Government Contracting M&A Updatemacpamedia.org/media/downloads/2013GVC/Davis_PPT2pp.pdf · Mezzanine Capital Raises ... Schafer Camber CRGT Booz Allen Kaseman ASI Gov’t ATSolutions

9/20/2013

1

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

Aronson Capital Partners

1

Agenda

I. Introduction to Aronson Capital Partners

II. Federal Market Trends & M&A Landscape

III. M&A Nuts & Bolts: Building Shareholder Value & Exit Strategies

9/20/2013

2


2

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


3

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

9/20/2013

3


4

portfolio company of

on its sale to

xxportfolio company of

Advised

on its acquisition of

Advised

on its sale to

Advised

on its sale to

Advised

on its sale to

Advised

on its sale to


Advised

Advised

on its sale to


Advised

on its sale to


Advised

on their sale to

Advised

on its sale to

Advised

on its sale to


Recent Government Services Qualifications

Advised

on its sale to


Advised

on its sale to

Advised

on its sale to

Advised

on its sale to

Advised

on its sale to

Advised

on its sale to

Advised

on its sale to


Advised

on its sale to

Advised

on its sale to

Advised

on its sale to


Advised

on its sale to

Advised

on its majority recapitalization by

Advised

on its sale to

Advised

on its sale to

Advised

on its sale to


Advised

on its sale to

Advised

on its acquisition of


5

Agenda




9/20/2013

4


6

Federal IT Market: Component Market Size & Growth Rates ($ in billions)

Government Services Market Headwinds

Trends

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)


7

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 484811 1,073

1,372 1,368294

339

509

747

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)

9/20/2013

5


8

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

22

11

3

4

55

66

77

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


9

Comparable Public Company Valuations

9/20/2013

6


10

Software Engineering & Development

The 80/20 Phenomenon

Due 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


11

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

9/20/2013

7


12

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%

0

20

40

60

80

100

2007 2008 2009 2010 2011 2012

Federal M&A Transactions % Cyber/Big Data/Cloud/Health IT


13

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 FlexPoint

Digital Sandbox

PhaseOne

Applied CommunicationSciences

(still seeking platform)

LIST

Ticom Geomatics

9/20/2013

8


14

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 Buyers

Strategic 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


15

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 AND

MARKET 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

9/20/2013

9


16

Agenda





17

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&Ocontract

‒ 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

9/20/2013

10


18

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 supporthigher 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, drivinghigher 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


19

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

9/20/2013

11


20

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 Issues

Company 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


21

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

9/20/2013

12


22

Overview of Strategic Alternatives

Alternative 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


23

Conclusion

Questions?

[email protected]

Documents

Government Contracting M&A Updatemacpamedia.org/media/downloads/2013GVC/Davis_PPT2pp.pdf · Mezzanine Capital Raises ... Schafer Camber CRGT Booz Allen Kaseman ASI Gov’t ATSolutions