SRA Today, CACI Tomorrow?

By Stephen D. Simpson, CFA | March 31, 2011 AAA

Acquisition announcements on Fridays are a bit rare, but that was about the only really surprising part of the announcement that IT services provider SRA International (NYSE:SRX) was taking a bid to sell itself. What may be more interesting for investors, though, is the speculation as to whether SRA will get a competing bid and/or whether other leading IT service companies may see a revaluation of their shares.

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SRA - A Solid Bid at Last
There have been rumors for a little while that SRA was attracting buyout interest. There was a rumor back in January that Britain's Serco had offered $2 billion, and the company has basically been in play ever since. Those rumors came to some fruition with the announcement Friday that the company had accepted a bid from Providence Equity Partners for $31.25 a share in cash, or a total deal value of $1.9 billion.

At $31.25 a share, Providence is giving shareholders a 10% premium to Thursday's closing price and more than a 50% premium to the price before the deal speculation really got going. Like the eBay (Nasdaq:EBAY) deal for GSI Commerce (Nasdaq:GSIC), this offer is including a 30-day go-shop period; likely in the hopes of de-fanging the ambulance-chasing class action suits that seem to be popping up these days whenever a deal is announced. (For more, see Is eBay Looking At GSI Commerce As Another PayPal?)

It is also worth noting that management specifically addressed the supposed Serco bid. Though they did not mention Serco by name, they indicated that they had never actually received a bid for $2 billion and had instead only received "expression of interest" in a deal with a price between $30 and $31 a share.

Anybody Next?
SRA is hardly alone in its business of providing consulting, system design and integration services to government clients. What's more, worries about future federal and state budgets have many of SRA's rivals trading at valuations that presume pretty unimpressive growth in the future. Perhaps this deal will stimulate a little M&A activity in the sector and/or a revaluation of some of these shares.

CACI International (Nasdaq:CACI) jumps to mind as one of these candidates. CACI is indeed heavily dependent on the federal government and areas like defense, intelligence and homeland defense particularly, but the company has been seeing good bookings of late. This company would do well to convince investors that it can reverse an unappealing downward trend in operating margins (and returns on capital), but this stock does not look expensive on even modest future growth expectations.

ManTech (Nasdaq:MANT) would likewise seem to be vulnerable to broad cutbacks in government spending. That said, equal across-the-board cuts are not how budgets are typically managed, and the company's focus on counter-terrorism and cybersecurity is likely to be a strong buffer to whatever budget cuts may come. ManTech likewise seems too cheap even with modest forward growth projections.

Along similar lines, while SAIC (NYSE:SAI) gets about three-quarters of its revenue from the Department of Defense, areas like intelligence, surveillance, cyber security, energy and healthcare are not likely to see major spending cuts anytime soon. That means that investors might want to seriously consider this stock, as it offers a double-digit return on capital, an EV/EBITDA of around six, and a solid history of above-market growth and improving margins. (For more, see Mergers And Acquisitions: Understanding Takeovers.)

The Bottom Line
Although SRX shares very briefly traded above the deal price in early Friday trading, it is anyone's guess as to whether there will be a rival offering. There is no question that private equity groups are flush with cash. Moreover, a major defense company like L-3 Communications (NYSE:LLL) Lockheed Martin (NYSE:LMT), Raytheon (NYSE:RTN) or Northrop Grumman (NYSE:NOC) might want to start building up its IT services business, not only to capture efficiencies of scale, but perhaps also as a way of capturing more of what may be a shrinking pie in the near future.

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