SAIC and Unisys Federal: Penetration, growth and confidence, with questions around IP and integration

Consolidation continues

SAIC’s agreement to purchase Unisys’ federal business for $1.2 billion (which includes present value tax assets of approximately $175 million) is just the latest example of the continued consolidation of the public sector IT services market, which has been ongoing for the past four years. For example, Leidos (NYSE: LDOS) purchased Lockheed Martin’s (NYSE: LMT) IT services business; General Dynamics Information Technology (GDIT; NYSE: GD) purchased CSRA; DXC Technology’s (NYSE: DXC) U.S. Public Sector business combined with Vencore and KeyPoint Government Solutions to form Perspecta (NYSE: PRSP), which subsequently purchased Knight Point Systems in 2019. The same year, SAIC purchased Engility, CACI (NYSE: CACI) made six acquisitions and Raytheon (NYSE: RTN) announced a “merger of equals” with United Technologies (NYSE: UTX), to be finalized in 2020. Additionally, Leidos recently finalized its purchase of Dynetics and announced the purchase of BAE’s airport security business only days before SAIC announced its plans to acquire Unisys Federal. Along with these marquee deals, the market saw a smattering of smaller and/or less strategic deals over the past four years. Much of this M&A activity has in some way emphasized scaling to compete for mega-deals such as Next Generation Enterprise Networks Re-compete (NGEN-R) or Defense Enterprise Office Solution (DEOS) contracts. Based on recent market activity and the federal government’s increasing emphasis on digital transformation and next-generation technologies, it seems unlikely the need for scale will diminish for federal market players anytime soon. For SAIC to acquire another company of this size so quickly after the purchase of Engility only underscores the importance the company’s leadership places on scale. In fact, this purchase would theoretically boost SAIC to fourth place in TBR’s Public Sector IT Services Benchmark (behind only Leidos, GDIT and Booz Allen Hamilton [NYSE: BAH]) based on the most recent trailing 12-month federal revenues of the companies we track.

Unisys Federal impact and opportunities

Aside from the additional scale in both employees and revenue, Unisys Federal will provide SAIC with deeper access to the Department of Homeland Security and Treasury Department through U.S. Customs and Border Protection (CBP) and the IRS, respectively. For calendar year 2019, Unisys Federal had approximately $179 million in obligations to CBP and $84 million in obligations to the IRS. Both agencies are relatively underpenetrated by legacy SAIC and should provide more opportunity for growth with other civilian agencies. Unisys Federal realized a CAGR of 10% over the last two years, far outstripping the average of 4.6% for the 15 companies tracked in TBR’s Public Sector IT Services Benchmark, supported by a $1.8 billion backlog (2.6 backlog-to-revenue ratio), which TBR believes should provide ample opportunity for the new SAIC to continue Unisys Federal’s strong growth, especially in cloud adoption and other modernization services. Most of this backlog consists of slightly higher-margin projects than legacy SAIC engagements. TBR expects this deal will improve margins for SAIC by somewhere between 20 to 40 basis points by the two-year mark. In addition to the scale, agency access and large backlog, SAIC now has the right to sell CloudForte, a key platform for Unisys Federal’s business in the public sector that typically forms the backbone for the cloud services the company has delivered and likely will continue to offer as part of SAIC.

TBR believes SAIC’s (NYSE: SAIC) purchase of Unisys Federal, announced on Feb. 6, 2020, will provide the combined company with broader agency access and a strong potential for growth while signaling the extreme confidence of SAIC’s leadership. We also believe the lack of IP included in the deal and the challenges associated with SAIC’s previous and upcoming integrations mean this deal likely carries more risk than reward. This acquisition comes almost exactly one year after SAIC’s purchase of Engility for $2.5 billion, which has yet to produce organic growth for SAIC, though SAIC claims cost synergies have been fully realized. The inorganic boost of Unisys Federal (which achieved approximately $689 million in revenue for the trailing 12-month period ending Sept. 30, 2019, with an impressive 10% two-year compound annual growth rate) will bring the combined organization’s annual federal revenue for the same 12-month period to approximately $6.6 billion on a pro forma basis.