More to Come? 11th Annual Federal M&A Outlook

small-business -2While nobody ever admits to having a crystal ball, the consensus of the brave prognosticators who gathered at Morrison & Foerster’s recent 11th Annual Federal M&A Outlook trended toward the optimistic. The heavily anticipated event, held annually in Northern Virginia, was attended by hundreds of the region’s top federal contracting executives, investors, analysts and other leaders.  Ed Caso of Wells Fargo Securities once again delivered the keynote address that set the stage for subsequent roundtable discussions with panels comprised of investment bankers and CEOs.  Overall, speakers and panelists felt confident that the government services sector has room for continued M&A activity through the end of the year and into 2016, especially among midsize players.

The optimism in the room remained cautious, however. Mr. Caso led off by noting that a government shutdown had been averted only a week before, and that looming budget fights had merely been pushed down the road to December. The investment banking panel that followed also alluded to recent comments by Frank Kendall, Under Secretary of Defense for Acquisition, Technology and Logistics, that seemed to disapprove of prime-level industry consolidation among defense contractors.

But panelists generally agreed that the more fragmented, higher-competition government services industry will likely see further consolidation, fueled in part by “mega deals” among the larger players. Mr. Caso supported this notion, explaining that strategic buyers are getting back into the market, but also that “mergers of equals” and other creative deals are starting to appear. These and other trends support an overall positive outlook for continued activity in the sector. In fact, presenters latched onto the idea of the emergence over the next couple of years of five to seven government service providers with $5 billion or more in revenue, perhaps even involving spin-offs from the larger primes.

The emergence of consolidated players could create large, active acquirers in the market and put additional pressure on midsize companies. But investment banking panelists cautioned that buyers will not be looking to acquire targets merely “for the sake of being bigger,” and that the best deal outcomes still go to truly innovative target companies that present opportunities for real organic growth following the transaction.  Panelists also agreed that while valuations remain high in certain hot sectors, target companies still need to distinguish themselves and demonstrate their value to buyers. For example, although “cyber” will remain a hot buzz word for the foreseeable future, using “cyber” in your mission statement without actually doing cyber isn’t enough. The CEO panelists also spoke of considering whether the complementary nature of the buyer’s and the target’s respective customer bases and company cultures will support growth and continued success post-transaction.

One investment banking panelist cited another reason that 2016 may be a particularly active year for federal M&A: potential buyers can derive more comfort from federal budgets that are projected to remain flat or even rise, which could spur acquisitions. While comfort may not be thrilling, at least it’s a reason to stay optimistic.