Conclusiones

In this section of the report, we present the results of the survey relative to mergers and acquisitions (M&A) from several different perspectives including the overall M&A environment, the prices paid for acquired businesses, due diligence issues, and the overall success of the acquisition. We also address the contract administration aspect of M&A including the advantages and disadvantages of contract novation after the acquisition has been consummated.

Exit strategy

In previous surveys, we reported that selling the company is the most favored exit strategy for privately held government contractors. This continues to be the case in this year’s survey. We asked respondents which exit strategy was receiving the most consideration at their company. A very significant percentage (74%) of privately owned companies favor sale of the company as an exit strategy. A much smaller percentage (2%) indicated they intended to convey the company to a family member as a gift or through inheritance.

For the respondents planning to sell the business, 17% plan to sell in the next 2 years, 52% plan to sell in 3 to 5 years; while the remaining 31% plan to sell within 6 to 10 years.

M&A environment

There has been a rather robust M&A environment in the government contracting industry going back at least 25 years which was caused by several key factors including (a)

consolidations in the wake of the dissolution of the former Soviet Union; (b) the major increase in the Government’s use of IDIQ contracts which forced companies to work together in large teams and significantly reduced the number of new business opportunities from non-IDIQ orders; (c) the very significant impact on products and services caused by the technological advances in the 1990s; and (d) the increased politicization of Government procurements which has either delayed or in some cases entirely terminated contracts for major products and services.

We asked surveyed companies whether they were involved in M&A activity during the past year and only 4% answered in the affirmative. This is consistent with the finding from our last survey and the low rate is at least partially the result of budget uncertainties caused by sequestration.

We also asked companies about their expectations for the M&A environment over the next 12 months and there is great optimism that the environment will improve. The results are shown in Figure 39. A very significant 56% of respondents expect the environment to improve while only 9% expect it to worsen. The remaining 35% expect no change in the M&A environment over the next 12 months.

Not-for-profit Publicly traded Privately owned

Fig 39: Expected change in the M&A environment in the next 12 months

Improve 56% No change 35% Worsen 9%

44 Grant Thornton's 2015 Government Contractor Survey

Success of the acquisition

We asked surveyed companies involved in an acquisition to rate the success of the acquisition. The results are shown in Figure 41. As shown, 21% rated the acquisition highly successful; 79% rated it successful; and no respondent rated the acquisition unsuccessful.

Divested operations

We asked companies whether they had divested any of their operations in the past year and 7% responded in the affirmative. The reasons given included (a) the divested business was not core to the remaining business, and (b) the divested business created potential organizational conflicts of interest which could prevent the company from pursuing other business opportunities.

Price paid for acquired business

We asked those companies that acquired a business to provide the price paid as a multiple of annual revenue. Fifty percent of the prices were less than 50% of revenue, 33% were between 100 to 125% of revenue, and the remaining 17% were above 125% of annual revenue.

We also asked the companies to provide the price paid as a multiple of EBITDA. The price of one third of the transactions was less than five times EBITDA, another third between five to seven times EBITDA, and the remaining third sold for factors ranging from nine to twelve times EBITDA.

Due diligence

Government contracts generally carry far greater risks and uncertainties than those found in many commercial businesses and therefore, the due diligence review should be tailored to identify and quantify those unique risks in order not to overpay for the company being acquired. A history of excellent performance does not guarantee future business because of the competitive requirements for follow-on business and because of the unique nature of the government source selection process. Changing government priorities may cause government programs to be abruptly terminated for the Government’s convenience even in cases where there are no performance issues on the contracts. Unlike commercial business, government contracts frequently include the requirement that costs and billings be audited by government personnel creating another unique risk factor when acquiring a government contractor. We asked companies involved in an acquisition whether the acquisition price had been reduced as a result of due diligence and 57% responded in the affirmative. We also asked companies that considered acquiring another company whether they had walked away from the acquisition as a result of due diligence and the results are presented in Figure 40. As shown, 69% walked away from an acquisition as a result of findings in due diligence which compares to the 63% reported in the previous survey.

not requested requested

Fig 40: Walked away from potential acquisition as a result of due diligence Yes 69% No 31% Not-for-profit Publicly traded Privately owned

Fig 41: Success of the acquisition Highly successful 21%

Successful 79% Unsuccessful 0%

Contract novation

A government contractor cannot assign a contract to another company without government approval. If the company being sold will be dissolved and absorbed into the acquiring company, the buyer and seller may endure an often burdensome contract novation process. This process requires the submission of the purchase agreement to the contracting officer, declarations from both companies’ boards of directors, audited financial statements, opinions of legal counsel; evidence that security requirements have been met, and other information.

In our experience with M&A involving government contractors, many companies forego the novation process and maintain the seller’s corporate identity for a period of time after the acquisition is consummated. In such cases, the transaction is usually handled as a stock sale, and the seller maintains its corporate identity as a subsidiary or other form of operating segment within the buyer’s organization. A frequently used strategy is to phase out the selling company as its contracts conclude and to compete for follow-on work under the buyer’s name. This phased approach seems to work well in terms of integrating the operations of the buyer and the seller. We have also noted that M&A agreements occasionally include earn-out provisions under which the final price is determined in part by the performance of the seller after the acquisition. Delaying contract novation can be helpful in earn-out situations in order to maintain separate accountability for each company during the earn-out period.

We asked companies involved in M&A activity whether they had elected to novate the contracts of the selling organization or whether the seller’s corporate identity was maintained after the acquisition. Sixty-seven percent of the respondents elected to novate the acquired contracts.

Raising capital

We asked companies whether they intended to raise capital within the next three years and 48% responded in the affirmative. We also asked the reasons for raising capital and the responses are shown in Figure 42.

Product vs services Customer Function Location Fig 42: Reasons for raising capital

Growth and operations 40% Acquisitions 49%

Refinancing 4% Returning capital to shareholders 7%

46 Grant Thornton's 2015 Government Contractor Survey 46 Grant Thornton's 2015 Government Contractor Survey