Market Pulse – KippsDeSanto & Co.

Perspectives from the HELI-EXPO Convention

Michael J. Misantone — Wed, 22 Feb 2012 13:00:09 +0000

KippsDeSanto & Co. attended the HELI-EXPO convention, the largest rotary-wing gathering in the world, in Dallas, Texas on February 13 and 14. The HELI-EXPO convention offers a unique opportunity to bring companies from along the supply chain – from OEMs to subsystems manufacturers to aftermarket services providers – in one of the most dynamic sectors of the aerospace / defense industry.

A key takeaway from the conference and conversations with suppliers is that the rotorcraft market is experiencing a bifurcation in growth and demand similar to what is occurring in the fixed-wing aircraft market. On one hand, the commercial helicopter market is improving in 2012 and the sense is that 2011 was likely the trough of the cycle.

In fact, according to a market forecast Honeywell released, “…the outlook still calls for overall industry growth for the five-year period 2012 through 2016, compared with the previous five-year period” and “specific purchase plans for 2012 remain very strong.” Eurocopter also released a market forecast, which projects steady, growing demand in the civil sector, with military sales peaking in 2015 before entering a long steady decline. And the military end market represents the flip side of the coin – given the defense budget dynamics both in the United States and across the world, military sales are expected to decline in the intermediate and long term. The recent cuts to platforms such as the Bell / Boeing V-22 Osprey and Sikorsky’s UH-60 Blackhawk are just two examples of decreases in military platform spending.

Among the new product announcements, Bell Helicopter unveiled the 525 Relentless (pictured below), a new super-medium twin aircraft featuring Garmin’s G5000H helicopter avionics suite. Expected to enter into service in 2014, the 525 is expected to fit Bell’s gap in that size of the market (vs. Agusta Westland and Eurocopter).

Industry Week in Review – February 17, 2012

Michael J. Misantone — Tue, 21 Feb 2012 18:13:21 +0000

This week President Obama released the Budget for Fiscal Year 2013. In it the Department of Defense has requested a total of $613.9 billion – $525.4 billion for base discretionary spending and $88.5 billion for Overseas Contingency Operation (“OCO”) spending. In all, the Pentagon’s 2013 budget outlines the elimination of $259 billion over the next five years, which is in line with the Budget Control Act of 2011’s requirement of $487 billion in defense cuts over the next decade.

According to the budget proposal, the Pentagon has stated that $75 billion will be saved over the next five years by reorganizing its investment strategy. A large portion of these cuts, $15.1 billion, will come from reorganizing the Joint Strike Fighter program, with another $13.1 billion from reducing the Navy’s shipbuilding plans. Overall the Pentagon has requested $179 billion in 2013 to buy and develop aircraft, ships, vehicles, missiles, and satellites.

Specifically, the 2013 budget requests breakdown for military services are:

$136.6 billion for the Army – about $700 million more than appropriated in 2012
$155.9 billion for the Navy – about $900 million less than appropriated in 2012
$140.1 billion for the Air Force – about $4.8 billion less than appropriated in 2012
$94.9 billion for defense-wide issues – about that same as was appropriated in 2012

Big Movers

Finmeccanica SpA (Up 17.7%) – Shares are up this week amid investor speculation that euro-area officials are nearing an agreement on a Greek bailout deal, as well as the announcement that the company’s subsidiary Telespazio signed contracts worth about €112 million ($147 million). All of the contracts signed support various space operations.

Mine Safety Appliances Co. (Up 6.1%) – Shares rose this week after the company announced record net sales in the fourth quarter and full year. MSA earned $0.46 a share on net sales of $303.7 million, compared to $0.32 a share on $285 million a year ago.

Ceradyne, Inc. (Down 4.3%) – Shares declined this week after the company reported 4Q2011 earnings per share of $0.56, $0.05 below analysts’ estimates of $0.61. Revenue for the quarter also came in below estimates at $128.5 million, versus the consensus of $131.9 million.

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Federal News Radio – Mark Amtower interviews Kevin DeSanto

Melissa Curling — Thu, 16 Feb 2012 14:00:28 +0000

Mark Amtower, host of Amtower Off-Center on FederalNewsRadio.com, interviews Kevin DeSanto, Managing Director of KippsDeSanto & Co., about the robust M&A market despite the downturn of the economic atmosphere. They discuss top deals from 2011 and the dynamics within those processes, the most sought after industries for today’s buyers, the important steps for companies to best position themselves as acquisition targets, and why service providers are so vital to a transaction. Kevin explain the importance of building a strong company from inception regardless of how short or long term acquisition goals may be.

To listen to the broadcast, please click here.

Kevin DeSanto co-founded KippsDeSanto & Co. in 2007. The desire to maintain a strong and precise focus for the firm allows the team to be industry leaders and top advisors for middle market government and technology companies.

Breaking Down the Numbers – Invest to Meet Your Goals (A Case Study in F&O Contract Pursuit)

Marc Marlin — Wed, 15 Feb 2012 13:00:28 +0000

With the wealth of information, resources, and advisors available to the owners and senior leadership of Federal contractors, it’s important to remember the risk / reward trade-off applies to broader strategies beyond just day-to-day operations.

The financial snapshot of two illustrative companies is detailed in Exhibits A and B; both with exceptional successes during 2010 and 2011. Aside from the exhibits, assume in each year the companies’ characteristics are identical (e.g., clients, capabilities, depreciation, recompete timing, employee base).

Holding all else equal, Company A was more profitable and set to generate more cash flow to its shareholders. However, adding the context that both companies are planning to sell in 2012 changes the dynamics significantly.

What’s happening? Company B made bid / proposal and business development investments to target strategic full and open (“F&O”) opportunities. In early 2011 these paid off, and it was awarded two, five-year F&O contracts worth $35 million and $40 million. Company A continued to leverage its set-aside status and was awarded $75 million of small business contracts.

Why does it matter? Market multiples (e.g., EBITDA multiples) are often misunderstood, inconsistent, and many times used as sanity checks rather than buyers’ valuation methodology. As a business grows, an owner may be inclined to take current market multiples and apply. In this example, using this approach without recognizing the importance of contract mix results in a higher anticipated transaction value for Company A than Company B. However, taking Exhibit B into account, it’s quite possible the opposite is true.

Where does the logic break down? Uncertainty equates to risk; risk lends itself to discounted future cash flows. There’s often greater uncertainty to set-aside contracts than F&O upon a change of control, as explained here [October 2011 blog “Focus on the High Value Revenue”].

Should my Company exclusively target F&O work? Not necessarily. The above case study ignores the risk / reward balance that owners and senior leadership navigate daily. Objectives and priorities drive day-to-day decisions. If an eventual sale is a shareholder objective, then making calculated investments in strategic F&O opportunities can significantly impact buyer interest and valuation.

Contributors: Marc Marlin and Robert Dowling

Industry Week in Review – February 10, 2012

Michael J. Misantone — Tue, 14 Feb 2012 13:59:21 +0000

This week, Europe’s air safety authority (“EASA”) ordered checks to the entire global fleet of Airbus A380 after cracks were found in some of the planes’ so-called “wing rib feet” – the metal brackets that connect the wing’s ribs to its skin. The order extends a previous order for nearly a third of the planes to be inspected. Airbus has announced that they have developed repair kits for the problem and that, despite the cracks, the aircraft are safe to fly. Still EASA has said that “this condition, if not detected and corrected, could potentially affect the structural integrity of the airplane.” Currently 68 planes are flying with seven airlines. The agency has given airlines between four days to six weeks to complete checks on the A380 aircraft.

Also this week, India selected Dassault Aviation as the preferred bidder for a 126 fighter jet deal. The award was determined largely on the 25% cheaper price tag, compared to the Eurofighter Typhoon jet, which would have cost five billion dollars more than Dassault’s Rafale fighter. In April of last year India pulled a surprise move, cutting out Boeing and Lockheed Martin from the procurement process, as well as Saab AB and Russia’s makers of the MiG-35. Now as the biennial 2012 Singapore Airshow, among the world’s top three aviation events, kicks off February 14^th, attention is on the Eurofighter and Boeing. If these planes lose in South Korea and Malaysia, as they have in India and Japan, questions will be raised as to the future of these planes in the international market.

Big Movers

TransDigm Group Incorporated (Up 7.8%) – Shares rose this week after the company raised its FY2012 guidance. Sales are expected to be in the range of $1.47 billion to $1.51 billion, up from $1.43 billion to $1.47 billion. EBITDA is now expected between $723 million to $743 million, compared to $705 million to $725 million previously

Aeroflex Holding Corp. (Down 11.9%) – Shares are down this week after the company posted 2Q2012 sales of $171.1 million compared to $181.6 million the same quarter last year. Additionally, net income fell to $12.6 million or $0.15 per share from $14.3 million or $.19 per share last year.

iRobot Corporation (Down 31.7%) – Shares fell this week after the company announced that it expects to report first quarter earnings per share (“EPS”) between a loss of $0.08 and break-even. Consensus estimates for EPS were $0.30 and $1.45.

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Recap: Fairfax Chamber of Commerce – Symposium for Government Contractors

Marc Marlin — Thu, 09 Feb 2012 13:00:04 +0000

We had the opportunity to attend the Fairfax Chamber of Commerce – Symposium for Government Contractors in Tyson’s Corner earlier this week. The morning included a number of panels with topics focused on M&A, the impact of private equity, and managing increased oversight – all themes relevant to the growing and emerging government contractor in the space. Some observations and themes worth noting:

Competitive Landscape

Marketplace remains highly competitive. More players are fighting for fewer contracting dollars. Larger businesses are becoming very aggressive in pricing in order to protect the top line. This approach is expected to increasingly pressure the mid-size contractor.

Public Market Trends

Publicly company valuation sit at or near multi-year lows, driven by low to no organic growth and the aforementioned pricing pressures. Near term “buy” ratings by the Wall St. Analysts remain unlikely; however, government IT services should remain an attractive segment for the long term investor as the sector has been for the past 20 years.

Opportunities

Big data, data analytics and mobile apps are key, especially given the volume of “data” across the federal government. Mobiles apps are likely to become more pervasive as a way for citizens to interact with the government, especially for everyday activities – “where is my check, where is my fishing license etc.” Mobile apps as an interface are also is in line with broader themes of efficient access to information at lower cost points. Positive momentum for the next decade is that IT will be the enabler to cut government spending, right size government, and achieve mission objectives.

M&A Trends

General consensus that consolidation shall continue, with buyers focused on the cyber, health, Intel and ISR. However, this is a small population of the market. Valuations should remain very strong in these areas given the supply and demand imbalance. As for the continued spread between public company valuations and those paid in the M&A markets, this is also anticipated to continue. Public investors often thinking quarter to quarter, whereas M&A investors are thinking and paying for a 3-5 year growth story.

Expectations for 2012 Government Services M&A Activity

Marc Marlin — Wed, 08 Feb 2012 14:00:19 +0000

While 2011 announced M&A deals was slightly down, the market for companies looking to sell and buyers’ interest in highly strategic acquisitions, was active as ever. At first glance, these seem to conflict; however, the key to the aforementioned is highly strategic. Gone are the days of acquiring simply for scale as the norm, but what is telling is how true the government services buyers are staying to their “wish list.” Coveted attributes come in different forms (e.g., contract vehicles, presence in high growth markets, scalable technologies / intellectual property, robust infrastructure, exceptional leadership team), but the key takeaways are growth potential, leveragability, and risk mitigation. 2012 is poised to be highly active; however, we anticipate actual transaction volume similar to 2011 levels as there remains a dearth of targets to meet buyers’ very particular acquisition criteria and reach a meeting of the minds around valuation. A few takeaways for 2012:

1. Corporate growth expectations given the macro Federal funded outlook remain bearish.

Evidence of Trend: Public government services multiples near all-time lows.

What to Expect: Continue acquisitions focused on the fast growth market segments – cybersecurity, intelligence, healthcare, cloud computing, and big data.

2. Potential for 2013 tax increases may drive deal volume

Evidence of Trend: Elevated 2010 deal volume; at least in part due to some sellers’ anticipating 2011 tax hikes.

What to Expect: Lots of deal activity in the second half of the year as sellers try to pre-empt potential 2013 increases.

3. The 2012 Presidential Election may drive uncertainty and motivate buyers to place (or withhold) their acquisition bets.

Evidence of Trend: Strong transaction volume in 2008 and major concerns with mounting deficit pressure.

What to Expect: Stakeholders’ looking to exit before the “storm” and buyers’ hesitancy to acquire companies in markets that have even a perceived risk of major cuts.

4. Changing landscape of Overseas Contingency Operations and a leaner, more mobile military force.

Evidence of Trend: Drawdown of Department of Defense and ramp-up of Department of State (“DoS”) in Iraq occurred faster than most anticipated.

What to Expect: Significant M&A activity for contractors in markets such as: (i) DoS (including the limited pool of awardees on DoS contract vehicles); (ii) special operations; and (iii) intelligence (e.g., all-source, counterintelligence, HUMINT).

Contributors: Marc Marlin and Robert Dowling

Industry Week in Review – February 03, 2012

Michael J. Misantone — Mon, 06 Feb 2012 15:29:44 +0000

This week Republican senators introduced a bill aimed at delaying the spending cuts required under sequestration by one year. Senator John McCain, R-Arizona, introduced the legislation entitled, the “Down Payment to Protect National Security Act of 2012,” aimed towards reducing federal spending by $127 billion over the next ten years. Republicans hope to realize these savings through an extension of the federal pay freeze, including members of Congress, by an additional year and a reduction in the federal workforce through attrition. According to John McCain, roughly $110 billion is required to cover the first year of cuts under sequestration; however, President Obama has formerly stated that he would veto any plan that would undo the Budget Control Act of 2011’s sequestration provision because he believes it could still force Congress to come together on a much broader solution to reduce the country’s deficit.

As budget cuts are pushed throughout the military, reductions in the Air Force are expected to be met through a heavier reliance on multirole aircraft. According to Dan Goure, an analyst at the Lexington Institute, the service cannot afford to maintain fleets of specialized aircraft anymore, even though it might mean the Air Force ends up with planes capable of performing many missions, but none particularly well. Given the delays on the F-35, however, the Air Force is currently modifying roughly 350 F-16s to add capabilities and extend the aircrafts’ service life.

Big Movers

Northstar Aerospace Inc. (Down 62.3%) – Shares plunged this week after the company received a notice from a major customer claiming breach of obligations under certain contracts. The aircraft parts maker said that it expects to violate its financial covenants as of January 31.

Cubic Corporation (Up 10.6%) – Shares rose this week after the company released Q12012 sales and operating income of $318.7 million and $28.2 million, compared to $284.4 million and $27.2 million the same quarter last year, an increase of 12% and 4%, respectively. The company also announced a record backlog of $3.2 billion.

BE Aerospace Inc. (Up 10.4%) – Shares are up this week after the company announced fiscal 2012 estimated revenue and earnings per share (“EPS”) to be approximately $2.95 billion and $2.75 per diluted share, respectively. Analysts had expected revenue of $2.86 billion and EPS of $2.74 for fiscal 2012.

Recent Acquisitions

ICF International Inc. to acquire GHK Holdings Limited, a multidisciplinary consultancy serving government and commercial clients on government, health, and international development issues. The acquisition is expected to strengthen ICF’s European presence and create critical mass for ICF in high-growth Asian markets. Terms of the deal were not disclosed.

Wynnchurch Capital, Ltd. acquired the assets of Burtek, Inc., a manufacturer of ground-based mobile military equipment, such as radar systems, ground vehicles, and shelters, for nine million dollars. Wynnchurch originally offered $14 million two months ago, but reduced its offer after Burtek lost two contracts while the deal was still pending. The deal closed late Thursday after a U.S. District Court approved the sale.

Berger Group Holdings, Inc. Acquired Ranger International Services Group, Inc., a provider of aviation, logistics, and engineering services both domestically and internationally, for an undisclosed amount. The acquisition is expected to increase Berger’s capabilities in government operations contracting, operations and maintenance, airfield operations, and specialized technical services. Ranger International Services Group, Inc., will now do business under the Louis Berger Services, Inc. name.

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2011 Government Services M&A: Year in Review

Marc Marlin — Wed, 01 Feb 2012 13:00:28 +0000

Looking back at 2011, the year resulted in a healthy level of government services activity. During the year, 89 deals were announced. Although the total deal activity fell 10% from the 99 deals announced in 2010, 2011 activity was well above 2009 levels of 77 deals.

Similar to 2010, hot areas in the M&A market continued to be cybersecurity, intelligence, ISR, and healthcare IT in 2011, but firms with mobility and cloud-oriented capabilities were also in high demand. We saw buyers trying to align themselves with these strategic federal funding areas, amidst overall uncertainty in federal budgets. Others buyers used acquisitions to gain access to certain high-priority customers, contract vehicles, and capabilities.

Strategic buyers announced the majority of the 2011 deals, representing 85% of the total. The strategic buyers were mainly government services players, while defense and diversified strategic buyers dabbled in the market. CACI, General Dynamics, KEYW, and Ultra Electronics were the most active buyers in 2011 with three transactions each, followed by nine other buyers with 2 transactions – CH2M Hill, ECS, Harris, IBM, ManTech, Raytheon, Salient Federal Solutions, Sotera Defense Solutions, and URS.

The activity shows that larger buyers with healthy balance sheets and plenty of cash, aren’t afraid to use it. Two other trends worth noting were the influence of private equity who participated in ~35% of deals as the buyer or via an existing portfolio company, and increased willingness of larger players to acquire much smaller companies that are strategic in nature, but don’t immediately move the needle from a revenue basis.

Moving into 2012, there is significant momentum given the number of buyers that remain hungry for deals, but have very focused and disciplined M&A strategies as well.

Top 5 Largest 2011 Government Services Deals: ⁽¹⁾

Date ⁽²⁾	Buyer	Target
4/1/2011	Providence Equity Partners LLC	SRA International, Inc.
8/16/2011	General Dynamics Corp.	Vangent, Inc.
11/7/2011	HMS Holdings Corp.	HealthDataInsights, Inc.
10/19/2011	The Parsons Corporation	Cobham Analytic Solutions (formerly SPARTA)
3/3/2011	Ares Management LLC	Global Defense Technology & Systems, Inc. (now known as Sotera Defense Solutions, Inc.)

(1) Based on enterprise value and publicly available information

(2) Announcement date

Written by Marc Marlin and Laura Hockensmith.

Industry Week in Review – January 27, 2012

Michael J. Misantone — Mon, 30 Jan 2012 16:26:39 +0000

This week, Defense Secretary Leon Panetta held a news conference on defense budget cuts at the Pentagon. “The military will be smaller and leaner, but it will be agile, flexible, ready and technologically advanced; it will be cutting edge,” he told reporters. The U.S. Army will be reduced from 547,000 active-duty soldiers to 490,000, while the U.S. Marine Corps will be cut to 182,000. The Army also plans to remove at least eight brigade combat teams from its existing force structure. To reduce projected spending by $487 billion over the next 10 years, the Pentagon is eliminating what it describes as “poorly performing programs” and has identified an additional $60 billion in efficiencies. The first tranche of those spending cuts — $259 billion — will come over the next five years. These cuts do not take into consideration the possibility of sequestration which could initiate an additional $500 billion cut in January 2013 if Congress does not find an alternative way to reduce the country’s deficit. In 2013, the Pentagon is requesting $525 billion for its base budget, with an additional $88.4 billion for overseas contingency operations. Today’s five-year spending plan projects the Defense Department will need $567 billion for its base budget in 2017.

Big Movers

Textron Inc. (Up 17.3%) – Shares are up this week after the Company announced that it expects revenues of approximately $12.5 billion and earnings per share (“EPS”) from continuing operations to be in the range of $1.80 to $2.00. According to estimates, analysts were expecting the Company to report revenues of $11.9 million and EPS of $1.66 for fiscal 2012.

CIBER, Inc. (Up 13.6%) – Shares are up this week after the Company announced that it entered into a purchase agreement to sell its Federal Division and related assets to CRGT Inc.

Wesco Aircraft Holdings, Inc. (Up 9.3%) – Shares are up this week after the company announced results for its fiscal first quarter ended December 31, 2011. Revenue for the first fiscal quarter was $192.6 million, another quarterly record and an increase of 11.0% compared to $173.5 million in the prior year period. Wesco demonstrated strong international growth during the quarter with revenues in the Rest of World segment increasing by 29.7% compared to the prior year.

Relevant Transactions

CRGT, Inc. acquires Federal Division of CIBER, a provider of emerging technology solutions for the U.S. federal government for $40 million. CRGT is a portfolio company of Veritas Capital. The acquisition furthers CRTG’s strategic growth plan, positions the Company to better serve a broader spectrum of the Federal marketplace, and adds unique capabilities that are provided to a diverse customer base.

Sun Capital Partners to acquire Pacific Safety Products, Inc., a manufacturer of advanced armor and personal protection solutions. The acquisition allows Sun Capital Partners to enter into the person protection equipment market. Terms of the deal were not disclosed.

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