Civilian IT Budget Continues Growth, but M&A Lags
According to Deltek, government spending on information technology is set to grow by $1.9 billion in GFY 2016 to $79.1 billion — a 2.5 percent increase. However, as the chart on the right shows, the Department of Defense (“DoD”) is not expected to reach its GFY 2014 level, and federal health agencies (Department of Health and Human Services’ (“HHS”) and Department of Veterans Affairs (“VA”)) have increased overall spending from GFY 2014 levels yet faced with headwinds from prior year. The only group that has shown consistent growth year-over-year are the Civilian agencies, as modernization spending has been a key focus. This continued growth further aligns Civilian agencies with priority technology trends in the Federal space (e.g. cloud computing, big data).
Despite this spending trend, the M&A activity paints a different picture. Of the representative Federal IT services transactions since 2014, DoD-focused sellers have dominated, representing ~67% of all targets, despite seeing a decrease in overall DoD IT spending. Moreover, federal health sellers represented 12% of Federal IT transactions and Civilian-focused sellers ~21%. What causes this misalignment?
One contributing factor is agencies allocation of set-aside, small business (“SB”) contracting dollars for both prime and subcontracting procurements. Evidenced by the U.S. Small Business Administrations (“SBA”) FY2015 SB procurement goals, on average, Civilian agencies look to allocate ~34% of prime and sub-contracting dollars to small business. For comparison, this percentage is 7% and 9% higher than Federal Health agencies and the DoD, respectively. How does this affect M&A? Given the challenges and conversion risks SB contracts bestow upon large business buyers, buyers continue to be very much risk-averse towards elevated percentages of SB revenue in a seller’s profile, a cross-agency issue. Given this trend, despite the increasing IT spending within the Civilian agencies, it remains to be seen if the M&A activity will increase in 2016.