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Booz Allen Units to Part Ways
McLean Consulting Firm's Government Division Being Sold to Carlyle Group

By Zachary A. Goldfarb
Washington Post Staff Writer
Saturday, May 17, 2008

The consulting firm Booz Allen Hamilton said yesterday it is splitting up, selling its U.S. government business to private-equity firm Carlyle Group for $2.54 billion and spinning off its commercial business into a separate company.

The deal pairs two of the largest private companies in the region. Booz Allen, based in McLean, has 13,000 local employees and is one of the government's largest providers of services. Carlyle, based in the District, has $81.1 billion under management and is one of the largest private-equity firms in the world.

The move is the culmination of more than two years of soul-searching at Booz Allen, which has struggled to reconcile the diverging paths of its units. The government unit's business surged after the post-Sept. 11 boom in government spending. The commercial unit, however, has failed to keep pace. That has created tensions between the units and amplified differences between their cultures, management and clients.

The deal, financed partly by debt, was seen as a sign of improvement in the credit markets, at least for certain deals, after the tightness of the past year. It was possibly the largest buyout of a government contractor ever, and Carlyle's biggest since its $6.3 billion bid to buy Manor Care in August. Despite the deal's size, participants said the agreement did not necessarily mean the industry would see other acquisitions soon.

Carlyle is well-known for buying firms, shaking up their operations to spark growth and selling them, but company officials said it has no plans to revamp Booz Allen.

"Continuing to operate their business as they have will generate a level of growth that will get us the increase in value we're hoping to achieve," said Peter Clare, a Carlyle managing director who oversees the firm's defense, aerospace and government services portfolio.

Carlyle, as a majority owner, will be in a position to advise Booz Allen on what markets to enter and can provide capital if Booz Allen pursues acquisitions, Clare said.

"This was opportunity-driven. This is our ninth investment in a government services firm, so this isn't a sea change for us," Clare said. "I think our focus in our transactions is ultimately on the sectors of government services that we find most attractive -- [information technology], security, intelligence."

Ralph W. Shrader, Booz Allen's chairman and chief executive, said employees had no reason to be fazed by the announcement: "My message to the staff is, 'You will see no changes.' "

Shrader, who had planned to retire next year, will stay indefinitely to run the newly constituted government business.

Analysts said they expected Carlyle and Booz Allen to try to bring the company public in a few years, but Shrader and Clare both said it was too early to know if and when that might happen.

John Allen, co-head of the defense and government services group at Reston's BB&T/Windsor Group, said the Booz Allen deal is the latest and highest-profile of a string of smaller private-equity deals in recent years. Chief among them: New York-based Veritas Capital bought Falls Church contractor DynCorp for $850 million in 2005.

"I certainly see it as a continuation of that movement," he said.

But John Hamre, president of the Center for Strategic and International Studies and a former senior Pentagon official, said he does not expect many more deals after years of rising valuations following the post-Sept. 11 boom.

"It's harder to find a good buy in the defense industry," Hamre said. "There's also unease in the investment community about, 'How long does this investment bonanza continue?' "

The deal, which must still be approved by Booz Allen's partners and government regulators, is slated to close by the end of the year. Booz Allen's board will consist of several Carlyle representatives, Booz Allen partners and outsiders.

As for Booz Allen's commercial business, it is preparing to announce a new name and plans for its management, said spokesman Michael Bulger. The two new firms have an agreement to work together. But diverging fortunes and cultures are at the heart of the split.

The government unit works with the National Security Agency, Food and Drug Administration, and countless other government agencies. It recruits a broad range of people, including recent college graduates, veterans and engineers. Teams working on government contracts can include 100 or more people.

The commercial unit, by contrast, competes with rivals McKinsey and Boston Consulting Group in helping companies set strategy. It recruits from Harvard Business School, the Wharton School of the University of Pennsylvania and other top schools and assembles groups of seven to 10 consultants to work with clients.

Booz Allen is owned by about 300 top executives, most of whom are in the commercial unit. As the government business has boomed, many executives there have felt an inordinate share of profit was going to executives in the commercial division. The deal in effect allows the partners of the government unit to buy out their commercial counterparts.

"In some respects it had become a very large government services firm with a consulting business," Shrader said. "Watching the business begin to change in tone and complexion prompted questions about whether we should be running this thing as two disparate parts under one umbrella."

The split will also help free the commercial side, which now works under some of the regulatory strictures required by Booz Allen's government work. Employees in both divisions must follow stringent spending and security guidelines, including a requirement that they prominently display their nationality on identification cards and in e-mails. For Booz Allen's business abroad, that's been particularly frustrating, especially in places that frown on U.S. involvement in Iraq.

In the past, some Carlyle critics have raised questions about the firm's ties to the U.S. government -- it has had prominent former political and military officials on the payroll -- and about its foreign investors. In a fact sheet about the Booz Allen deal, Carlyle wrote that its directors won't have access "to any classified information" and that contractors it has owned in the past "have had an exceptional record of properly safeguarding the integrity of sensitive government information."

Michael Lent, a former Booz Allen employee who now writes a newsletter called Government Services Insider, said Carlyle's experience could help Booz Allen gain more business at the Pentagon, where it runs up against bigger firms such as Boeing and Lockheed Martin.

"The firm would like to be more of a player in defense IT than it has in the past," Lent said. "Carlyle, with its defense experience, its connections and its right as owners, may be helpful in making it happen."

Carlyle said the deal was the latest of several recent buyouts, offering evidence of a recovery in the investment industry. "There has been a modest degree of thawing, that the markets have improved a little bit, and that does help this transaction to happen," said Clare, the managing director.

Private-equity expert Robert A. Profusek, a lawyer at Jones Day, said the deal shows that "the credit markets are clearly better than they were at the height of the doom and despair." But he said the money is nowhere near as readily available as it was a few years ago. "It's a return to the pre-bonanza time," he said. "It's a typical private-equity financing."

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