Government IT Services Sector M&A Update – November 2023

National Security Demand Buoys Consolidation Activity in Government IT Services Sector

Government information technology (IT) service providers have benefited from the government’s ongoing shift to cloud computing, specifically at the federal level. Through the first half of 2023, the U.S. government has awarded $1.7 billion in IT services contracts, compared to $1.6 billion in the prior year period, a 6.3% increase year-over-year (YOY) according to USASPENDING.¹ Federal IT contract awards have focused on both sustaining current capabilities and developing infrastructure for new IT systems. U.S. intelligence community organizations have been at the forefront of the shift to cloud computing, advanced data analytics, and modernization. While the most lucrative intelligence community IT contracts are typically awarded to large public companies, middle market players with innovative capabilities have been able to capitalize on demand for niche services and disruptive software systems. Of note, System High, an IT protection solutions provider and portfolio company of Enlightenment Capital, was awarded a $50 million dollar contract to provide the controlled destruction and disposal of classified IT systems for an unnamed member of the U.S. intelligence community in July 2023, according to System High’s website.² These examples showcase that while the broader U.S. government continues to modernize its IT systems, the intelligence community is expected to spearhead national security IT investment through contracts and strategic partnerships with innovative and agile contractors, fostering a healthy merger and acquisition (M&A) environment for the middle market. Capstone has remained active in the Government IT Services sector with current deals in market in software development, E-procurement, identity management, and IT modernization.

While the IPO and M&A markets have cooled considerably across the US economy, we witness notable resilience in the government sector, driven by countercyclical dynamics, pressing geopolitical challenges, and commitment to technological modernization across Federal, state and municipal organizations alike.

David BrinkleyManaging Director, Capstone Partners

IT Investment in Defense and Intelligence Agencies Benefits Public Company Players

Public companies in the sector are benefitting from U.S. government investment in IT modernization for defense and intelligence agencies. In recent earnings calls, public companies have cited the normalization of contract award activity as a harbinger of continued profitability. “Award activity is returning to normal levels after a protracted period marked by procurement delays under running budget authority. A more active environment bodes well for Leidos with our long history of being able to thrive in a competitive market,” said Leidos (NYSE:LDOS) CEO Roger Krone, in the company’s Q1 2023 earnings call.³ Leidos, a leading provider of IT services for the Intelligence end market, exceeded its gross awards plan for Q1 2023 and booked a net of $3 billion in awards, bringing the company’s total contract backlog at the end of the quarter to $35.1 billion, a 17% YOY. This trend continued as Leidos was awarded a $375 million prime contract in July to provide intelligence and IT project management services to the Office of the Director of National Intelligence (ODNI), according to a press release.⁴

Strategic priorities in the Department of Defense’s (DOD) national security posture have also influenced operational plans for leading public companies in the sector. The DOD has identified the People’s Republic of China (PRC) as “our pacing challenge,” while moving significant national security resources to the Indo-Pacific region, according to a DOD press release.⁵ Of note, Booz Allen Hamilton (NYSE:BAH) has expanded its presence in the Indo-Pacific region in support of the U.S.’ intelligence missions. Booz Allen Hamilton’s operational initiatives to support the DOD have included growing its office and team in Hawaii to over 300 professionals, while also positioning 200 more professionals across the entire region, according to the company’s fiscal year Q4 2023 earnings call.⁶

Public company earnings have been bolstered by a focused national security strategy and new high-value DOD contracts. In June, CACI International (NYSE:CACI) was awarded a $5.7 billion blanket purchase agreement contract from the U.S. Air Force for Enterprise Information Technology-as-a-Service (EITSaaS). This represents the largest contract award for the company to-date, according to a press release.⁷ CACI reported a quarter-over-quarter (QoQ) fiscal Q3 revenue increase of 10%, citing the $1.1 billion in Q3 contract awards as the next major revenue driver, according to an earnings release.⁸ This translated to an 8% YOY increase in contract value for CACI and brought its current backlog value to $25.3 billion. Such awards have demonstrated the lasting impact of high-value contract wins on earnings for the public companies in the space.

Government IT Sector M&A Normalizes to Pre-COVID Levels, Valuations Remain Robust

M&A activity in the Government IT Services sector has moderated, with 54 transactions announced or completed through year-to-date (YTD) 2023. This is compared to 84 transactions in YTD 2022, highlighting a slowdown in deal activity following historic activity in 2021 and 2022. The decline in Government IT Services M&A points to a normalization in transaction activity as YTD 2023 deal volume has surpassed YTD 2020 (42 transactions) and kept pace with YTD 2019 (56). Additionally, amid high inflation and a more costly debt environment, the demand for quality companies with robust margin profiles and unique capabilities has grown, resulting in premium valuations for well positioned companies. Sealing Technologies, a Maryland-based cybersecurity and technology company serving the DOD and intelligence community, was acquired by Parsons (NYSE:PSN) in August for an enterprise value of $200 million. The acquisition expands Parsons’ customer base across the National Security landscape while further enhancing its digital infrastructure protection and secure data management capabilities. Additionally, the deal highlights strategic buyers’ willingness to offer competitive valuations for critical intellectual property and revenue growth exceeding 10%, according to a press release.⁹ Despite a lull in acquisition activity in the sector and in the broader M&A market, companies with long-term contracts, appealing margin profiles, and unique capabilities are expected to attract buyer interest and command premium valuations.

Elevated Cybersecurity Demand Drives Consolidation Among Providers Serving the Intelligence End Market

Demand for sector services from the DOD and U.S. intelligence community has trickled down to the M&A market in 2023, where targets serving the Intelligence end market have comprised an increased share of total transactions. Through YTD 2023, targets in the Intelligence segment have accounted for 20.4% of all transactions, compared to 9.5% during the same period in 2022. Notably, Enlightenment Capital-backed iNovex’s acquisition of Secure Innovations (June 2023, undisclosed) has embodied the motivations driving a robust transaction environment in the segment. Heightened demand for cybersecurity services from the intelligence and broader national security community has helped to proliferate deal activity in the segment. “Cyber dominance is the new ‘arms race,’ and the national security community is actively seeking novel approaches and innovative solutions from emerging prime contractors,” said Jason Rigoli, Chairman of the Board at iNovex, in a press release.¹⁰ Secure Innovations’ cybersecurity solutions and proven track record of serving the intelligence community is expected to integrate well with iNovex’s software development capabilities, strengthening iNovex’s position as a leading middle market company with prime contract awards over $2 billion, according to the press release. Additionally, Capstone has been active in the Intelligence segment in recent years with the advised sale of ManageYOURiD to System High in August 2022 for an undisclosed sum. ManageYOURiD provides privacy protection services to a range of clients including the Federal Bureau of Investigations (FBI), the U.S. Secret Service, and the DOD, according to the company’s website.¹¹ Capstone expects consolidation activity in the Intelligence segment to continue growing in response to increased demand for innovative intelligence security services from middle market companies.

To learn about Capstone’s wide range of advisory services and Government IT sector knowledge, discuss the effects of national security on government demand for IT services, or provide an update on your business, please contact us.

Joe Collins, Analyst, was the lead Market Intelligence contributor to this article.

Endnotes

1. USASPENDING, "Contract Award Data, Spending by Time," https://www.usaspending.gov/search/?hash=9f60afe198d7d67db009aa19bf8d0d98, accessed August 10, 2023.

2. System High, "System High Awarded $49.9 million Classified IT Destruction Contract," https://www.systemhigh.com/system-high-awarded-49-9-million-classified-it-destruction-contract/, accessed July 28, 2023.

3. Seeking Alpha, "Leidos Holdings, Inc. (LDOS) Q1 2023 Earnings Call Transcript," https://seekingalpha.com/article/4598847-leidos-holdings-inc-ldos-q1-2023-earnings-call-transcript, accessed July 28, 2023.

4. Leidos, "Leidos awarded $375 million contract to support Director of National Intelligence," https://www.leidos.com/insights/leidos-awarded-375-million-contract-support-director-national-intelligence, accessed August 3, 2023.

5. U.S. Department of Defense, "Department of Defense Releases the President's Fiscal Year 2024 Defense Budget," https://www.defense.gov/News/Releases/Release/Article/3326875/department-of-defense-releases-the-presidents-fiscal-year-2024-defense-budget/#:~:text=The%20FY%202024%20budget%20request%20includes%20%2430.6%20billion%20for%20munitions,Strategic%20Missiles%20%2D%20%247.3%20billion., accessed August 3, 2023.

6. Seeking Alpha, "Booz Allen Hamilton Holding Corporation (BAH) Q4 2023 Earnings Call Transcript," https://seekingalpha.com/article/4607668-booz-allen-hamilton-holding-corporation-bah-q4-2023-earnings-call-transcript, accessed July 28, 2023.

7. CACI International, "CACI Awarded $5.7 Billion Enterprise Information Technology as a Service (EITaaS) Wave 1 Agreement by the Air Force," https://investor.caci.com/news/news-details/2023/CACI-Awarded-5.7-Billion-Enterprise-Information-Technology-as-a-Service-EITaaS-Wave-1-Agreement-by-the-Air-Force/default.aspx, accessed August 3, 2023.

8. CACI International, "CACI Reports Results for its Fiscal 2023 Third Quarter," https://investor.caci.com/news/news-details/2023/CACI-Reports-Results-for-Its-Fiscal-2023-Third-Quarter/, accessed August 3, 2023.

9. Parsons Corporation, “Parsons Acquires Sealing Technologies,” https://www.parsons.com/2023/08/parsons-acquires-sealing-technologies-inc/, accessed October 3, 2023.

10. Intelligence Community News, “iNovex Acquires Secure Innovations,” https://intelligencecommunitynews.com/inovex-acquires-secure-innovations/, accessed September 18, 2023.

11. ManageYOURiD, “About,” https://www.manageyourid.com/, accessed September 18, 2023.