Government Contracting M&A Persists: War-driven defense shifts prompt industry players to hunt for acquisitions

There’s no let-up in sight in dealmaking among companies that supply products and services to the federal government, especially those in the defense, Homeland Security, and IT markets. Defense Department spending shifts away from big-ticket weapons and toward communication, surveillance, and intelligence technology, players’ desire to be one-stop shops offering a variety of defense and technology products, and even the problem-plagued security clearance program are all fueling the dealmaking fire. While major artillery expenditures are expected to wane in coming years, spending on IT – including military communications and battlefield simulation software – is rising. L-3 Communications Corp., for example, anticipated this trend and has been acquiring tech players for a number of years. The company is now positioned to provide everything from guidance and navigation systems and power supplies to simulators and satellite communication products. Other traditional weapons makers also are feeling the need to morph into defense/IT hybrids and are hunting for acquisition targets that can broaden their product mixes. As the nature of warfare changes, the Armed Forces will require nimble troops equipped with the latest technology for identifying, assessing, and neutralizing the new types of threats they face, like improvised explosive devices (IEDs), notes John Hennessey, a Vice President at RSM EquiCo. “There’s a tidal wave of new technology out there, and a whole turnover going on in military technology,” notes Paul Weisbrich, a Senior Managing Director at RSM EquiCo. The Pentagon is planning on spending billions of dollars to modernize military equipment. Everything from antennas and power sources to chips and software will be updated, he says. Major aerospace and defense contractors are keeping a toe in the weaponry pond, however, knowing that in time, money will be flowing to purchase supplies to replace equipment lost and damaged in the war in Iraq, says Larry Yanowitch, a Partner in the Northern Virginia office of Morrison & Foerster and Co-Chair of the firm’s M&A group. “I wonder whether the growth on the IT side will remain the same since so much equipment will need to be replaced,” he adds. Another major deal driver, Weisbrich asserts, are changing priorities in homeland defense. The market offers opportunity for double-digit spending growth over the next several years, and border/port security and communications interoperability especially will be hot niches. “A lot of companies want to get into homeland defense. PE firms have started funds to get into the market,” he says. Other nontraditional buyers eyeing the sector include foreign players and special purpose acquisition corporations (SPACs). Companies with a high percentage of security-cleared employees will also be prime targets, says Joseph Schmelter, an M&A Partner at Venable and a Co-Chair of the firm’s business transactions and government contractors practice. Colleague Scott Hommer, a Venable Partner and a fellow Co-Chair of the practice, notes that the September 11, 2001 terrorist attacks brought to light deficiencies in the country’s intelligence capabilities. Since then “there has been an urgency to get into the game on the intelligence side,” he states. Progress has been limited since entree into the market requires security clearances, and the government is having problems getting clearances issued in a timely manner, he adds. The clearance period is more than a year now, Hommer says. A new spin on the talent acquisition “A company with a number of cleared employees is worth substantially more than one with few or without cleared people. Given the lengthy time frame for gaining clearance, it may be easier to acquire a company with cleared people than to wait while you clear your own people,” says Yanowitch. (c) 2006 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com