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Today…..

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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Today…..

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

  2. Today….. • M&A Environment - Federal • M&A as Strategic Tool • Creating Value…Deal Pricing…Deal Structure…Buyer/Seller Mistakes

  3. 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’

  4. M&A Environment –Federal Services

  5. 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

  6. 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

  7. 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

  8. Large Corporate Buyers Tier 1

  9. Mid-Tier Buyers – Tier 2

  10. Mid-Tier Buyers – Tier 3

  11. Mid-Tier Buyers – Tier 4

  12. M&A as Strategic Tool

  13. 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

  14. 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

  15. 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

  16. Acquisitions by Federal Mid-Tier Buyers Increasing % of deals by mid-tier buyers Jan-July ’03 (49 deals) Jan-July ’04 (39 deals)

  17. 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

  18. Representative Mid-Tier Buyers

  19. Creating and Defining Value Deal Pricing Deal Structure Buyer/Seller Mistakes

  20. M&A Valuation – Size/Specialty Matters

  21. 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

  22. 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)

  23. 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

  24. 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)

  25. 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

  26. 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

  27. Contact Data Paul Serotkin President Minuteman Ventures LLC 781 750 8065 703 894 1270 781 254 7267 mobile paulserotkin@minutemanventures.com www.minutemanventures.com

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