By Griff Witte
Washington Post Staff Writer
Wednesday, April 27, 2005
Telecommunications equipment maker Nortel Networks Corp. agreed yesterday to purchase Fairfax-based IT contractor PEC Solutions Inc. for $448 million in a deal that highlights the strength of the federal information technology market.
Under terms of the acquisition, Canada-based Nortel will pay $15.50 a share in cash to acquire PEC, representing a 37 percent premium over the price of PEC shares at the end of Monday trading.
When the deal closes, which is expected in June, Nortel plans to create a U.S. subsidiary called Nortel PEC Solutions that would inherit PEC's contracts serving the government in such rapidly growing markets as homeland security, intelligence and defense. Because Nortel is a foreign company, it will establish a separate board to distance the U.S. subsidiary from the Canadian parent, a move that Nortel thinks will create "a firewall" to ensure that sensitive U.S. government information is protected, according to Charles Saffell, president of federal network solutions for Nortel.
Nortel has struggled in recent years with accounting irregularities that delayed its financial statements and led to the ouster of several top executives. It has also suffered from sluggish sales in a commercial market rocked by the telecom downturn. Yesterday's deal is designed to give the firm a larger stake in the less fickle, federal computer-networks market.
Even as other federal spending programs have faced cuts, President Bush's proposed budget for 2006 includes $65 billion for information technology, up from $60 billion in 2005.
"The government's budget for IT is large, and it's had a pretty steady growth factor to it," Saffell said. In particular, he said, the deal gives Nortel the chance to compete for massive, multi-year, multi-agency contracts that previously would have been beyond the company's reach. Nortel said it has no plans to cut jobs at PEC, where 80 percent of the 1,700 employees have security clearances.
PEC chief executive David C. Karlgaard said in an interview that PEC had not been looking to be acquired but that Nortel came calling. "We were not up for sale. This was not part of our plan. We were approached by Nortel several months ago, and during the time since then, we've gotten to know the company quite well," said Karlgaard, whose firm had $202.7 million in revenue last year, much of it from selling the government communications and identity-verification systems.
Karlgaard and two other top PEC executives will stay on at the combined company as part of the board of directors that will oversee Nortel PEC Solutions.
With the government technology market heating up, mid-sized IT contractors such as PEC have been highly sought after by much larger firms. In February, defense giants Lockheed Martin Corp. and Northrop Grumman Corp. each made acquisitions designed to beef up their IT divisions.
Yesterday's deal was different, however, because until now Nortel has not been considered a major player in the federal contracting business, particularly when it comes to providing services. Only about 40 of its 30,000 employees worldwide have U.S. government clearances, Saffell said. By contrast, the high number of PEC employees who have some form of government clearance allows the company to perform the critical work that has increasingly shifted in recent years from government employees to contractors.
Karlgaard said the size of Nortel, which had $10.2 billion in revenue in 2003, will allow the combined company to compete with some of the nation's largest contractors. "We've had a great run over the past five years as a public company, but we've reached sort of the middle-market stage and we want to be a top-tier player," said Karlgaard, who founded PEC with two colleagues in 1985 and took it public in 2000. "It would take a while to do that organically. This is a chance to leapfrog right up there with the big players."
Joseph Vafi, an analyst who follows the federal IT market for Jefferies and Co., said the acquisition allows Nortel to make a transition into the government service market that would have been difficult to accomplish without buying an existing player.
Timm P. Bechter, an analyst at Legg Mason Wood Walker Inc., said the deal makes strategic sense for Nortel because it gives the company improved access to a prime market for its large-scale telecommunications equipment. But he questioned whether it paid too much.
Shares of PEC surged yesterday on news of the deal, up $4.01 to $15.32. Nortel fell 3 cents, to $2.73.