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Summer 2018 Market Pulse

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Summer 2018 Market Pulse Summer 2018 Market Pulse Aerospace | Defense | Technology | Government Services Public Markets and Valuation Trends Fall Outlook Special Operation Forces (SOF) Update Notable Transactions Public Company Comparables and Recent M&A Transactions Representative ACP Transactions Larry A. Davis Philip J. McMann Mark Shaheen Partner Partner Managing Director (301) 231-6225 (301) 231-6202 (301) 222-8227 [email protected] [email protected] [email protected] 805 King Farm Boulevard, Suite 300 | Rockville, Maryland 20850 | P 301.231.6200 | F 301.231.7630 | aronsoncapitalpartners.com Summer 2018 Market Pulse Aerospace | Defense | Technology | Government Services Public Markets and Contractor Valuation Trends Federal contracting continues to LTM Contractor Returns outperform the broader market, 140 outpacing the S&P 500 by 5% to 20%. 2018 returns are supported by 120 a clearer budget outlook and favorable tax policies. 100 LTM 7/25/2018 Returns Defense Electronics continues to be Defense System/Electronics: 33.6% one of the most valuable industries Mid-Tier: 28.0% Indexed Performance Indexed 80 Aerospace: 20.1% as the Department of Defense Tier-1: 17.8% places significant premiums on S&P: 13.9% 60 high-tech, turnkey solutions to Jul-17 Nov-17 Mar-18 Jul-18 legacy systems. Mid-tier returns have been boosted LTM Contractor Multiples by: 20.0x • ICF (+60% LTM), who has seen 18.0x significant success internationally, 16.0x • CACI (+43% LTM), who beat 14.0x 12.0x analyst earnings expectations by LTM 7/25/2018 Multiples almost 50%, and, 10.0x 8.0x Defense System/Electronics : 17.6x Tier-1: 14.8x • Booz Allen (+31% LTM), who Enterprise EBITDA Value/LTM 6.0x Mid-Tier: 14.2x Aerospace: 13.0x expects to increase earnings by 4.0x over 25% in the next year Jul-17 Nov-17 Mar-18 Jul-18 Aerospace returns were elevated by the Farnborough Air Show where Boeing and Airbus saw a surge in demand for planes. Combined, the two manufactures received over 1,100 orders for new planes, versus less than 900 at last year’s Paris Air Show. Valuation growth has steadied in the past two years, though industry multiples still remain in double-digits, evidencing investors’ belief in federal spending growth, along with the premiums placed on the industry’s stability. Historical EBITDA Multiples Mid-Tier Tier-1 Defense Electronics Aerospace 17.6x 16.3x 14.6x 14.8x 13.8x 14.2x 13.0x 12.9x 12.7x 12.4x 12.4x 11.7x 11.6x 10.5x 10.5x 10.3x 10.4x 9.7x 10.0x 9.6x 9.5x 9.9x 7.7x 7.3x 7/2013 7/2014 7/2015 7/2016 7/2017 7/2018 805 King Farm Boulevard, Suite 300 | Rockville, Maryland 20850 | P 301.231.6200 | F 301.231.7630 | aronsoncapitalpartners.com 2 Summer 2018 Market Pulse Aerospace | Defense | Technology | Government Services Fall Outlook Defense In June, the Senate Appropriations Committee submitted a fiscal year 2019 funding bill with $675 billion to support the military and national security. This is a $20.4 billion increase over FY 2018’s enacted budget. Some of the major drivers of growth in the Defense budget include: • F-35 Joint Strike Fighter, a $10.8 billion Air Force, Marines and Navy program • Virginia Class Submarine, which requested $7.4 billion, $1.9 billion more than 2018 • $6.0 billion for the DDG-51 Arleigh Burke Class Destroyers The DoD has also requested $13.7 billion for Science and Technology to encourage innovation. This money will support the DoD’s academic and industry partnerships in developing innovations in Hypersonics, Autonomy, Cyber, Space, Directed Energy, Electronic Warfare, Artificial Intelligence. Contractors with a presence in these niche technologies will continue to win large, high-margin work from the Department of Defense. Public markets have recognized this as Defense and Electronics contractors have significantly higher valuations than other companies in the federal space. Defense System / Electronics Multiples USD in Millions, excluding share prices As of 7/25/2018 Price Enterprise YoY NTM Multiple Revenue Growth Company 07/25/18 Value Growth Rev. EBITDA 2018P 2019P Defense System / Electronics Firms Rockwell Collins $137.30 $29,311 17.1% 3.3x 13.6x 28.6% 4.3% Harris 151.36 21,702 25.4% 3.3x 13.9x 4.1% 6.5% L3 Technologies 200.26 18,771 11.1% 1.9x 13.7x 4.6% 5.2% Teledyne Technologies 214.65 8,500 41.0% 3.0x 16.9x 8.5% 3.7% FLIR Systems 58.59 7,160 32.0% 3.9x 15.1x (0.8%) 5.3% Cobham 1.73 4,618 (14.8%) 1.9x 12.7x (5.8%) 2.1% Cubic 69.00 2,088 37.9% 1.7x 16.8x (21.1%) 10.3% Mercury Systems 39.64 2,038 2.1% 3.6x 15.6x 19.8% 16.4% Ultra Electronics 22.28 1,748 (27.7%) 1.8x 10.6x (0.3%) 2.2% AeroVironment 73.64 1,496 112.0% 4.9x 40.1x 29.3% 2.3% Kratos Defense & Security Solutions 12.79 1,477 5.3% 2.2x 23.8x (14.2%) 11.4% Defense System / Mean 2.9x 17.5x 4.8% 6.3% Electronics Firms Median 3.0x 15.1x 4.1% 5.2% Tier 1 and Mid-Tier Mean 1.5x 12.4x 7.2% 6.1% Source: Pitchbook Govenrment Contractors Median 1.2x 12.6x 5.0% 5.5% 805 King Farm Boulevard, Suite 300 | Rockville, Maryland 20850 | P 301.231.6200 | F 301.231.7630 | aronsoncapitalpartners.com 3 Summer 2018 Market Pulse Aerospace | Defense | Technology | Government Services Fall Outlook (cont.) Information Technology Congress’ FY 2019 Budget includes $82.8 billion for federal IT, a $2.1 billion increase from 2018’s estimate. The largest increase comes from Veterans Affairs. VA has chosen Cerner to implement a new electronic healthcare record system. The program is estimated to cost up to $18 billion over ten years. It’s goal is to replace 130 legacy systems under Veterans Information Systems and Technology Architecture (VistA). The new system is to be modeled after DHA’s Genesis Program. The federal government is still focused on finding new ways to implement cloud solutions, leading to creative new ideas from legislators. Congress’ Technology Modernization Fund is funding contractors that provide customer service portals, cloud migrations, and legacy system replacements. With past systems failing, the government is resorting to more commercial service solutions. IT procurement continues trending towards IDIQ’s and contract vehicles. Notable IT vehicles includes Veterans Technology Services (VETS), NASA SEWP, Schedule 70, NETCENTS-2, and the US Army’s CHESS and ITES contracts. In June, the Alliant 2 contract finished a protest battle after being awarded in November, 2017. The $50 billion contract has a base of five years, including five additional option years and officially began on July 1st. 2018 M&A Expectations Expect accelerated M&A activity to continue in the second half of 2018. Increased activity and valuations are driven by numerous factors: • Potential acquirers will be challenged by “Outlier Bidder” dynamics and a limited quantity of well-positioned, differentiated targets with scale. • Buyers, especially in private equity, are under pressure to deploy more capital. • Strong valuations are supported by growing budgets and lower tax rates. • Valuations are also supported by strong public market • Consistently low interest rates support debt backed acquisitions. • Uncertainty in the 2020 elections and beyond drive a desire to mitigate risk. Premium valuation drivers continue to include: • Mission critical assets with differentiated solutions • Commoditized services and solutions • Solutions platforms (especially cyber and intel) 805 King Farm Boulevard, Suite 300 | Rockville, Maryland 20850 | P 301.231.6200 | F 301.231.7630 | aronsoncapitalpartners.com 4 Summer 2018 Market Pulse Aerospace | Defense | Technology | Government Services Special Operation Forces (SOF) Update An important trend in the government services market over the past two years is the growing valuation gap between “mission focused” companies and counterparts in the market providing more standard, commoditized services. Companies on the winning end of this dynamic tend to provide specialized engineering, analytic, and IT services (including C4ISR, cyber, and data analytics) to high-barrier-to-entry customers, often in the intelligence community and specific areas of law enforcement and defense. A key aspect of this trend is the emergence of U.S. Special Operations Command (SOCOM) as an increasingly sought after customer. Middle market and lower middle market contractors focused on the SOCOM market are attracting acquisition interest at valuations once reserved almost exclusively for high-end intelligence community (IC) contractors. The attractiveness of SOCOM as a customer is relatively straightforward – threat- driven policy decisions have resulted in the prioritization of special operations forces as a tool of policy. Robust funding has followed, and SOCOM will spend in excess of $3 billion with contractors in FY18. SOCOM’s demanding mission requirements and funding flexibility have led to development of a community of contractors who can provide high-end, high-value services. The Command’s emphasis on small business (historically a third of contracts) has led to the development of a strong lower middle market base of emerging, mission-focused solutions providers. Solid funding and contract flexibility on the part of SOCOM designed to ensure acquisition of mission-essential services have attracted flexibility on the part of SOCOM designed to ensure acquisition of mission-essential services have attracted leading edge, high performing companies. Importantly, an emerging trend is the crossover from SOCOM into the larger but equally demanding market in the IC. 805 King Farm Boulevard, Suite 300 | Rockville, Maryland 20850 | P 301.231.6200 | F 301.231.7630
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