CACI International (CACI 0.02%) has been one of the most aggressive players in the rapidly-consolidating government services sector. The company last year fell short in its audacious bid to steal CSRA from the arms of defense titan General Dynamics, but in the quarters since has found intriguing ways to deploy its firepower.
CACI on January 30 said it would acquire two privately-held companies, LGS Innovations and Mastodon Design, for a combined $975 million, continuing its push towards higher-value specialized products and away from vanilla consulting and IT management contracts. The deals, coupled with encouraging fiscal second quarter results, are evidence that an ongoing shift in focus by the company is beginning to take shape. Growth-focused investors would be wise to take notice.
The details
The two target companies CACI is buying both specialize in electronic warfare and signal intelligence. LGS, which got its start as the government R&D unit inside the famed Bell Laboratories and was later spun off as part of Lucent Technologies, is a provider of spectrum management, cyber and intelligence products, and command and control products for the Pentagon and intelligence agencies. Mastodon Design, meanwhile, specializes in rugged and light-weight modules used for signal intelligence and electronic warfare.
Government contractor CACI International is going on the offensive. Image source: Getty Images.
CACI earlier in the decade established its electronic warfare credentials with a $820 million deal for Six3 Systems. Company CEO Ken Asbury, speaking on a call with analysts following the earnings release, said the newly-acquired businesses will complement CACI's existing businesses and fill in some product gaps and create a one-stop shop for a range of products.
Current CACI products and solutions will utilize the technologies and manufacturing capabilities of both LGS and Mastodon. Likewise, LGS and Mastodon can integrate CACI's set of capabilities into their product and solutions while greatly expanding their access to the CACI customer base. Combined, we will be able to provide truly differentiated offerings in real-time spectrum management, signals analysis and exploitation, again, EW, photonics and cyber.
CACI said it expects the purchases to add about $480 million in revenue and $82 million in Ebitda over the next 12 months, a significant addition for a company that reported $4.64 billion in total sales and Ebitda of $456.86 million in the last twelve months.
On the earnings front CACI's $2.71 earnings per share figure easily beat analyst expectations of $2.25 per share as stronger-than-expected results from operations offset a higher tax rate. The company's 8.7% Ebit margin was up slightly from a year prior, though free cash flow was dampened by the cost of a new facility and shutdown-related closures of some government payment offices late in the quarter.
CACI also raised its full-year guidance to earnings per share of $9.96 to $10.35, up from $9.77 to $10.16, to reflect the contribution of the acquired businesses and "improved performance in the core CACI."
What it means
CACI has been working for years to shift away from its traditional role of providing outsourced IT services and other consulting and towards higher-value technologies, a push that has become more urgent due to a wave of consolidation in the government IT sector that has created a handful of large players who are better able to compete on price.
Since the beginning of 2016, Leidos Holdings acquired the IT business of Lockheed Martin for $4.6 billion, General Dynamics paid $9.7 billion for CSRA, and more recently Science Applications International Corp. acquired Engility Holdings.
CACI tried to match that scale with its attempt at CSRA, but this specialization route appears to be a better option. The businesses the company is acquiring have higher margins and less recompete risk than traditional IT work, because the government customer is willing to pay up for effective specialized equipment. CACI through these deals is establishing itself as a priority vendor for the intelligence community and the Army in particular.
There are risks to dealmaking. CACI is paying a rich 11.9 times forward Ebitda projections for the properties, although that figure will be reduced somewhat by the estimated $140 million in transaction-related tax benefits that are expected. CACI is also levering up to fund the transactions and expects to have net debt 3.5 times Ebitda at close. CACI is an experienced acquirer and has worked with these businesses in the past, so management should have a clear integration road map in place, but will have to tread carefully to make sure the purchases turn out as planned.
The company ended the quarter with a backlog of $13 billion, up 16% from a year prior, and it has nearly $10 billion in submitted bids awaiting award. About 80% of those submissions are for new work, and not defending existing contracts from competitors. CACI said it expects to submit another $14.3 billion worth of bids before the end of June, with 70% of that total attempts at new business. The company isn't likely to win all that work, but even some modest success there would help boost growth heading into 2020.
The truth is CACI is being aggressive because it has to be, and for most investors I prefer more-established rivals including Leidos and Booz Allen Hamilton that aren't under as much pressure to act. But I believe CACI's strategy is on target, and management so far is doing a good job of executing on that strategy.
CACI, trading at 16.25 times trailing earnings, is also cheaper than Booz Allen (21.48x) or Leidos (18.05x). For those with a tolerance for some risk, CACI is a stock worth taking a look at.
