Strategic Drivers of M&A in the Middle Market, Part III: The Importance of Priority Market Access
A strong driver of “middle market” M&A over the past five years has been (and we expect to continue to be) sellers’ presence within priority, well-funded customer and capability markets. Between 2001 and 2009, Federal spending on contractor services grew at an unprecedented rate, primarily driven by ongoing military action overseas, the growth of the U.S. intelligence apparatus, and the maturation of the Federal IT environment. The proverbial “high tide” certainly benefited all ships, including the large defense contractors and system integrators, who consequently came to be viewed as attractive investment opportunities by public market investors. However, the origins of today’s budget realities began taking form in 2010, and the growth opportunities that once abounded had quickly become scarce.
Companies were forced to quickly refocus their corporate growth strategies towards areas that would continue to prove lucrative despite the broader market downturn – cybersecurity, intelligence operations, cloud computing, “Big Data,” and healthcare IT. In today’s market, the strategies are largely the same, and the quickest, highest-impact way to acquire in-demand customers and capabilities is via M&A. Acquisitions of small and middle-market contractors in these priority areas afford an opportunity to quickly acquire scale, customer relationships, and market credibility. Moreover, smaller acquisitions in priority markets send a positive, “growth-oriented” message to the industry (and sometimes the investor base), which in turn motivates additional goodwill for the acquirer.
Between 2009 and 2011, we witnessed a string of “priority market” acquisitions from several of the large primes in the industry, whose low costs of capital and mature corporate infrastructures can acquire, integrate, and leverage small targets to generate revenue synergies. Since 2011, we’ve continued to see “priority market” acquisitions drive a sizable amount of activity, but with a higher level of involvement from small- and middle-market acquirers, who are building their corporate strategy around priority growth markets and largely avoiding the diversified nature of their larger competitors. For example, Vistronix completed a string of small acquisitions in late 2014 (e.g., ExaTech Solutions, Objective Solutions, Agency Consulting Group) to build up its capabilities in the cloud computing, Big Data, cybersecurity, and intelligence operations; this represents a concerted corporate strategy by Vistronix to harvest differentiated skill sets in order to position itself well within well-funded, growing markets. Novetta Solutions has executed a similar strategy in the past few years, with acquisitions such as Sentinel Applied Analytics (Big Data; 2014), Global News Intelligence (Big Data, Intel; 2014), and International Biometric Group (Cybersecurity, Intelligence; 2012). As the uncertain political and budget environments persist in the Federal space, we expect to continue to view buyers, both large and small, look to reinvent themselves within priority markets through M&A.