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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.

Enterprises leverage disruptive emerging technologies within their operations to improve processes and accelerate digital transformation

Extension remains the most natural jumping-off point for digital transformation (DT) initiatives, as enterprises can experiment with disruptive technologies within familiar business operations, see their value in generating new business insights, and then use those insights to re-imagine processes. TBR’s Digital Transformation Insights Report: Voice of the Customer shows that vendors need to orient toward development of pointed, industry-centric solutions to retain mindshare. This report, authored by Senior Analyst Boz Hristov, shares survey results across a spectrum of DT issues as well as excerpts from extensive, in-depth discussions with clients currently purchasing DT services.

Additional assessments publishing this week from our analyst teams

While trailing 12-month IT services revenue growth decelerated from 4Q18 to 1Q19, according to TBR’s IT Services Vendor Benchmark, year-to-year growth in 1Q19 of 2.6% surpassed that of 1Q18, which was 2.2%. Vendors are investing in niche digital design areas and industry expertise to drive advisory services activities with C-Suite executives. They are also leveraging established footholds and trust with new buyers to pursue managed services around clients’ application and infrastructure estates. Improving profitability provides vendors with flexibility to invest gains in high-growth and high-value technology-enabled solutions. — Elitsa Bakalova, Senior Analyst

In TBR’s 2Q19 Accenture Initial Response we continue to assess if scale and appetite for innovation still define and shape Accenture’s success as it becomes a solutions broker. We will also look into how platforms supporting omnichannel architecture will underpin Accenture’s efforts to capture custom work and reach $47 billion in sales by 2020. — Boz Hristov

In 1Q19 Dell EMC’s Infrastructure Solutions Group faced year-to-year revenue declines across all segments, including storage, servers and networking, due to a combination of seasonality headwinds and go-to-market challenges. As Dell EMC’s cloud revenue is largely tied to hardware sales, these same challenges compromised its cloud top-line performance. An increasingly strategic partnership with VMware coupled with the new Dell Technologies Cloud portfolio will help boost performance in coming quarters. — Cassandra Mooshian, Senior Analyst

TBR’s Hyperconverged and Converged Market Landscape explores the vendor landscape of these two markets, including leaders and laggards, and the existing and emerging disruptors in the space. This report details recent announcements in the space made by key vendors as well as the disruptive dynamics of emerging hardware trends from nontraditional vendors, such as Amazon Web Services (AWS) with its AWS Outposts.— Stephanie Long, Analyst

TBR’s Hyperconverged Platforms Customer Research surveys hyperconverged customers to analyze purchasing patterns, spending habits, adoption trends and the evolving drivers behind vendor selection. Key highlights of this report include customer desire to leverage hyperconverged infrastructure (HCI) for private cloud environments and the ongoing shift to consumption-based pricing. We also surveyed current HCI customers to determine their likelihood of adopting AWS Outposts, along with where customers will pull funding from to support this new hardware model. — Stephanie Long

SAIC officially began its integration of Engility’s nearly $1.9 billion in revenue and 7,500 employees in 1Q19, aiming to leverage Engility to accelerate its expansion with a more balanced, diversified and lower-risk portfolio and an enhanced competitive stance in markets adjacent to its core Department of Defense and federal civilian sectors, particularly space and intelligence. A new leadership era is also beginning at the top of SAIC’s executive management, as CEO Tony Moraco will retire effective July 31 and will be succeeded by COO Nazzic Keene, who was elected to the CEO post by SAIC’s board of directors in March. Keene has already implemented numerous changes during the CEO transition period as part of the broader initiative she has spearheaded to flatten SAIC’s management pyramid and streamline operations amid the integration of Engility.— John Caucis, John Caucis

TBR’s 1Q19 Booz Allen Hamilton (BAH) report details how the company completed its fiscal 2019 with strong top-line expansion and record revenues, better-than-anticipated earnings, and its largest quarterly dividend increase in years. BAH’s performance throughout its last fiscal year reflects a soundly differentiated market position and multilayered alignment of the company’s technology and advisory portfolio with the primary missions of its federal customers. In May 2015, when BAH launched its Vision 2020 strategy, industry and company observers criticized the plan over concerns BAH would be investing ahead of demand, which had yet to materialize. BAH has sustained a top-line growth CAGR of nearly 6.2% and an average operating margin of 8.5% (both in excess of peer averages for these metrics in TBR’s Public Sector IT Services Benchmark) since Vision 2020 was enacted, affirming the strategic framework was well conceived and has been well executed. — John Caucis

Tune in Wednesday at 1 p.m. EDT to hear Stephanie Long share highlights from TBR’s HCI research including exclusive recent findings from TBR’s Hyperconverged Platforms Customer Research. The webinar will highlight how the HCI market has shifted over the last few years and where TBR sees it headed. Additionally, this will be a great opportunity to ask our analysts your questions about the HCI market. Sign up today!

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.

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.

Post SAIC-Engility question: who and what next?

SAIC has now made their deal, so we can take them off the table as a buyer of scale. They have to digest Engility and make that combination work as the federal IT environment continues to change and change fast, as Technology Business Research public sector IT analyst Joey Cresta wrote in a research note Monday.

“SAIC’s long‐term challenge will be no different than it is today: the automation of transactional tasks and the technology‐driven compression of windows of competitive advantage threaten its legacy business model,” Cresta wrote. “(Intellectual property) monetization will help to define winners and losers amid these disruptive environmental factors.”

Full article

Consolidation accelerates in government contracting. Who’s next in M&A?

Joey Cresta, an analyst with Technology Business Research Inc. in Hampton, New Hampshire, who closely tracks the government services market, wonders if SAIC’s (NYSE: SAIC) deal for Engility — a marriage of two legacy companies providing systems engineering and technical assistance (SETA) services to the government — might signal the beginning of the end of contractors chasing scale.

That advantage, Cresta writes in a new research note, erodes in an era where in-demand, agile tech skills, industry partnerships and expanding intellectual property portfolios will provide more of a competitive advantage than size.

“If SAIC focuses purely on the scale advantage of the Engility deal rather than the IP monetization factor, it could in short order find itself in a race to the bottom,” he adds, “with diminished pricing due to labor automation hamstringing financial flexibility and capacity for continued reinvestment to keep up with the ever-accelerating pace of technological change.”

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Legacy’s last gasp: SAIC, Engility and the importance of skills over scale

SAIC’s planned purchase of Engility combines federal contractors with business models similarly disrupted by the march of technology

Themes of consolidation continued to pervade the U.S. federal government IT and professional services market on Monday, Sept. 10, with SAIC (NYSE: SAIC) announcing it will acquire peer Engility (NYSE: EGL). The proposed deal would combine two legacy providers of systems engineering and technical assistance (SETA) and ITO services to U.S. defense, intelligence, civilian and space agencies. The combination makes strategic sense for both parties as the commoditization of labor-based services compresses margins, compelling companies to look for scale advantages to optimize cost structures and maintain competitiveness to capitalize on the federal market’s current upswing.

The proposed deal would add to the lengthy list of market-shaping acquisitions and divestitures over the past five years. SAIC can be viewed as an instigator of the trend, as the company split from its former parent company, now Leidos (NYSE: LDOS), in 2013. Engility has also played a role in the industry’s consolidation through its acquisition of TASC in 2015. In the few years since, Leidos purchased Lockheed Martin’s (NYSE: LMT) IT services business, CSRA briefly gained independence before combining with General Dynamics IT (GDIT) earlier this year, and another new company, Perspecta (NYSE: PRSP), emerged from the combination of DXC Technology (NYSE: DXC) U.S. Public Sector assets with Vencore and KeyPoint Government Solutions.

While scale motivated all of these moves to varying degrees, SAIC’s planned purchase of Engility may represent the beginning of the end of this trend. As rapid technological change disrupts legacy business models, TBR believes the importance of scale will diminish. The deal will help SAIC in the near term, but what the company does next will determine its long-term survivability in the Business of One era.

Engility, CACI and SAIC do the federal services consolidation tango

On Wednesday, July 11, Reuters released an exclusive report citing unnamed sources that U.S. federal services contractor Engility (NYSE: EGL) is exploring a sale. The report noted interest in Engility from federal services peers CACI (NYSE: CACI) and SAIC (NYSE: SAIC), which both dwarf Engility in size at $4.45 billion and $4.55 billion, respectively, in TBR-estimated 2018 revenues, compared with Engility’s $1.87 billion. The report was no surprise to TBR, as we have been monitoring the consolidation trend within the federal services sector over the past several years, including past deals such as CACI’s acquisition of L-3 National Security Solutions, Leidos’ purchase of Lockheed Martin Information Systems & Global Solutions and General Dynamics’ recently completed acquisition of CSRA.

SAIC sees more market stability & another CR in September

To remain competitive in those (SETA) areas may require engaging in M&A to add scale; alternatively, moving up the value chain means investing more in applications development and higher-skilled talent. SAIC has options, and its next choices will determine its fate in a rapidly changing industry. — Joey Cresta, Analyst

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