2017 M&A Recap
A total of 98 M&A transactions were announced in the defense technology and government services market in 2017, which was an increase in comparison to transactions completed in the prior year, but slightly lower than 2015. M&A deal count in 2017 further validated Aronson Capital Partners’ reference in the 2016 M&A Recap regarding the normalized level of deal activity that has occurred since the flurry of activity in 2015.
Despite normalizing to historical levels, the industry continues to ride the positive momentum brought on by President Trump’s budget proposal plans, which called for an increase in funding for a number of agencies including but not limited to the Department of Defense (9.0%+ y-o-y increase), Department of Homeland Security (7.0%+ y-o-y increase) and Veteran Affairs (6.0%+ y-o-y increase). Furthermore, the Administration pledged to make cybersecurity a major priority for both the public and private sectors, with a heavy reliance on government contractors developing innovative methods and technologies.
In addition, the 2018 National Defense Authorization Act, including the Modernizing Government Technology (MGT) Act, was signed at the end of 2017 and will be a year-plus effort allowing federal agencies to reprogram unused IT budget allocation to fund future modernization projects. This is an important step forward to a next-generation (Next-Gen) federal government focused on enabling the movement to the cloud, implementing shared services and improving cyber defenses. The improved efficiencies from the MGT Act will authorize agencies to modernize their legacy IT systems, better protect data from cyber-attacks and ultimately save billions in taxpayer dollars by reducing long-term spending.
2018 M&A Outlook
Several trends are surfacing that will drive continued deal flow in 2018. Expect to see continued M&A interest in companies providing next-gen technologies (e.g., cloud, cyber, mobile, agile development, digital transformation services, artificial intelligence). Continued adoption by the government of commercialized IT will drive demand for companies with next-gen technologies and larger companies with access to capital on the balance sheet may target companies with these differentiated capabilities to move up the “food chain”. The recent announcement of Amazon Web Services (AWS) Secret Region offers the Intelligence Community a solution with Top Secret-level security and the Pentagon’s recent visit to the West Coast further solidifies the demand for these types of technologies.
2018 is also likely to see continued participation from private equity firms across the government services landscape, as they continue to get comfortable with the funding outlook and growth prospects. The emergence of this trend is seen in multiple transformational deals that have occurred in 2017 such as H.I.G. Capital’s acquisition of NCI, Inc. for $283 million, who holds many multiple-award IDIQ contracts in the services space, and the funds subsequent acquisition of Whitney, Bradley & Brown Inc. (WBB), a management consulting firm who focuses on process improvement and organizational efficiencies. These deals are anticipated to set a precedent for future deals; the private equity presence will be strong in 2018.
Strategic buyers are expected to be active in 2018, as referenced in recent conference calls from larger publicly-traded government contractors (e.g., Mantech, L3). In addition, recent changes to tax laws could potentially free up cash flow for public strategic buyers to allocate to M&A efforts. With thriving equity markets and shifts in corporate finance strategy, do not be surprised if Q1 2018 is a record quarter for M&A announcements for Tier 1 and Mid-Tier companies as they continue to acquire niche companies with differentiated capabilities that allow them to move up the value chain into a pure solutions provider.