our recap of transactions announced or closed in April 2008.

Along with the announcement that Booz Allen will split, selling the majority of its government business to Carlyle Group, HP's $13.9 billion purchase of EDS created quite a stir in financial markets this week. Most analysts point to HP's desire to make a strategic play into services to match IBM's solutions model, while some point out EDS's struggles to grow and lagging stock price as making the deal attractive. The deal will certainly make waves in both the commercial and government sectors.

On the Federal Market side, EDS had already been besting IBM in prime contract obligations according to FPDS data below, and the addition of HP's Federal obligations -- while not rounding error -- does not vault them into the ranks of major IT services players such as CSC and SAIC.

Source: FPDS, INPUT

The combination does bring synergy across some major Federal agencies. The chart below shows relative obligations at major agencies, but it does not include EDS's $1.76 billion in 07 obligations at the Navy, their biggest customer (where HP adds another $24 MM).

Source: FPDS, INPUT

In a market where domain experience and relationships are key to maintain control over allocated dollars, the new "EDS -- an HP Company" should be able to consolidate some competitive positions assuming they can navigate the integration of two workforces.

While the Booz and HP moves were expected to some extent, many are wondering whether these mega-mergers will lead to others, especially in the government space. Some analysts are saying "don't hold your breath", citing the credit crisis and lack of participation by Private Equity players. The government M&A market, however, may continue to churn. We have been tracking significant activity so far this year, and given INPUT's forecast of less than stellar growth in the Federal IT market in the coming years, we believe companies will be looking to M&A to fill revenue gaps. Other product firms may look to make a move in the Federal space by acquiring a service provider such as Harris Corp. And, we wouldn't surprised to see the emergence of some Private Equity roll-ups of medium sized firms. Finally, a major foreign player may take the opportunity of the weak dollar to enter the market much as Canada's CGI did. Thus, we feel comfortable with our prediction of 2008 as the year of the buyout in the Federal space.

A busy past few days for M&A announcements and rumors, with the biggest announcement today.

TIMELINE

On Friday, the Wall Street Journal reported Harris Corp. is exploring strategic options that could eventually lead to a sale.

The last big contractor to explore its strategic options was CSC in 2006. CSC is still intact. What will happen to Harris?

Why now?

Is Harris riding high from the war? Yes. Federal sales from its RF Communications unit in Rochester, NY, traces the success. $71 million in FY 2000. From FY01 to FY04, bounces between $120 million and $220 million. More than doubles to near $500 million in FY 2005 and doubles again to $1 billion for each of the past two years. (Source: Harris Corp. INPUT vendor profile)

Possible buyers:

1. Private equity? Unlikely given possible interest from the largest contractors to stay the largest contractors, and tough credit markets.
2. Equal or larger integrator? Lockheed Martin, Boeing, Northrop Grumman, General Dynamics, Raytheon, BAE Systems, United Technologies, L-3 Communications. I think this is not as obvious as it appears given the non-government work may be difficult to spin-off and could depress the value to a traditional integrator.
3. Large networking player? Cisco, Motorola, or Ericsson (who tried their hand with SBI-net).
4. Foreign buyer? No. While British buyers (BAE, QinetiQ) have bought some primes, and others are targeting subs (Finmeccanica with DRS Technologies), Harris' technology and contracts are too politically and national security sensitive for foregin ownership.

A split?

If Harris was split up, where would the lines be drawn? Government/commercial? Manufacturing/services? A majority of Harris' estimated $5 billion in annual revenue (4x last quarterly revenue) comes from government work. Harris' government work lies in two business segments - Government Communications Systems and Defense Communications and Electronics. Could they be sold separately from commercial work? Maybe, but a break-up of Harris and its core manufacturing business may be even more difficult than what was considered with CSC whose 'simple' outsourcing business was reportedly too complex to split government/commercial with attractive valuations.

From a review of Harris' federal prime contract obligations:

1. Nearly 90% from defense work; top customer is Navy
2. Organic and inorganic (13 acquisitions since 2000, notably Multimax in 2007 and Orkand in 2004) growth from $336 million in FY 2000 to $1.75 billion in FY 2007
3. $1 billion annually from RF Communications business (part of Defense Communications and Electronics segment)
4. Nearly $200 million in FY 2007 from Air Force's NETCENTS contract; NETCENTS 2 procurement is in progress
5. High-profile hiccup - 2010 Census' Field Data Collection Automation contract - is only 5% of federal prime work

Source: Harris Corp. INPUT vendor profile

What is the contract portfolio?

While Harris' most valuable contracts today measured by revenue are specialized defense communications contracts, other contractors may place attractive valuations on relatively smaller pieces of Harris' contract portfolio.

Harris' brand-name technology contract vehicles: