By Marc Marlin, Managing Director, KippsDeSanto
Editor’s Note: Over the next five days, this senior executive with KippsDeSanto, an investment bank who has closed a majority of the Federal Health IT transactions in the past few years shares some of the common myths and realities when it comes to M&A. #5 is posted below.
Whether it’s the latest tweet, LinkedIn post, awards gala or breakfast seminar, there is information overload about the GovCon M&A. What is fact? What is fiction? How can I apply lessons learned to achieve my strategic objectives. The following are a few common assumptions and perceptions, demystified.
1) The Higher the Revenue, The Higher the Valuation
While revenue size matters, revenue composition can meaningfully enhance value. An acquirer’s ability to leverage the target – customer relationships or capabilities – to bend the combined growth curve of the business often underpins the value equation. Prime AND F&O contracts are the gateway to many M&A discussions. These attributes may dictate the overall salability of the business, and serve as guideposts for valuation. That said, in today’s M&A market, scale and the ability to “move the needle” is important for many of the larger, strategic buyers. Scale (e.g., $100 million / year) can be perceived to imply a maturity of process, diversity of contract base, and culture that affords a more seamless integration. The combination of both size and composition is valuation nirvana.
2) Selling (Buying) Duplicate Vehicles Is Easy
As duration of contract vehicles are lengthened, there is natural consolidation of holders due to M&A, graduates of size or other preference tracks, and/or on-ramps. There are hungry and successful business that either weren’t awarded the contract vehicle initially or were not in a position to compete for the vehicle at the time of procurement, for whom now the contract is important to the ongoing growth plan. This desire has motivated many of the contracts purchases to date. We especially have seen this in CIOSP3, Alliant, and OASIS, amongst others. However, the sale of duplicate contracts (in actuality the business unit/entity which houses the contract) is complicated. First, existing task orders on the contract nearly always need to convey with the master contract. Thus, naked contracts are most sought after and most easily transferrable. Second, the sale must be worth the time and effort of the seller – legal, novation, employee transfer etc. The value proposition for the contracts is usually in the hundreds of thousands to few million; not the tens of millions. Finally, larger businesses especially are reluctant to introduce new competitors to the field. Contract consolidation is good for existing holders given fewer companies chasing the same total addressable market. However, the secondary market for contract vehicles is and we anticipate to remain very active in the foreseeable future.
3) Your Top Competitor is the One Likely To Buy You
“We beat these guys all the time, they got to buy us!” is something we often hear from executives of growing firms. However, M&A priorities are longer term than the day-to-day wins and losses, and frequently part of a more complex strategic growth plan. If firms are competing, there is probably already some level of customer access or capabilities, albeit insufficient if characterized by unbalanced winners and losers in that market. A strategic hire(s) or leadership change is often a first step vs. acquisition. Moreover, an acquisition requires a business unit champion, willing to put their badge on the table and advocate for a deal. M&A and the buyer/seller match is also about timing and white space. While a seller may indeed be the leading firm in ABC market or provider of XYZ capabilities, if the competitor’s strategic plan is prioritizing M&A dollars to augment the strategy of a business unit outside those customers or capabilities, they will likely pass. The final buyer will be the one with the greatest conviction that the seller completes their strategic picture, as constituted at that time.
4) A Prime Spot on a Contract Vehicle = A Lottery Ticket
As IDIQ and GWAC’s have experienced a significant increase in the number of awards, the contract itself is generally a cost of admission, but not the main event. With sometimes 100+ contractors on the vehicle, the total addressable market becomes less relevant than the proven ability to win task orders and prove performance (e.g., SPARC). The value of the contract “paper” is very unique to each potential suitor, and the amount of work that a given buyer believes they could drive under the vehicle. For example, if a buyer were to pay $10M for a contract, that buyer may need to win $100M of TCV at a 10% margin to simply break even on that purchase (ignoring taxes and time value of money). It’s often not about the vehicle itself, it’s about the book of business or opportunity for the book of business under it.
5) Cost Synergies Drive Deal Making
M&A is rarely about cost synergies, but rather revenue growth. Cost take-out is a one-time event, while revenue synergies are the gift that keeps on giving. Deal announcements will highlight costs synergies and tax advantages, but these are elements of the broader strategy. Gaining scale and being able to spread reduced costs over the bigger base increase costs competitiveness of the firm, better positioning the company for capitalizing on future growth opportunities. This enduring advantage is especially important in the current cost sensitive contracting environment. However, the core thesis of the deal is to better position the business for top-line growth.