While worldwide economic troubles and tightened credit markets have combined to dampen deal activity for financial buyers, the federal services market has remained an attractive investment space for private equity groups seeking safe places to deploy capital.

Buyout Market Trends

Way back in December of 2008, Leon Black, co-founder of the Apollo Group, was already touting that “….traditional private equity is dead and has been for a year;” he further forecasted that private equity investing would remain “dead” for the next couple of years. Certainly private equity investors have suffered through an onslaught of negative press in recent years, as funds have been forced to write down, and in many cases write off, the values of struggling investments while suffering the added ignominy of having to notify their prestigious investors of each such failure. With lenders reducing the amount of leverage that they are willing to extend, buyout deal volume is down more than 35% over the last twelve months (see Exhibit: PE Buyout Deal Volume Trends). Perhaps even more striking than the drop in volume is the smaller size of the deals being closed – capital invested over the past twelve months has decreased more than two thirds from the prior twelve. The data looks even worse when you consider the private equity boom times of 2007, home to the four most active quarters in deal making history. Comparing deal volume from the twelve months ended March 2008 to the most recent twelve months yields an alarming drop in deal volume of some 65%. All of this data points to an exceedingly bleak past twelve months for private equity groups across the board, with fewer and smaller deals getting done.

Exhibit: Equity Buyout Deal Volume Trends


In the midst of this turmoil, however, the pace of private equity deal making in the government services space has actually increased dramatically. As credit markets have begun to thaw, investors, desperate to find safe investments for their limited partners’ dollars, have found that banks are exceedingly willing to extend credit to well positioned companies that rely on the federal government for the bulk of their revenues. Over the past twelve months, private equity groups have invested in 27 companies with a significant federal services presence, compared to just eleven over the prior period.

Government Services Buyout Market: The Recent Past

Since the 1990s, clear revenue visibility, predictable cash flow, growth in government spending, and a fragmented industry have been attracting private equity interest in the federal market. Emboldened by their early successes, be they through IPO (Anteon, DynCorp, ICF, SI International) or sale to a larger strategic buyer (Vertex Aerospace, Athena Innovative Solutions, NISC), many of these groups have become repeat buyers of federal services firms. In fact, a handful of groups now maintain an exclusive focus on the government market, including such industry luminaries as CM Equity, DC Capital, JF Lehman, and Veritas Capital, among others.

For the twelve-month period April 2008 to March 2009, seven new government services platforms were established, but only one, Metalmark Capital’s buy of Schafer Corporation, represented a group’s first time foray into the government services market. The market for add-ons only saw four deals completed, all with traditional old-line federal services market investors, including CM Equity, DC Capital Partners, New Mountain Capital, and Veritas Capital. Historically, private equity investors in the industry have used these smaller acquisitions to complement their platform’s existing capabilities, customers, and contract base while building the value of the investment as a whole. As an example, data exploitation and cyber security focused Multi-Threaded represented the last add-on acquisition to DC Capital’s NISC platform prior to its sale earlier this year to IBM.

Exhibit: Private Equity Add-On Deals, April 2008 – March 2009

1Acquired Aptiv's government health integration group.


Exhibit: Private Equity Platform Deals, April 2008 – March 2009

Government Services Buyout Market Today

With the wider buyout market in a tailspin over the past twelve months, private equity groups have invested in thirteen new government services platforms, nearly doubling the number created during the prior twelve month period. These investments have ranged from a handful of smaller, sub-$100M revenue firms to General Atlantic/KKR’s acquisition of TASC, a $1.6 billion unit of Northrop Grumman; from niche logistics plays like Relativity’s purchase of MHF Services, Inc. to acquisitions of high-end intelligence contractors like Harding Security Associates, Inc. Only three of these platform investments were made by firms with a notable track record in the government services market: GTCR Golder Rauner’s Six3 Systems Platform, Riordan Lewis & Haden’s Secure Mission Solutions Platform, and Veritas Capital’s pickup of Kroll Government Services, Inc. Even beyond these eight new entrants into the federal services buyout market, dozens of other groups have approached, and bid on, potential industry platforms.

Exhibit: Private Equity Platform Deals, April 2009 – March 2010


The market for add-on acquisitions to existing platforms has also seen a significant ramp-up in activity. Over the past twelve months, fourteen of these deals have been announced, with at least a handful more rumored but never publicly announced. Three platforms -- Altegrity (the former United States Investigative Services), Huntsville, AL-based Camber Corporation, and CoVant Technologies’ A-T Solutions – each acquired two firms as their financial sponsors race to round out their offerings in preparation for their eventual exits. Given the preponderance of new industry platforms, we expect the pace of bolt-on acquisitions to intensify as we continue into 2010 and 2011.

Exhibit: Private Equity Add-On Deals, April 2009 – March 2010

Federal Services Buyout Market: Key Trend

In order to fully capitalize on the government services sector opportunity, many private equity firms are making strategic hires of well known industry executives. By leveraging these industry insiders’ expertise, eager investors are able to accelerate their understanding of critical industry nuances, such as the federal procurement process and DCAA cost accounting standards, while instantly accessing deep industry relationships and battle tested insights through trusted, cleared personnel. These A-List government contracting names provide their financial sponsors with a range of services, including identification of strategically positioned acquisition targets, advice on public sector strategy for existing portfolio companies, and occasionally taking the helm of a fund’s new platform investment.

In 2009 alone, at least half of a dozen funds have announced new partnerships with well known industry veterans. Randy Dobbs, former CEO of US Investigations Services, joined the Welsh, Carson, Anderson & Stowe team in early 2009. Dobbs has been assisting WCAS in the initiation and implementation of growth objectives and operational improvements for existing portfolio companies. In April 2009, the former President and COO of Mantech International Corp, Robert Coleman, teamed with Chicago-based private equity fund GTCR to form a new national security focused acquisition vehicle called Six3 Systems. It did not take long for Coleman to make an impact – Six3 announced the acquisition of Harding Security Associates, Inc. less than three months after his arrival and has already made an add-on acquisition of Sterling, VA-based BIT Systems, already giving his new platform annual revenue approaching $200 million. More recently, David Langstaff, Veridian’s former CEO, joined private equity firm General Atlantic LLC as a Special Advisor, and Frontenac Capital announced a new platform vehicle with former SI International CEO Brad Antle called Salient Solutions. Given the pace of industry acquisition activity and the outsized investor interest, expect to see more bold-faced industry names signing on with eager financial sponsors hoping to accelerate their understanding of this market.

Going Forward: The Fragmented Government Services Market

While there are signs that the leveraged buyout market is improving as investors and lenders regain confidence in the wider economy, we at Aronson Capital Partners expect that private equity will continue to aggressively grow its presence in the government services industry. Despite years of consolidation, the industry still remains highly fragmented and rife with companies that would be extremely attractive to outside investors, both as platform investments and potential add-ons. Due in part to preferential contract award requirements, constantly shifting mission requirements, agency fiefdoms, and disparate geographic needs, among many other factors, there are literally thousands of government contractors with annual revenues less than $100M. These firms typically employ management teams with a certain set of industry relationships and service capabilities, comprised of some combination of former contractors, retired federal management personnel, or military veterans-turned-entrepreneurs. By adding professional management with industry leading best practices, formalized business development processes, sound investments in infrastructure with a positive ROI, and corporate finance expertise, sponsors are able to accelerate a small to mid-sized contractor’s growth and drive it to the next level.