Raging Bull

For the average information technology company, the last year has not been good. Companies such as MicroStrategy Inc., PSINet Inc., Cisco Systems Inc. and Intel Corp. send chills through the stock market daily with warnings of lower than expected earnings and layoffs. Even the beloved Pets.com and eToys are no more.

As companies of the New Economy dim their torches, businesses that have devoted themselves to bringing IT services to the federal government — once an ignored market — appear to have won immunity from the volatile economy.

Top executives at those firms say they have never regretted their commitments to the federal market. And now the market is rewarding them.

"The gap that has historically existed between pure-play commercial companies and pure-play government companies has narrowed, and in some cases, the government companies have had a better valuation story in the past year," said John Allen, co-president of Quarterdeck Investment Partners Inc.

A quick look at the stock performance of integrators such as CACI International Inc., Affiliated Computer Services Inc. (ACS) and PEC Solutions Inc. tells stories of rising earnings and businesses untouched by a recent downturn. The secret: a strong and steady base of federal customers.

"The New Economy wasn't ready for the degree of acceleration the promoters wanted," said Jack London, CACI chairman and chief executive officer. "These days, a steady business is more attractive to investors."

Firms similar to CACI, which is 85 percent federal and grew out of a modeling and simulation heritage at the Defense Department, are not only meeting their projections for growth but are also using their experience with some of the most interesting government problems to sell themselves on Wall Street.

For CACI, that means providing the Justice Department with the automated litigation system that helped attorneys in tobacco lawsuits, asbestos cases and even the investigation of NASA's Challenger space shuttle explosion.

"I'm looking for people who have a challenge," London said, adding that's what he's always done to keep CACI's revenue and earnings solid. "We're not exciting, except when their [investors'] exciting stocks lose money for them."

For other companies, such as SRA International — with 95 percent of its business in federal IT — it means helping uncover lost White House e-mail messages. The list of interesting work in the government is endless and is just one of the reasons companies with skills that might bring higher margins in the private sector stick with the federal government.

"In the dot-com heyday, everyone thought growth was going to come from the commercial marketplace," Allen said. But a slowdown in commercial spending has caused a convergence between the commercial IT market and the estimated $50 billion- a-year federal IT market that has nothing to do with technology, he said.

Certain pockets of government IT, such as outsourcing, e-government and information assurance, are seeing higher growth rates than the traditional 4.5 percent to 5 percent the federal market is used to, Allen said. In addition, federal procurement reforms have offered contractors a commercial-like buying model that increases vendors' profitability.

All that makes the once-unpopular federal technology market much more alluring. So much so that firms having trouble staying afloat in the commercial market may be eyeing acquisitions to bring them into the more stable, federal fold.

"The good news for the traditional, federally focused company is that if commercial companies take an interest in the sector, it should increase the value of their businesses," Allen said. "The bad news is you're going to face another competitor when you go for work."

But many companies, including CACI, ACS, PEC, Electronic Data Systems Corp., Computer Sciences Corp., Science Applications International Corp. and Anteon Corp., have a firm place at federal agencies.

That's a welcome situation as far as Harold Gracey is concerned. The former acting chief information officer at the Department of Veterans Affairs worked a one-year stint at FedBid.com before landing at PEC Solutions as vice president of the systems integration division. FedBid.com took its Web site down earlier this year. PEC Solutions, which became a public company about a year ago, reported its 2000 revenue as $68.3 million, compared with $53.2 million the year before, and a net income of $7.3 million for 2000, compared with $5.6 million in 1999.

"What's going to be critical to the success of anyone who tries to come newly into the federal market is understanding the government," Gracey said. "You have to have in your mind the time and resources to learn the federal market."

PEC, founded in 1985 by three former CSC employees, is almost solely focused on the federal government with state and local IT services business. PEC recently signed a five-year deal with EDS for network operations centers and server farms under the Navy Marine Corps Intranet contract.

Even with the relatively modest increase in federal IT spending proposed in President Bush's fiscal 2002 budget request, Gracey doesn't see the work of government or the need for federal integrators disappearing any time soon. "The phase the government is in right now — the ramp up — is going beyond technology for technology's sake." And companies like PEC will be well-positioned to help it, he said.

Firms that are making their names in the federal market weren't always there. Anteon, for instance, didn't enter the federal market until it acquired Odgen Professional Services Corp. in 1996. Anteon has been methodical in making acquisitions that fit the company's goals and culture ever since, said Joseph Kampf, president and CEO of Anteon.

Under Kampf's leadership, Anteon has completed four successive acquisitions: Vector Data Systems in 1997, Techmatics Inc. in 1998, Analysis & Technology in 1999 and Sherikon Inc. in October 2000.

"Companies that build strong internal cultures typically do well, even in bad times," Kampf said. Anteon now has about $600 million in revenues and a growing backlog of work.

Unlike most commercial integrators, Anteon has exceeded its plans for the first few months of 2001. "Ours is a rather isolated market from economic swings because it's based on long-term contracting. If you build around that, a company that invests its resources wisely, you create a lot of value," Kampf said.

Anteon took the pain upfront to integrate its acquisitions, and as a result, it has been successful in winning contracts, he said. In the future, Anteon wants to acquire businesses that give it capabilities in information assurance, network design and integration, and e-government. Kampf said he is looking at two deals right now.

Perhaps the most often cited example of a company acquiring its place in federal IT is Northrop Grumman Corp., which started with its acquisition of Logicon Inc. and now has a $4 billion-plus business. In five years, Northrop acquired Federal Data Corp., Sterling Software (U.S.) Inc., Comptek Federal Systems Inc. and has just added Litton PRC Inc. and Litton TASC Inc. with its Litton Industries Inc. acquisition.

"There's been a tremendous amount of consolidation," Allen said. "Nearly half of the companies are relatively new entrants to the marketplace, and they got there through consolidation."

With giants such as Northrop, Lockheed Martin Corp. and Raytheon Co. finishing their IT growth spurts, other companies, including Anteon, CACI, ACS and Veridian Corp., are scouting for similar acquisitions.

ACS took its stab at the federal IT market when it acquired Computer Data Systems Inc. in 1997. CACI has made 17 acquisitions since 1994.

CACI's goal is to have $1 billion in sales by fiscal 2005, and it is about 60 percent of the way there with about $600 million in revenue, London said. Mergers and acquisitions bring new technology, such as intelligence IT, and new customer bases, such as the State Department business that came with its acquisition of Century Technologies Inc. As it makes future acquisitions, CACI is looking at bites of $50 million to $60 million.

"It's a big piece of the business strategy going forward," London said. "Internal growth is tough. You need a steady acquisition program."

The next wave of consolidations likely will be led by the consulting arms of the Big Five accounting firms; hardware and software vendors looking to build a services practice, such as Hewlett-Packard Co. and IBM Corp.; and traditional IT services companies such as EDS and ACS, Allen said. Those companies welcome the stable revenue and profit base of buying a federal IT company, he said.

Although consulting practices, such as KPMG Consulting LLC and Accenture are not really new to the federal market, it would be wise for them to increase their federal stakes, Allen said.

Federal integrators have disproved the perception that government work is unprofitable and boring. When investors' dreams fail, they come to the companies whose customer — the government — always pays its bills.

But federal agencies still exercise caution. The future of outsourcing is dependent on the success of contracts such as the Navy Marine Corps Intranet and the National Security Agency's Groundbreaker.

Another area is e-commerce. Longtime contractors are seizing the opportunity to use newly acquired capabilities to keep their federal customers, even as they move to e-government.

The government, PEC's Gracey said, has been rightfully cautious to minimize its business with dot-com start-ups.

"In retrospect, if you're going to try to create a Web-enabled government, the way to do it is with folks that already know the way government works."