Executives and boards of directors of publicly traded government contractors are constantly evaluating capital deployment alternatives in an attempt to balance growth with providing returns to investors. In general, companies have four primary alternatives, including (i) pay down debt; (ii) make acquisitions; (iii) buy back previously issued shares; and (iv) pay dividends. Unless the company is overleveraged, equity research analysts and the investment community view the later three alternatives as the more attractive capital deployment strategies since the current cost of debt is relatively inexpensive. The variety of capital deployment strategies in the industry illustrates several interesting trends in today’s government services M&A market. The exhibits below track historical capital deployment activity across government contracting sub segments over the past five years.
The Tier 1 Contractors on average generated $2.4B of leveraged free cash flow in 2013, but cumulatively only deployed $367M on acquisitions. Despite appreciating share prices throughout the year, these firms continued and accelerated their share repurchase programs while maintaining dividend payments in attempt to maximize shareholder value. Northrop Grumman, for example, announced a goal of retiring approximately 25% of the Company’s outstanding common stock by 2015 last year, and reaffirmed its commitment to its share repurchase program last month. In February, General Dynamics announced that its board had authorized a $2.0B share buy back plan. The lack of acquisitions by the Tier 1 sub market highlights the scarcity of sizable, well positioned targets that can “move the needle” and help reposition these companies into a new market or expand an existing capability.
Mid-Tier Government Services firms and Defense Electronics contractors take a different approach, and continue to express interest in maintaining or expanding their M&A programs in a much more aggressive manner. CACI’s acquisition of Six3 Systems, which accounted for more than 90% of the total Mid-Tier acquisition value in 2013, is an example of this buyer group’s commitment to deploy capital via acquisitions. During ManTech’s February earnings call, the Company also stated that it would more aggressively pursue M&A now that the recent appropriations bill has provided some clarity into the market. After only using $11M of cash for acquisitions in 2013, ManTech announced its $45M acquisition of Allied Technology Group last month. Engility Holdings closed its $202M acquisition of Dynamics Research earlier this year; the value of this acquisition exceeded the cumulative value of all Mid-Tier acquisitions in 2013 if you exclude the CACI / Six3 transaction. The main outlier in the Mid-Tier segment is Booz Allen, who has historically focused on organic growth and utilized special dividends to boost returns to shareholders, including a $1.00 special dividend (5.6% annual yield) announced in February 2014.
Continue reading Aronson Capital Partners’ March Market Update and find out more about:
- Industry Indicators
- Selected M&A Transactions for March 2014
- Government Services Industry Performance
- Public Company Comparables
- Recent Industry M&A Transactions
- Representative ACP Transactions