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The State of M&A in the Federal Market October 15, 2004 Presented by Paul Serotkin 2004 Government Contractors Conference Maryland Association of Certified Public Accountants, inc. Today…. M&A Environment - Federal M&A as Strategic Tool

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The State of M&A in the Federal MarketOctober 15, 2004Presented by Paul Serotkin2004 Government Contractors ConferenceMaryland Association of Certified Public Accountants, inc.

today
Today…..
  • M&A Environment - Federal
  • M&A as Strategic Tool
  • Creating Value…Deal Pricing…Deal Structure…Buyer/Seller Mistakes
minuteman ventures llc
Minuteman Ventures LLC
  • Investment Bank focused entirely on Federal and Defense services, solutions and technology market
  • Immersed in small-to-mid tier federal M&A market every day
  • Team consists on former owners, CEOs, senior executives in small-to-mid tier federal sector

‘Investment Banking for Entrepreneurial Companies’

why an active m a market in federal defense services
Why an Active M&A Market in Federal/Defense Services
  • Sector Rotation – Defense in vogue today, a result of post 9/11 world
  • Public Federal IT companies have approximately $20bn in capital for M&A
  • Industry awash in capital -$2bn raised from IPO and debt offerings since 2002; internal cash flow very strong
  • Private company M&A multiples at close to historic highs
  • Federal government outsourcing - aging of the workforce, technology changes, and the need to use military personnel for active engagements.
  • Substantial outsourced amounts going to under $100m firms
  • Companies valued on 20-25% top-line growth, but government outsourcing growth under 10%
  • Mid-tier buyers able to compete with larger firms on price, M&A integration, benefits, culture; mid-tier suing M&A to fend off contract bundling, set aside programs
  • Well-positioned firms (intel, security, C4ISR, biodefense, network-centric warfare) yield M&A premium
  • Uncertainty in market –GWAC restructuring, small business recertification, performance-based contracts, Base closure
  • Private equity helps to lubricate M&A market
seller transaction profile defense federal it
Seller Transaction Profile – Defense/Federal IT
  • Mostly smaller companies – 8 of 10 with revenue under $50m

<$20m

$50m – $100m

$100m – $250m

$20m - $50m

$500m +

$250m - $500m

buyer transaction profile defense federal it by acquirer size
Buyer Transaction Profile – Defense/Federal IT (By Acquirer Size)
  • Major SIs very active
  • Smaller companies selectively transacting deals
  • Mid-sized buyers using M&A to add strategic pieces

$50m-$100m

$100m-$250m

< $50m

$500m+

$250m-$500m

mid tier federal defense services buyers two tiers
Mid-Tier Federal/Defense Services Buyers – Two Tiers
  • Profile: $150-$500m firms
    • Publicly traded, several having completed IPO in last two years
    • Federal Government is largest if only customer
    • Valued by capital markets on basis of top line 20-25% growth
    • See path to become $1bn companies
    • Typically have primary M&A role on staff
    • Cash flow strong, considerable debt capacity, prospect of secondary offering
mid tier federal defense services buyers two tiers14
Mid-Tier Federal/Defense Services Buyers – Two Tiers
  • Profile: $50-$150m firms
    • Privately held
    • Federal Government is largest if only customer
    • Experienced organic growth and may have successfully integrated previous acquisitions
    • Some backed by private equity
      • Serial entrepreneurs reinvesting – Lau, Paravant, BTG
      • PEG interest growing, new players emerging – e.g., Arlington Capital, Paladin Capital
    • See path to become $200m-$1bn companies
    • Are growing or want to grow faster than government technology market
    • Deploying outside advisor to support M&A initiative
    • Internal: part-time use of senior executive for M&A
who the mid tier is acquiring the federal defense services universe
Who the Mid-Tier is Acquiring: the Federal/Defense Services Universe
  • Closely held, few shareholders, with perhaps an ESOP
  • Geographically strong in two, possibly three locations
  • Mainly serving two, perhaps three customers at the services branch level, with diversified contract base within that customer set
  • Broad services – System engineering/integration, training/ simulation, network services, legacy migration, DB maintenance, logistics, modeling, application development, PM/acquisition support, base ops, facilities management
  • Usually at least five years old, many times 15+ years duration
  • Founder often involved, at least in ownership, if not operations
  • May have some SBSA/8a work remaining, or weaning themselves from these programs
  • Little, if any, outside ownership, or equity investment from third parties
  • Under $100m in revenue, often under $50m
acquisitions by federal mid tier buyers increasing
Acquisitions by Federal Mid-Tier Buyers Increasing

% of deals by mid-tier buyers

Jan-July ’03

(49 deals)

Jan-July ’04

(39 deals)

how mid tier acquirers compete in m a with tier 1 primes
How Mid-tier Acquirers Compete in M&A with Tier 1 Primes
  • High ‘cultural’ appeal of the Mid-tier
    • Entrepreneurship
    • Ready access to the acquirer CEO, senior execs
    • Acquirer CEO likely to have experienced many growth company situations
    • Seller owners, employees retain sense of criticality in acquiring company
    • Benefits can be just as strong as Tier 1
  • Lenders educated on government M&A, very comfortable with mid-tier
    • Cost of debt capital still low
    • Not as needed to finance internal growth, bankers eager to finance M&A
  • Mid-tier companies gain immediate cleared employees, market share, customer penetration/extension, key technical/managerial personnel
  • As Tier 1 firms grow, less likely to find smaller, truly strategic M&A fits, leaving more opportunity for the mid-tier
  • Private equity gravitates to mid-tier firms as a platform in the federal sector
  • Strong case for buy v. make
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Creating and Defining Value

Deal Pricing

Deal Structure

Buyer/Seller Mistakes

the value table 10 leading factors in determining defense company value
Contract Alignment with the Mission de Jour

Cleared Employees

Recaptured Business

Prime Contract Awards

Small Business Set Aside (SBSA) Awards

Weak Alignment - 1Strong Alignment - 10

0-20% Employees Cleared - 120-60% Cleared 60% or Over Cleared - 10

0-20% Recompete Revenue - 120-50% Recompete 50% or Over Recompete - 10

0-20% Prime Contract Revenue - 120-70% Prime 70% or Over Prime - 10

70-100% SBSA Revenue - 130-70% SBSA 30% or Under SBSA - 10

The ‘Value Table’ – 10 Leading Factors in Determining Defense Company Value
the value table 10 leading factors in determining defense company value cont d
Time in Business

Contract Concentration

8a Revenue

Competent Management

Sustained Revenue Growth

1-3 years - 14-6 years 7-10 years - 10

60%+ revenue from 1 contract - 125-60% less than 25% - 10

50-100% rev. from 8(a) - 115-50% from 8(a) Less than 15% from 8(a) - 10

Lightly regarded management - 1Highly regarded management - 10

0-7% compounded ann rev. growth - 18-15% growth 15%+ growth - 10

The ‘Value Table’ – 10 Leading Factors in Determining Defense Company Value (cont’d)
common deal feature earn outs
Common Deal Feature: Earn-Outs
  • Single-event Based
    • Contract award or renewal (including migration to F&O)
    • Successful claim, litigation, or collection
  • Performance Based
    • Most frequently used metrics include revenues, gross profits, and net profits
    • Occasional factors include employee retention rates, contract awards, and backlog
  • Agreement Provision Implications
    • Maintain entity as separate subsidiary or division
    • Limits and control over overhead and parent charges
common mistakes for acquirers
Common Mistakes for Acquirers
  • Paying too much
  • Going after deals that are too big
  • Lack of correct priorities and balance in the process

Typical Process*

20% searching, 20% due diligence, 50% negotiations, 10% integration

Recommended Process*

10% searching, 30% due diligence, 20% negotiations, 40% integration

(Courtesy: Michael Solley, President, NCI Information Systems)

common mistakes by sellers
Common Mistakes by Sellers
  • Owners believe their company is better than all the others and expect a better-than-market value
  • Sellers think they deserve public company valuations without preparing the company to meet the same standards
  • Sellers are not exactly sure what they want to do
  • Seeking advice too late and then getting in a hurry
  • Management has cut investments to increase EBIT, but still argues that their growth rates are going to increase
recap
Recap
  • Federal/Defense M&A Market remains robust for under $100m defense companies
  • Buyers come from all size firms; Mid-tier firms stepping up
  • Market factors favor consolidation continuing for some period
contact data
Contact Data

Paul Serotkin

President

Minuteman Ventures LLC

781 750 8065

703 894 1270

781 254 7267 mobile

paulserotkin@minutemanventures.com

www.minutemanventures.com