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  1. 1. ‘ REPORT FROM THE FRONT: Federal/Defense Technology M&A – ‘Who’s Buying, Who’s Selling, and Why’ Conference: Examining the Economic Impact of SBIR and STTR March 18, 2004 Paul Serotkin
  2. 2. Today….. <ul><li>The Federal/Defense Technology Company Universe </li></ul><ul><li>Current M&A Environment </li></ul><ul><li>Seller/Buyer Profiles </li></ul><ul><li>M&A Valuation/Deal Pricing in the Federal/Defense Technology Sector </li></ul>
  3. 3. Minuteman Ventures LLC <ul><li>Investment Bank focused entirely on Federal/Defense Technology Sector </li></ul><ul><li>Work with private firm owners approaching M&A as either 1) a first time strategic growth path, or 2) a liquidity event </li></ul><ul><li>Founder involved with small business trade association in effecting passage of SBIR in 1982 </li></ul><ul><li>Work with private and public companies in transacting corporate transactions </li></ul>
  4. 4. The Federal/Defense Technology Company Universe <ul><li>Under $100m in revenue, often under $50m </li></ul><ul><li>Closely held, few shareholders, with perhaps an ESOP holding a minority position and some option-holders; typically no outside capital </li></ul><ul><li>Geographically strong in two, possibly three locations </li></ul><ul><li>Having true market presence at two to three agencies </li></ul><ul><li>Widely ranging services, systems and solutions across a spectrum –demarcated by degree of commoditization, classified/intel work and technology differentiation </li></ul><ul><li> - System engineering/integration, training, modeling/simulation, network services, technology R&D, legacy migration, database maintenance, logistics, software application development, program management/acquisition support, systems/platform systems, IT/communication technology </li></ul><ul><li>Usually at least five years old, many times 15+ years duration </li></ul><ul><li>Founder often involved, at least in ownership, if not operations </li></ul><ul><li>Could have some SBSA/8a work remaining </li></ul>
  5. 5. Government Technology Firms- Industry Stratification, By Revenue, FY02 Source: Eagle Eye Publishing/Government Services Insider
  6. 6. Favorable M&A Environment for Federal/Defense Technology Firms <ul><li>Supportive Capital markets- $2bn in new issues last 18 mos.; aggregate 50% increase in’03 enterprise values </li></ul><ul><li>Inexpensive debt capital, with attractive lending ratios </li></ul><ul><li>Government infusing more complex technology into processes and warfare </li></ul><ul><li>More outsourced federal functions </li></ul><ul><li>Public sector firms valued on basis of 15-20% annual growth </li></ul><ul><li>Good visibility into future revenue, earnings and cash flow </li></ul><ul><li>Modernization of legacy government IT systems </li></ul><ul><li>Steady growth in government IT budget strongest in intel/defense and homeland security </li></ul><ul><li>LEADING TO: Robust M&A pricing; market values at/near historic highs </li></ul>
  7. 7. Reasons Behind the Robust Government M&A Market <ul><li>Record levels of Federal/Defense Technology M&A Transactions. Why? </li></ul><ul><li>PART FEAR FACTOR, SECTOR MATURITY, CLASSIC MAKE V. BUY DECISION </li></ul><ul><li>Sector Rotation – Defense in vogue today - Will it be tomorrow? </li></ul><ul><li>IPO ‘Buyer’ Class of ‘02 – will this potential buying class be smaller in a few years, i.e., Veridian, Titan already sold </li></ul><ul><li>Active mid-tier buyers ($50m-$250m); strong private equity interest (success stories – Anteon, SI, Veridian) </li></ul><ul><li>Well-positioned firms (intel, security, C4ISR, network-centric warfare, law enforcement, public safety) yield M&A premium </li></ul><ul><li>Attractive tech firms supporting homeland security and 3-letter agencies </li></ul><ul><li>Large platform companies diversifying into services </li></ul><ul><li>Uncertainty in market –GWAC restructuring, small business recertification, performance-based contracts, base closure, War on Terrorism and deficits affecting civilian agency budgets </li></ul>
  8. 8. Seller Transaction Profile – Defense/Federal Technology (By Seller Size) <ul><li>Observations </li></ul><ul><li>(70+ transactions since Q4 ’02) </li></ul><ul><li>Mostly smaller companies – 8 of 10 with revenue under $50m </li></ul><ul><li>Ready willingness by large cos. to buy smaller ones </li></ul><$20m $20m - $50m $50m – $100m $100m – $250m $250m - $500m $500m +
  9. 9. Buyer Transaction Profile – Defense/Federal Technology (By Acquirer Size) <ul><li>Observations </li></ul><ul><li>(70+ transactions since Q4 ’02) </li></ul><ul><li>Major SIs very active </li></ul><ul><li>Smaller companies selectively transacting deals </li></ul><ul><li>Mid-sized buyers using M&A to add strategic pieces </li></ul>$500m+ $50m-$100m < $50m $100m-$250m $250m-$500m
  10. 10. Mid-Tier Companies: Growing, Robust Acquirers <ul><li>Profile: $50-$250m firms </li></ul><ul><ul><li>Government is largest if only customer </li></ul></ul><ul><ul><li>Experienced organic growth and successfully integrated previous acquisitions </li></ul></ul><ul><ul><li>Need to quickly add strategic pieces </li></ul></ul><ul><ul><li>Some backed by private equity </li></ul></ul><ul><ul><li>See path to become $500m companies </li></ul></ul><ul><ul><li>Are growing or want to grow faster than government technology market </li></ul></ul><ul><li>Lenders educated on government M&A, cost of debt capital still low </li></ul><ul><li>Promise of IPO; strategy and size both important </li></ul><ul><li>Immediate addition of clearances, key managers, new customers </li></ul><ul><li>Strong case for ‘buy v. make’ environment </li></ul>
  11. 11. Tier 1 Buyers Conquest 50.5 Public Boeing XonTech 28 Public Northrop Grumman Vredenburg .9 Public AMS Orion Scientific .5 Public SRA Adv. Eng & Research. .4 Public EDO Digital System Resources 16.6 Public General Dynamics Orincon 31.6 Public Lockheed Martin Information Spectrum 1.0 Public Anteon Solipsys 19.4 Public Raytheon Aeromet 4.9 Public L-3 Integrated Data Systems .7 Public Mantech International C-CUBED .9 Public CACI ADI, Soza 1.4 Public Perot Systems Mevatec 18.2 Public BAE Systems Atlantic Coast, EMA, AMA 6.5 Employee-owned SAIC Recent Transactions Revenue ($ billions) Status Company
  12. 12. Tier II Buyers High Technology Solutions $230m Public Wireless Facilities (WFII) Vector Research $178m Public PEC Solutions (PECS) User Technology Associates $330m Public DigitalNet (DNET) Andrulis, HJFord $245m Public Dynamics Research (DRC) Vitronics, ICI $175m Public MTC Tech. (MTCT) MATCOM $170m Public SI International (SINT) Recent Transactions Revenue-’03 Status Company
  13. 13. Tier III Buyers MacAuley-Brown $275m Private Sytex Business Plus Corp. $175m Private American Systems Corp. Innerbase Technologies $274m Private RCI 2 Arthur D. Little units $160m Private ICF Consulting Innovative Tech. Solutions $200m Private Alion Science and Technology Decision Systems Tech. $170m Private STG Fuentez Systems $190m Private Stanley Associates Scientific & Engineering Solutions $136m Private NCI SEA $200m Private ITS Services Recent Transactions Revenue Status Company
  14. 14. Tier IV Buyers -- “ Private Indus Corporation Strategic Mgt. Initiatives “ Private Calibre Systems ECI “ Private CHM Keymind “ Private Axiom Resources The Analysis Corp. “ Private SFA Kathpal Technologies, ClearBrook Solutions “ Private Management Systems Designers, Inc. (MSDI) IT Specialists, DKCS “ Private Innovation Technology Appl. AmerInd Under $100m Private FC Business Systems Recent Transactions Revenue Status Company
  15. 15. Who’s Buying Whom BUYER: SELLER: Under $20m SELLER: $20m - $50m Under $20m $100m-$250m $20m-$50m $250m-$500m $50m-$100m $500m+
  16. 16. Who’s Buying Whom (cont’d) SELLER: $50m-$100m SELLER: $100m-$250m BUYER: Under $20m $100M-$250m $20m-$50m $250m-$500m $50m-$100m $500m+ 100% 100% SELLER: $500M+
  17. 17. Federal/Defense Technology M&A Valuation – Size/Specialty Matters 1.5x-plus Specialist Firms (size irrelevant) 1.5x $100m 1.2x $50m - - - 6X EBITDA Under $25m Size Premium (Relative to baseline) Transaction Value -Baseline Category (by revenue)
  18. 18. M&A Valuation Source: Houlihan Lokey Howard & Zukin 7.7x .39x Base Operations 8.1x .70x Engineering/IT Services 9.9x .96x Intel Enterprise Value/EBITDA Enterprise Value/Revenue Company type
  19. 19. Technology Makes a Difference in Federal/Defense IT Transactions $49 Orincon Lockheed Martin $125 Digital Systems Resources General Dynamics $73 Xontech Northrup Grumman 115% $60 $69m Aegis Research Mantech 213% $52m $110m Paravant DRS 486% $35m $170m Solipsys Raytheon Price-to-Rev. Revenue Purchase Price Seller Buyer
  20. 20. The ‘Value Table’ – 10 Factors in Determining Federal/Defense Technology Company Value <ul><li>Contract Alignment with the ‘Mission de Jour’- Technology, key customers </li></ul><ul><li>Cleared Employees </li></ul><ul><li>Recaptured Business </li></ul><ul><li>Prime Contract Awards </li></ul><ul><li>Small Business Set Aside (SBSA) Awards </li></ul><ul><li>Weak Alignment - 1 Strong Alignment - 10 </li></ul><ul><li>0-20% Employees Cleared - 1 20-60% Cleared 60% or Over Cleared - 10 </li></ul><ul><li>0-20% Recompete Revenue - 1 20-50% Recompete 50% or Over Recompete - 10 </li></ul><ul><li>0-20% Prime Contract Revenue - 1 20-70% Prime 70% or Over Prime - 10 </li></ul><ul><li>70-100% SBSA Revenue - 1 30-70% SBSA 30% or Under SBSA - 10 </li></ul>
  21. 21. The ‘Value Table’ – 10 Factors in Determining Federal/Defense Company Value (cont’d) <ul><li>Time in Business </li></ul><ul><li>Contract Concentration </li></ul><ul><li>8a Revenue </li></ul><ul><li>Competent Management </li></ul><ul><li>Sustained Revenue Growth </li></ul><ul><li>1-3 years - 1 4-6 years 7-10 years - 10 </li></ul><ul><li>60%+ revenue from 1 contract - 1 25-60% less than 25% - 10 </li></ul><ul><li>50-100% rev. from 8(a) - 1 15-50% from 8(a) Less than 15% from 8(a) - 10 </li></ul><ul><li>Lightly regarded management - 1 Highly regarded management - 10 </li></ul><ul><li>0-7% compounded ann rev. growth - 1 8-15% growth 15%+ growth - 10 </li></ul>
  22. 22. Conclusions <ul><li>Federal/Defense Technology M&A Market remains robust </li></ul><ul><li>Buyers come from all size firms; Mid-tier firms stepping up </li></ul><ul><li>Technology advancement, infusion can be true pricing discriminator </li></ul><ul><li>M&A pricing gradation based on size, differentiators </li></ul><ul><li>Consolidation figures to continue for some period </li></ul>
  23. 23. Contact Data <ul><li>Paul Serotkin </li></ul><ul><li>President </li></ul><ul><li>Minuteman Ventures LLC </li></ul><ul><li>781 750 8065 </li></ul><ul><li>781 254 7267 mobile </li></ul><ul><li>paulserotkin@minutemanventures.com </li></ul><ul><li>www.minutemanventures.com </li></ul>