Could M&A Activity in the Federal IT Services Market Surge in 2025?

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What Caused the Initial Slowdown in M&A Activity in Federal IT Services?

In March 2022 the Federal Reserve raised the federal funds rate for the first time since 2018, increasing it by 0.25% Prior to this, contractors like Accenture Federal Services (AFS) and Booz Allen Hamilton (BAH) had been rapidly acquiring digital transformation capabilities to capitalize on the demand for IT services as well as emerging technologies from the Department of Defense (DOD) and Intelligence Community (IC).

Macroeconomic Pressures Mount

M&A activity by the vendors tracked in TBR’s Federal IT Services Benchmark began to slow down over the course of 2022 as borrowing rates continued to increase and target company valuations climbed. IBM Consulting’s acquisition of Octo Consulting during 4Q22 to expand the federal unit’s digital transformation capabilities for defense and civilian agencies signaled the end of meaningful M&A activity by IBM Consulting and these 10 other benchmarked competitors: AFS, BAH, CACI, CGI Federal, General Dynamics Technologies (GDT), ICF International, KBRWyle, Leidos, Maximus and SAIC.

What Have Vendors Been Doing to Counteract the M&A Slowdown?

In 4Q23, statutory and organic* revenue growth rates converged for the first time ever in TBR’s Federal IT Services Benchmark. These rates remained essentially the same during 1Q24, reflecting the lack of M&A activity in federal IT.

 

Vendors have been monitoring opportunities over the last couple of years but are largely prioritizing using their free cash flow to repurchase shares, make internal investments or reduce debts. For example, while ICF pursued an aggressive M&A strategy between 2020 and 2022 to penetrate the federal health market by vastly expanding its digital modernization business’s capabilities, the company has since focused on making its balance sheet healthy again while interest rates remain elevated.

 

Most vendors have also turned to strengthening their relationships with existing partners and expanding their alliance ecosystem while M&A has been off the table. For example, General Dynamics Information Technology (GDIT), a segment of GDT, has been working with Fornetix to capitalize on the DOD’s Combined Joint All-Domain Command and Control (CJADC2) vision by demonstrating zero trust security at the tactical edge during military exercises.
 

Click the Image Below to Watch: Senior Analyst John Caucis and Analyst James Wichert review key trends and happenings for the federal IT services market in 2024 as well as provide their outlook for the sector

A Different Route

Some vendors are also being creative. For example, BAH has seemingly favored making venture capital (VC) investments after spending over $725 million on M&A within a two-year period. By doing so, BAH can safely expand its capabilities and relationships without needing much financial leverage.

 

BAH launched Booz Allen Ventures, the company’s $100 million VC arm, in 3Q22. Since then, BAH’s capital allocation strategy has increasingly favored funding small promising companies that are innovating with emerging technologies. For example, in 3Q23 BAH invested in a startup AI security solutions developer called Hidden Layer.

 

Maximus also unveiled its own VC arm in 4Q23 called Maximus Ventures. However, unlike BAH, Maximus has not publicly shared any investments it has made with its VC arm and has stated little about Maximus Ventures other than noting the business was beginning to establish relationships with Seed to Series C partners.

Is M&A Activity Ramping Back Up?

While multiple leading federal systems integrators have indicated they will continue to deprioritize M& during 2024, there have been signs that company valuations have begun to decline, which could cause M&A activity to pick back up.

Recent Moves

ManTech was taken private by the Carlyle Group in September 2022 for $4.2 billion. As ManTech’s restructuring efforts continued, it leveraged the private equity company’s financial backing in September 2023 to purchase IT contractor Definitive Logic Corp. The move expanded not only ManTech’s headcount by 330 but also its AI, cloud and other digital transformation capabilities. It also expedited ManTech’s plans to provide a wider array of services to clients, such as by launching a digital transformation consulting practice.

 

While the acquisition of ManTech was notable, the biggest move from the vendors we cover came from AFS. In April the business announced its intent to buy digital transformation and cloud computing firm Cognosante. The deal was finalized in May and adds around 1,500 people to AFS’ workforce, strong relationships with health IT customers as well as a new health portfolio.

 

Shortly afterward, Deloitte announced it had acquired Gryphon Scientific. While this acquisition is significantly smaller in comparison to the other two acquisitions (Gryphon Scientific is expected to add around $6 million to $8 million in inorganic sales over the next year), it expands Deloitte’s public health research and advisory capabilities with AI and increases Deloitte’s expertise in biosecurity and data science.

 

These recent moves by AFS and Deloitte show that vendors are becoming increasingly interested in lucrative public health opportunities. While they could signal that a period of renewed M&A activity in federal IT is beginning, it is important to note that AFS and Deloitte have fundamentally different business models than most other federal players. They also have the scale and financial backing from their parent companies that most others do not have.

TBR Expectations for the Federal IT Services Market in FFY2025

When the M&A environment actually begins to ramp up, we anticipate that vendors will prioritize acquiring peers that can expand their niche capabilities in AI, cloud, cyber, electronic warfare (EW) and other areas as the DOD, IC and civilian agencies are showing more interest in emerging technologies. While private equity firms remain interested in expanding their capabilities in these areas as well, they will be under greater scrutiny by the Federal Trade Commission (FTC) and the Department of Justice’s (DOJ) Antitrust Division. These agencies published a request for information in May to assess how serial acquisitions are impacting competition in multiple industries including defense and cybersecurity.

 

If Tier 1 vendors do revive M&A activity in federal fiscal year 2025 (FFY2025), expect CACI to be one of the first to get involved. CACI has historically used acquisitions to expand its capabilities and penetrate new markets. Do not expect to see vendors abandon their alliance ecosystem or their joint ventures if this happens, though. Vendors will increasingly lean on the hyperscalers and partners that can help expand their capabilities with the emerging technologies as discussed in TBR’s U.S. Federal Cloud Ecosystem Report.

 

 

*TBR calculates organic growth based solely on the impact of acquisitions, unless the company in question provides guidance regarding the impact of divestitures on its top line. We consider the calendar quarter in which the acquisition was made to be the first of four calendar quarters, or one full year, in which inorganic revenue from the acquired company accrues to the acquiring company’s top line. After the one-year anniversary of the acquisition, we consider the peer purchase to be fully integrated from a revenue standpoint.