Serial acquirer ManTech International (NASDAQ: MANT) had been oddly quiet during a period of significant consolidation in the government services sector, but that changed on Feb. 27 when the contractor announced a $115 million purchase. The deal, though small compared with other government services transactions, has the potential to provide outsized returns thanks to some key contracts it brings with it.
ManTech is buying the government operations of professional staffing firm Kforce (NASDAQ: KFRC), gaining significant exposure to the Department of Veterans Affairs (VA) just as the agency is beginning a major effort to modernize its IT systems. The purchase fits well with a transformation going on at ManTech over the past few years, and helps make the case for the company as an intriguing investment.
Paying up for growth
Kforce Government Solutions (KGS) provides tech consulting, data management, and analytics to a range of civil and defense agencies, with about 60% of sales coming from the VA. The unit has more than 500 employees, and according to Kforce, generated EBITDA of $6.6 million on revenue of $98 million in 2018.
ManTech is trying to diversify away from Pentagon work. Image source: Getty Images.
ManTech will likely be able to extract significant back-office costs that will make the KGS business more profitable. But the purchase price is still somewhat lofty and is probably an indication that the KGS assets were of interest to multiple potential buyers. As they should be: The target is a prime contractor on the VA's "T4NG" IT modernization program that is expected to generate more than $22 billion in revenue through 2026.
For ManTech, the purchase continues the company's push to diversify away from pure Pentagon work and toward other federal agencies. ManTech has been a frequent buyer of small companies since its inception, but this is its first buy since a $180 million deal for InfoZen in 2017.
ManTech was hit hard earlier in the decade by the U.S. military drawdown in Afghanistan, and has been working to shift its business away from boots-on-the-ground type services and toward IT and other more steady work back at home.
More deals to come
ManTech might not be done with mergers and acquisitions (M&A). The company has one of the healthiest balance sheets in the sector, with just $2 million in net debt as of year-end, and finished 2018 with a backlog, at $8.4 billion, that has more than doubled since 2015.
The deal follows a wave of government-services consolidation that has created a number of titans in an industry where contract awards are often determined by price, and so scale is key. Industry leader Leidos Holdings, formed in 2016 via a merger with the IT business of Lockheed Martin, generated $10 billion in sales in 2018, versus ManTech's $1.96 billion in trailing 12-month revenue.
Elsewhere, General Dynamics expanded its services unit via a $9.7 billion deal for CSRA, and Science Applications International bought Engility Holdings for $2.5 billion.
ManTech management has pledged not to do deals for the sake of bulking up, with CEO Kevin Phillips on a conference call last year noting that "our size hasn't precluded us from winning two $800 million contracts. It hasn't precluded us from winning $4 billion of bookings."
Still, I doubt it is another 14 months before ManTech is making M&A news again. The company could be a buyer. Or it could be an enticing morsel for a larger competitor given its relatively small size (similar in revenue to Engility at the time it was sold), strong balance sheet, and a good range of high-value contracts including significant work for the intelligence community that doesn't often go out for rebid. The exposure to T4NG that it is getting via Kforce only adds to the attractiveness of ManTech to a potential buyer.
Multiple ways to win
It's unwise to invest based on a company's potential as a takeover target. Fortunately, a good case can be made to buy ManTech as an independent. It has good bookings momentum, and during the company's earnings call with investors last month, Phillips said the outlook for new business is "above average in terms of both bid volume and award volume" in the first half of the year. That would be great news if true, given ManTech still expects the third quarter, as typical, to be the heaviest in terms of total awards.
The company expects to submit $10 billion worth of proposals in 2019. It has limited recompete risk in 2019 and will have to resubmit a relatively light 20% to 25% of its business in 2020. Throw in the pristine balance sheet and a dividend yield of 1.8% that is on the generous side for government services firms, and ManTech looks like an attractive buy-and-hold with upside potential if the right transaction comes along.
ManTech has come a long way from doing outsourced logistics work and related tasks in the Middle East, and the Kforce deal is another step in the right direction. This is a stock that is worth a look.
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