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Peraton’s purchase of Perspecta: The latest move in the quest for scale in federal IT

Scale is king

Peraton’s purchase of Northrop Grumman’s (NYSE: NOC) IT services business and pending acquisition of Perspecta (NYSE: PRSP) are clearly aimed at obtaining the scale necessary to compete for large enterprise and digital transformation deals, which have become common in the public sector IT services market.

Peraton is hardly the first in this space to make such transformative purchases. SAIC (NYSE: SAIC) made two large acquisitions in two years with Engility and Unisys Federal in 2019 and 2020, respectively; General Dynamics IT (NYSE: GD) purchased CSRA in 2018; and Leidos (NYSE: LDOS) perhaps started the trend with its purchase of Lockheed Martin (NYSE: LMT) Information Systems & Global Solutions (IS&GS) in 2016. As federal agencies seek to modernize and transform their operations to take advantage of emerging technologies such as cloud, 5G, AI, machine learning, and AR and VR, large monolithic deals, such as the Next Generation Enterprise Networks Recompete (NGEN-R), Defense Enterprise Office Solution (DEOS), Global Solutions Management – Operations II (GSM-O II) and Joint Enterprise Defense Infrastructure (JEDI), among others, illustrate the importance of being able to deliver these technologies and surrounding services at scale.

Companies such as Leidos, General Dynamics Technologies (GDT) and Booz Allen Hamilton (NYSE: BAH) have come out as the clear winners on the vast majority of multibillion-dollar deals like the ones mentioned above, thanks largely to their ability to deliver digital transformation at scale and proven past performance. TBR believes this trend is only going to become more pervasive in 2021 as the federal government pursues continued IT modernization across defense, intelligence and civilian agencies. Alternatively, if the federal government begins to move toward smaller contracts in terms of total value and/or duration, Peraton’s newly acquired scale would no longer be an asset. However, this is likely only a long-term concern, as the federal government shows no signs of ramping down contract sizes or duration for the foreseeable future.  

Why Perspecta had to die

Perhaps nothing illustrates the importance of scale more than the death of Perspecta. When the company was formed from the merger of DXC Technology’s (NYSE: DXC) public sector business with Vencore and KeyPoint Government Solutions in 2018, the clear intention was to create a federally focused contractor of scale that could compete for the large transformative deals that have become commonplace. Most important among these was the NGEN-R contract, whose predecessor, the NGEN contract, was held by Perspecta and represented nearly 20% of the company’s total revenue.

Despite this, Perspecta was unable to win the $7.7 billion NGEN-R, which was awarded to Leidos and will begin to ramp up in 2H21, leaving Perspecta with a loss of 19% of its total revenue, which cannot be replaced quickly enough to avoid steep losses year-to-year.

Losing the NGEN-R bid put Perspecta in a very difficult place, beyond the obvious financial burden. The company’s leadership has fielded tough questions from Wall Street about where the company is headed without NGEN-R. Perspecta has been unable to win any comparable deals, such as DEOS or GSM-O II, on which it has bid in the last year or two. Additionally, the company does not have as strong of a portfolio in emerging technologies as many of its competitors, and it is highly unlikely Perspecta on its own could have returned to growth quickly enough to appease its stakeholders. In this context, it is clear that Perspecta needed to die. With its pending sale to Peraton, there is opportunity to reemerge as a more formidable competitor in the federal IT services market, free from the burdens associated with its past failures as part of Peraton.

On Jan. 27, Perspecta announced its purchase by Peraton, a Veritas Capital portfolio company, for an all-cash price of $7.1 billion. This acquisition comes on the heels of Peraton’s purchase of Northrop Grumman’s IT services business, which closed Feb. 1 (outlined in TBR’s special report End game for Northrop Grumman’s IT services business). The resulting company, which will retain the Peraton name, will be a $7.6 billion to $7.9 billion business on a pro forma basis with approximately 24,300 employees, in TBR’s estimates.

Two Back, Three Forward: All about consecutive quarters

In our new weekly blog series Two Back, Three Forward, we look at two numbers in TBR reports from the prior week as well as three numbers from our upcoming reports, highlighting the analysis TBR provides and the vast amount of data — the numbers — we’re working with every day. It’s all about the data and what that data means to you.

Two Back

$1.47B, Cognizant’s 4Q19 earnings from financial services clients: As noted in our full report, Cognizant’s Financial Services (FS) revenue increased last quarter, but at a slower pace than the company overall, partly due to softness from European banking clients, according to Cognizant. We’ve heard this complaint from other India-centric vendors and will be publishing a special report this month on what those companies have been doing to offset those pressures. To keep some context, FS remains Cognizant’s largest vertical, at 34.3%, but this trend bears watching.

3, consecutive quarters IBM’s healthcare IT services revenue has declined: 2019 was unquestionably an off year for IBM’s healthcare IT services (HITS), but our most recent analysis indicates the company will rebound in 2020 through new leadership, partnerships and technologies. Considering IBM’s long history of excelling in all three of those areas, we’re predicting a modest 2.2% expansion this year. See the full IBM HITS report for all the analysis.

Three Forward

71.2%, contribution of DXC Technology’s Cloud Professional Services segment to overall cloud revenue, per TBR estimates: Nothing surprising about cloud professional services earning the greatest share of revenue, but what stands out is the 9.6% growth rate of that service line within DXC’s overall cloud practice. Ahead of the other service lines and far better than the company as a whole (-3% over the same period). As we note in the upcoming full report, “DXC’s established relationships with major public cloud providers such as Microsoft and AWS [Amazon Web Services] enable the company to build out integrated solutions and maintain healthy growth in 2020 providing cloud management and migration services.” Further, the company continues investing in cloud-savvy professionals even as it bolsters its traditional IT services talent. DXC’s long-term strategy, including around cloud, appears solid.

More than 50%, Capgemini’s digital and cloud revenues as a percentage of total revenue: Like most IT services peers, Capgemini has strategically shifted resources and investments toward new opportunities in cloud and digital, in part through expanding capabilities alongside partners, developing solutions with partners like AWS, and acquiring talent and IP. Even if revenue growth slows from 5.3% year-to-year in constant currency in 2019 to something closer to 4% in 2020, as Capgemini expects, we don’t expect digital and cloud revenues will ever again dip below the 50% line, even if Capgemini joins market leaders in moving beyond the term digital.

3, consecutive quarters in which Perspecta elevated its FY20 guidance: Due to accelerated demand and strong bookings of net-new work, Perspecta is now guiding for annual revenue growth of between $4.45 billion and $4.5 billion, or 4.1% and 5.3%, over FY19. Even with healthy revenue growth, TBR projects the company’s full-year gross margin will erode 2020 (declining from 24.9% in 2019 to 23.6% in 2020) due to  accumulating costs from its acquisition of Knight Point Systems, the launch of new delivery facilities, and investment in Perspecta Labs. Perspecta’s 2020 operating margin should increase 10 points over 2019, from 6.2% to 6.3%, as unprofitable contracts are completed and Perspecta converts strong bookings of more lucrative and net-new contracts featuring the company’s expanding store of homegrown IP. In all, TBR sees steady growth as more important than financial guidance adjustments, given our concern for strategy and performance, not stock price.

Integration challenges ahead for Perspecta and SAIC as federal sector IT services vendors position for the rest of 2019

Publishing this week from TBR’s federal IT research program are our initial assessments of SAIC’s and Perspecta’s 1Q19 earnings performances. Perspecta is wrapping up its first complete fiscal year as an independent business entity. Its inaugural year has been characterized by significant challenges integrating a trio of large-scale legacy federal IT competitors, and we expect this will be reflected in its fiscal performance for 1Q19 and its FY19. The company won major contract extensions and successful re-compete bids to close out its FY19, setting the stage for improved performance in an increasingly growth-friendly federal IT market in its FY20.

SAIC will fully integrate Engility and its nearly $1.9 billion in revenue and 7,500 employees during the year, finishing a process that started in 1Q19. SAIC will leverage Engility to further accelerate its expansion with a more balanced, diversified and de-risked portfolio and an enhanced competitive stance in markets (space and intelligence) adjacent to its core Department of Defense and federal civilian sectors.

Read more of Senior Analyst John Caucis’ assessment of federal IT services vendors through the quarter and the upcoming quarterly benchmark.

Additional assessments publishing this week from our analyst teams

Wednesday

  • Salesforce continues to expand its global reach with new infrastructure investments and local partnerships in key regions. These developments, alongside ongoing improvements to its core portfolio in recent quarters, will enable Salesforce to deliver $3.68 billion in revenue for CY1Q19, according to TBR estimates. — Jack McElwee, Analyst

Thursday

  • TBR’s 1Q19 Cisco report explores how Cisco sustained revenue growth momentum in 1Q19 despite a significant slowdown in its Service Provider customer segment, where communication service providers are focusing much of their investment on the RAN layer and software-defined networking is causing disruption. Outside the service provider segment, however, Cisco’s refreshed product lines and strong brand are resonating across SMBs, large enterprises and public sector organizations. Cisco completed the refresh of its enterprise switching lineup with the introduction of the latest Catalyst product in 1Q19, which will help drive continued growth across non-service provider segments. — Michael Soper, Senior Analyst
  • Cisco Customer Experience’s use of partners to develop its portfolio around analytics, IoT and security as well as supplement delivery enables the company to maintain profitability and generate growth, as highlighted in TBR’s 1Q19 coverage of the company. Its pursuit of partnerships with technology-led vendors, including Microsoft Azure, Amazon Web Services and Google Cloud, will help Cisco Customer Experience generate additional advisory, implementation, and software and solutions support engagements. — Kelly Lesiczka, Analyst

And sign up here for the next TBR webinar, The Makings of the Telecom Edge Compute Market.

TBR Weekly Preview: March 4-8

As we start winding down beginning-of-the-year earnings calls, here’s what you can expect from the TBR team this week:

Tuesday:

  • In 3Q18 TBR noted Salesforce built on its industry-specific strategies by releasing Financial Services Cloud for retail banking and by expanding its target audience for Education Cloud. Salesforce’s ongoing innovation to address vertical use cases and ability to understand customers’ business needs enabled the vendor to execute multiproduct deals in 4Q18. TBR expects Salesforce will close 4Q18 with $12.2 billion in annual revenue, keeping the vendor on track to attain its $21 billion to $23 billion annual revenue goal in 2021. (See Jack McElwee for more analysis.)
  • Google Cloud’s hiring of Thomas Kurian as CEO (replacing Diane Greene) is meant to attract enterprise customers and facilitate stronger competition at scale with Amazon Web Services and Microsoft; Kurian, former Oracle president of Product Development, brings deep understanding and detailed messaging on the technical and business impacts of cloud. TBR’s 4Q18 report will detail Google Cloud’s continued innovation among its core AI and ML portfolios while partnering and leveraging Kurian’s clout to gain enterprise mindshare, which will be increasingly critical to long-term success. (For everything Google and cloud, see Cassandra Mooshian.)

Thursday:

  • Cisco continues to grow revenue as it transforms itself through acquisitions, divestments and new product releases that enable the company to reduce its reliance on hardware — a commoditizing market — and embrace software. TBR’s 4Q18 Cisco report will include deep dives on Cisco’s most recent acquisitions, including Luxtera, which will help Cisco attract more webscale spend and improve the performance of its proprietary-based solutions, as well as Ensoft and Singularity Networks, which will broaden Cisco’s software capabilities in the service provider space. (Mike Soper leads TBR’s analysis on Cisco.)
  • TBR will also report on Cisco Services and the company’s expansion around software and next-generation solutions, which has created advisory and implementation opportunities that enabled Cisco Services to accelerate growth in 2018. An increase in software-related services as well as adoption of next-generation secure and intelligent platforms and products that support clients’ digital business will create attached services opportunities for Cisco Services, driving revenue expansion throughout 2019. (For more on Cisco Services, see Kelly Lesiczka.)
  • TBR’s latest report on Perspecta will provide an update on how the fledgling company is managing the task of integrating three legacy organizations into a unified whole. In past reports, we have talked about how the company’s innovation incubator, Perspecta Labs, underpins its long-term position in the federal services landscape. Our 4Q18 Perspecta report will dive more deeply into how the company introduces Perspecta Labs to its biggest client, the U.S. Navy, in advance of the recompete of Perspecta’s largest contract, which entails managing the Navy Next Generation Enterprise Network. (Joey Cresta heads up TBR’s Public Sector practice.)
  • As reported in our initial response, NetApp earned $1.6 billion in revenue in 4Q18, representing a 1.6% year-to-year increase. Strong 1H18 revenue momentum enabled the vendor to achieve solid year-to-year revenue growth for 2018, demonstrating the success of some of NetApp’s strategic moves during the year. Our full report will dive into the 2018 establishment of a cloud infrastructure business unit that will enable NetApp to pivot its portfolio further in 2019, as the company, one of the few major pure play storage vendors left in the market, transforms itself to establish its brand as one that enables customers’ digital transformations. (See Stephanie Long for more analysis.)

Friday:

  • Utilizing its technology expertise and ability to address clients’ business challenges, Capgemini reached its 2018 revenue growth and profitability goals and is confidently moving into 2019. Capgemini’s bookings reached their highest level since 1Q17 in 4Q18. In the latest full report, TBR will note how the increase in bookings, combined with Capgemini’s unified go-to-market approach; enhanced offerings around digital, cloud and industry-specific solutions; and reinforced expertise via training and reskilling, will enable the company to sustain revenue growth. (Elitsa Bakalova covers Capgemini for TBR.)

Be on the lookout for additional analysis from TBR, including assessments of Accenture Technology and TELUS International. TBR’s next webinar will be held March 20 and feature Senior Analyst John Caucis talking about healthcare IT services.

Services Weekly Preview: Nov. 11-16, 2018

As we build toward the middle of the quarter, we’re wrapping up our periodic assessments of IT services vendors. Like last week, we also have some semiannual analysis on vendors in the management consulting space.

Monday: 

  • KPMG’s risk-averse culture pressured its performance, causing the firm to drop a spot in terms of revenue size among peers in the latest assessment of the management consulting practice. A potential KPMG and Bain marriage, however, could be a way for the firm to catch up with rivals and disrupt the management consulting space.
  • Continued expansion of its onshore presence, including the recent build-out of its co-innovation center in London, improves HCLT’s value proposition by enabling it to work alongside its clients to create larger-scale transformation engagements. However, HCLT faces some challenges in recruiting talent to support new centers, spurring the implementation of employee development programs.

Tuesday: Although Atos will grow revenues at a slower rate in 2018, the expansion of the company’s Digital Transformation Factory portfolio and recently announced acquisition of SIX Payment Services, which is expected to close in 4Q18, will enable the company to accelerate revenue growth in 2019. TBR’s 3Q18 Atos report analyzes the implications from Atos’ ongoing activities, such as the Syntel acquisition and investments artificial intelligence (AI) and security solutions and capabilities.

Wednesday:

  • Senior Analyst Jen Hamel examines EY’s strategy to provide clients with technological enablement of business transformation in her profile on the firm for our Fall 2018 Management Consulting Benchmark. One key takeaway: Increasing its investment in technology-enabled services, including those involving blockchain and AI, by $1 billion over the next two years will improve EY’s competitiveness with solutions-led peers IBM and Accenture.
  • We continue looking for signs Wipro will see improved performance, as its India-centric peers have, to align with its digital transformation strategy and expanded portfolio and capabilities. In this latest assessment, we’re still searching.
  • Capgemini has made changes to its portfolio, organizational structure and sales model to address rising demand from clients’ business side, rather than their technology side. In TBR’s 3Q18 Capgemini report, we will dive deeper into topics such as AI, digital marketing, and Capgemini Invent, the new global business line Capgemini launched in September.
  • In TBR’s 3Q18 Perspecta Initial Response, we will provide an overview of Perspecta’s second quarter as an independent company. Made up of Hewlett Packard Enterprise’s former U.S. Public Sector business, Vencore and KeyPoint Government Solutions, Perspecta faces some challenging financial and resource-related issues as it works to find its footing as a stand-alone company.  

Thursday:

  • TBR’s 3Q18 Raytheon Intelligence, Information & Services (IIS) full report explores how the emerging geopolitical power struggle in space and cyberspace plays to Raytheon’s strengths in cyber hardening, computer network operations, advanced analytics and AI. The report examines how IIS was able to outgrow federal IT services competitors in 3Q18 and how its deep mission knowledge in the U.S. provides a strong foundation as it pursues riskier adjacent market opportunities in volatile markets such as the Middle East.
  • TBR’s 3Q18 Leidos full report examines the company’s first quarter of year-to-year organic revenue growth since it acquired Lockheed Martin’s IT services business in 2016. The report explains Leidos’ positioning across defense, health and civilian markets and how the company is adjusting to disruption amid the federal market’s shift from bespoke proprietary technology development to configurable commercial-off-the-shelf IT solutions.
  • In our 3Q18 results on Wednesday, TBR expects Cisco Services to continue to accelerate revenue growth during the rest of 2018 and in 2019, positively affected by Cisco’s ongoing portfolio investments in and acquisitions around next-generation and software-driven solutions that generate professional services opportunities. TBR expects Cisco’s recent acquisitions and partnerships in cloud, security and networking to generate increased professional and technical support services for Cisco Services during the coming quarters.

Friday:

  • The previous edition of TBR’s Management Consulting Benchmark Profile: PwC described the firm’s efforts to make its Business, Experience, Technology (BXT) framework a companywide endeavor. Six months later, we’ve seen signs the firm’s ambitions around BXT have evolved from aspirational to operational, with global examples of the framework becoming an on-the-ground reality in working with clients.
  • Partners enable Fujitsu to enhance its core services with cloud, software and digital capabilities, helping to ease clients’ transition into emerging areas while offsetting declines from traditional services. However, without expanding its client base outside of Japan, Fujitsu could face challenges in maintaining revenue growth.

Federal initiatives around IT modernization translate to revenue growth for public sector services providers

Growth opportunities across defense and civilian agencies uplift vendor performance

The results of TBR’s 2Q18 Public Sector IT Services Benchmark demonstrate clear top-line benefits for services providers as government agencies accelerate IT modernization initiatives. Revenue for the 16 benchmarked vendors improved 5.3% year-to-year, which does not even factor in General Dynamics IT essentially doubling in size through its acquisition of CSRA. Including the impact of the acquisition, revenue grew 13.5% from 2Q17.

Graph showing weighted average total year-to-year revenue growth versus organic year-to-year revenue growth for 2Q17 through estimated 3Q18

Industry consolidation remains a prevailing theme in the market as the near-term opportunities tied to U.S. federal budget growth and the pursuit of innovation create a sense of urgency for vendors to capitalize. Scale advantages, complementary capabilities and broadened customer relationships make consolidation a compelling tool to facilitate near-term deal capture. Consolidation will remain a prominent strategic concern, evidenced by the announcement after the close of 2Q18 that SAIC (NYSE: SAIC) plans to acquire Engility (NYSE: EGL). However, in the long run, TBR anticipates the importance of scale will diminish as rapid technological change disrupts legacy business models.

TBR believes that the door is open for industry stalwarts to be disrupted if they elect to ignore the prevailing signs that the federal government, in particular the U.S. Department of Defense, seeks change in how it procures and fields technology.

 

TBR’s Public Sector IT Services Benchmark examines the key strategies, investments and performance metrics of leading government consultants, systems integrators, and IT and professional services providers. The benchmark examines 16 vendors across three groups: services units of aerospace and defense firms, U.S. federal government pure play vendors, and public sector verticals of commercially led IT services companies. We mix qualitative analysis of key investments and strategic initiatives with quantitative analysis of financial performance to uncover the drivers of business success for vendors that offer services to government customers.