At the same time, a push to cut costs has made government buyers more willing to look beyond contracting powerhouses in search of solid companies that might have new ideas and lower prices.
The changes within the market have opened a potential door for those who are neither too small nor too big.
Mid-tier firms boast they offer a wider range of skills than a small business, and because they typically have fewer layers of management than a big contractor, they can keep overhead costs down, and be more responsive to government requests.
The opportunity has attracted the notice of private-equity firms, which have invested in buying or building local mid-size contractors, including Sotera Defense Solutions and Six3 Systems, both in McLean.
“It’s a very good time to be” a mid-tier firm, said John Hillen, who heads Sotera, which was purchased by a private-equity firm in 2011 and posted $334 million in revenue last year. “The principal market force is that the customer wants a company like that; they want a choice other than huge super aerospace primes or small businesses.”
Many private equity firms swooped in when mid-tier firms faced more challenges. From 2000 to 2006, mid-tier companies’ market share dropped from nearly 38 percent of the total value of federal service prime contracts to just under 32 percent, according to data analyzed by the Center for Strategic and International Studies.
But more recently, medium-size contractors have staged something of a comeback, growing their share to just over 35 percent in 2010. Still, the road is proving rocky; in 2011, the number fell back to 33.6 percent.
Playing to their strengths
Industry analysts say mid-tier contractors are primed to do well in a difficult budget environment.
“There is a thirst from the government customer for a new idea, a new solution, a new approach,” said John Song, a senior vice president in Houlihan Lokey’s aerospace, defense and government group. “In a low-cost environment, the mid-tiers might be able to get there quicker, they might be willing to eat into the margins.”
Defining a mid-tier can be tricky. Most industry analysts and observers agree that to be mid-tier, a company can no longer qualify for small-business status, which typically requires somewhere in the range of $25 million to $35 million in revenue, depending on the industry. Generally companies are considered large once they pass about $1 billion to $2 billion in sales.
Jean Stack, managing director of the aerospace, defense and government group at investment banking firm Houlihan Lokey, said a company with $100 million in revenue that has a single contract isn’t a mid-tier. True mid-tiers must have a well-defined portfolio of customers and a distinctive skillset.
Most of the successful companies in the size group have seasoned management teams and financial backing, often through private equity, said Bob Kipps, managing director of the McLean-based investment firm KippsDeSanto.
“You can’t be a $500 million company with $50 million in 10 different areas,” Kipps said. “But if you’re [a] $500 million [intelligence business], you’re probably doing pretty well, or if you’re $500 million in health [information technology work], you’re probably doing pretty well.”
Fairfax-based Salient Federal Solutions, founded by contracting veteran Brad Antle, has made it an objective to reach mid-tier statusand has purchased several IT firms to grow its status.
Government customers “get financial stability, they get reasonable depth of resources and ... CEOs still make calls on lower-level customers,” Antle said.
Size makes a difference
But mid-size contractors can struggle, particularly because they’re more reliant on their largest contracts. While larger contractors typically own a place on a whole range of contract vehicles — allowing them to compete for a variety of individual task orders — mid-tiers tend to rely on just a handful.
“It’s just much more visible if you lose a particularly large contract,” Stack said. “There’s just less out there to offset it.”
Reston-based NCI has become something of a poster child for the challenges in contracting, particularly in contracting as a mid-tier.
The IT services contractor warned investors earlier this year that it expects revenue in 2012 to decline by about $200 million, meaning a drop from nearly $560 million in 2011 to a range of $345 million to $375 million.
NCI has attributed the decline to the end of a Pentagon base realignment program as well as other contracts that are ending or that have been reduced in size.
“While we all focus on the bad environment that we’re dealing with — the pricing, the intensity of the competition — one of the things that’s been a byproduct of that is that incumbency [on a contract] is no longer the lock that it used to be,” said Brian J. Clark, NCI’s president, of the company’s effort to win new work. “That’s where ... it can be more of an advantage for a contractor of our size, because we can be more agile, more flexible. We can put a different level of attention on things.”
Antle said medium-size contractors can also struggle to win prime contracts, noting that larger procurements often go to larger contractors, leaving mid-size companies to act as subcontractors, while small programs will go to small business, again forcing mid-tier businesses to be subcontractors.
But with a window open, it’s safe to expect others to keep trying. Falls Church-based Acentia, for instance, just closed a deal to merge with 2020 Co., also of Falls Church, in an effort to create a mid-size contractor with a specialty in health care information technology, one of the expected growth areas. (See related story, Page 10.)
Backed by New York-based private-equity firm Snow Phipps Group, Acentia is already looking for more acquisitions, said Todd Stottlemyer, the company’s chief executive.