CACI sales hit $3.6 billion in 2011, up from $558 million a decade earlier. By 2011, the Pentagon was spending nearly $200 billion on services, more than double what it spent in 2000, in constant 2011 dollars.
These companies became the bright stars of contracting. Unlike those that produce weapons, services businesses required relatively small investments to get off the ground and could quickly ramp up as demand grew. But as the government winds down its wars and takes a harder look at what it’s spending, their shine seems to be dimming.
The larger defense contractors such as Northrop Grumman and L-3 Communications have spun off their services businesses, which they say no longer fit with their strategy of pursuing higher-margin work, while companies that only offer services face new questions from Wall Street about the impact of federal budget cuts.
Many businesses in the sector are now finding themselves at an inflection point, revamping to win work in a competitive environment characterized by fewer opportunities and a more cost-conscious customer.
“Government services companies have to update their strategy to be successful,” said Bob Kipps, managing director of the McLean-based investment firm KippsDeSanto. “The strategy of the last 15 years is not going to be the strategy of the next five years.”
Falls Church-based Northrop Grumman was the first prominent defense contractor to rid itself of its services business in 2009, when it divested Tasc. A private-equity firm bought the unit, which operates out of Chantilly.
The spinoff came at a time when the government was promising to take a harder look at the potential conflicts of interest created when, for instance, a company’s services unit ended up testing a piece of equipment built by the same company’s manufacturing arm. For Northrop, it no longer made sense to put its products business — of drones and sophisticated military equipment — at risk.
Lockheed Martin followed suit in 2010, selling off its advisory services unit EIG. When L-3 Communications announced in 2011 it would spin off its services business, a company official said the lower-margin business didn’t fit with L-3’s focus on high-tech — which generally means high-margin — sectors.
“You have those growing concerns with government regulations, you have less prospects in terms of growth, a lot of the business that these companies used to do is drying up as overseas deployments are reduced,” said Philip Finnegan, director of corporate analysis at the Teal Group. “The growth that was part of the attraction in the past isn’t there anymore.”