The General Services Administration reviewed whether CACI International Inc. of Arlington should remain eligible for future government contracts after learning that CACI provided interrogation services in Iraq under a contract designed for the purchase of information technology products and services. GSA ultimately did not curtail CACI's eligibility, but requested and received CACI's commitment to comply with all rules covering purchases by the U.S. government. An Aug. 23 Business article should have included that information
ManTech International Corp. last week spelled out some bottom-line damage created by the post-Sept. 11, 2001, merger mania in the government contracting field, as companies scrambled to buy their way into the booming intelligence and anti-terrorism field.
For the first time since becoming a publicly traded company in early 2002, ManTech reported a money-losing quarter. The problem, the Fairfax contractor said, stemmed not from its core technology services business but from unexpected complications with the security clearance business it entered through the purchase of MSM Security Services Inc. of Greenbelt last spring.
Other local companies have had unpleasant surprises from acquisitions. Among them are CACI International of Arlington and Lockheed Martin Corp. of Bethesda.
Contractors embarked on acquisition sprees in the past two years to keep up with shifts in government spending priorities toward anti-terrorism and intelligence initiatives and the war in Iraq.
Last year government technology companies completed 85 acquisitions, up from 47 in 2001. Defense contractors bought 71 companies last year, compared with 38 in 2001, according to Houlihan Lokey Howard & Zukin, a McLean investment banking firm.
And the pace has not slowed. In the past 12 months, technology and defense contractors have completed nearly 200 acquisitions -- more than all the deals in 1998 and 1999 combined.
Before the Sept. 11, 2001, attacks, many government contracting firms provided information technology and other products and services that did not involve sensitive intelligence work. Breaking into that secretive and specialized world on their own could have taken the companies years, so many of them set out to gobble up firms already doing such work.
However, the number of companies in the intelligence or anti-terrorism world was limited. So was the number with large staffs of employees holding the necessary high-level security clearances. Competition for firms with either characteristic was intense. Due diligence was complicated because deals were done in such quick succession and portions of the work done by acquisition targets were classified. Beyond the usual challenge of checking out the finances of a potential acquisition, purchasers were faced with imponderables, such as the future course of federal spending and international geopolitics.
Executives with ManTech and CACI have said they exercised proper due diligence before making acquisitions that later proved problematic. A Lockheed spokesman declined to comment for this story.
Others involved in the area's contracting business said red flags raised during the due diligence process were not always incentive enough for contractors to call off a proposed purchase. "Maybe they saw some of the problems but felt the business opportunities were enough to cushion whatever problems they saw," said Claude P. Goddard, a government contracting lawyer with Wickwire Gavin in Vienna.
Even large defense contractors, who have more expertise, sometimes stumbled, because they failed to understand that the small, niche companies they were buying might not be as attentive to federal rules and regulations, said John W. Douglass, president and chief executive of the Aerospace Industries Association in Arlington. Small companies often "have to learn by getting their fingers burned," he said.
Wall Street contributed to the intense merger pressure, said Jerry Grossman, a managing director with Houlihan Lokey. As the commercial economy faltered, many investors began shifting cash to the government contracting sector. That gave companies fresh cash but also more intense demands for stellar growth rates.
Investors wanted publicly traded government contractors to post 10 to 20 percent annual growth rates, Grossman said. But the federal market grows about 3 percent a year, he said. To satisfy Wall Street, companies raced to purchase companies that could get them quickly into intelligence and anti-terrorism work, where growth rates and profit margins seemed more promising.
That pressure may have induced some to take shortcuts in investigating the companies they wanted to acquire, according to some experts. "There could have been some steps that would have been taken in a slower environment that might have been done quickly or overlooked," Grossman said.
ManTech, which was founded in 1968, for years did engineering and information technology work for the government. During the past few years, the company set out to increase its work in the intelligence sector.
In March 2003 it bought MSM, a 100-person firm focused solely on conducting background investigations, for $4.9 million. ManTech and MSM already had joined forces to win a contract for Defense Department background investigations that was expected to be worth $50 million over three years. Just a week earlier, ManTech had purchased for about $57.7 million Integrated Data Systems, a Chantilly company that also had clients in the intelligence world.
At first the MSM venture appeared to be rewarding. The Pentagon asked ManTech to increase the number of investigations it was completing from 35 to 425 per day, and the contract was on track to be worth more than $37 million in the first year alone. ManTech tripled the unit's staff, moved it into a new 40,000-square-foot facility and created a training program for the new employees it was rapidly trying to hire.
But turmoil erupted when the Defense Department agreed to transfer its security clearance caseload to the Office of Personnel Management (OPM). The Pentagon stopped giving ManTech new cases to investigate, and OPM delayed for three months the new contract ManTech had counted on winning in March. Its profit margins under the existing contract turned out to be much smaller than expected because the remaining Defense Department investigations entailed more arduous, time-consuming work than expected.
Last week the company told shareholders problems with the division caused it to lose $5.2 million (16 cents a share) during the three months ended June 30, compared with a profit of $8.9 million (28 cents) in the same period of the previous year.
ManTech executives say they had carefully vetted MSM, including research on the company's financial standing and the stability of the industry. Chief executive George J. Pedersen said the company's problems were caused by policy shifts he never could have foreseen.
"We have a very detailed financial approach to this. . . . We run all the 'what if' models. The issue here is not the acquisition, it's that the whole market changed," Pedersen said. But that doesn't mean Pederson is immune from buyer's remorse. "Would I like to have back the decision to enter that business? Yes."
CACI has been an even more aggressive acquirer. It has made seven purchases in the past three years. Recently it has struggled to deal with the fallout from Premier Technology Group Inc., a small Fairfax company focused on intelligence analysis service that it bought in May 2003. The following August, CACI's new subsidiary was awarded a contract to supply interrogators in Iraq.
The deal catapulted the 42-year-old company into the international spotlight when one of its employees was implicated in an Army report on prisoner abuses at Abu Ghraib prison outside Baghdad. In the four months since the abuse allegations surfaced, CACI has been the subject of numerous government investigations.
CACI executives contend that they fully researched Premier Technology Group before buying the firm and maintain that its employees acted properly in Iraq. And the scandal, they say, will not prevent them from using acquisitions to increase CACI's reach.
"There is no intent to go outside the boundaries of where we're currently playing, but there are ample opportunities and target companies to acquire," Stephen L. Waechter, chief financial officer, said in an interview last week. "We're constantly looking at opportunities. . . . At any time there are probably six to eight companies that we're looking at."
Lockheed Martin's November 2003 purchase of some assets of ACS Defense Inc. has also subjected it to scrutiny. Lockheed paid $585 million for ACS's federal units, a division with 5,800 employees that specialized in back-office computer support to intelligence agencies.
ACS provided interrogation support for the U.S. military at Guantanamo Bay, Cuba, under a contract designed for the purchase of information technology products and services. As with CACI's contract in Iraq, the General Services Administration is reviewing whether its contracts were misused to complete the deal.
Lockheed also aggressively pursued Titan Corp., of San Diego, for its long list of intelligence agency customers. But in June, Lockheed called off the acquisition because Titan could not settle a bribery investigation with the Justice Department.
After the cancellation of the merger, Thomas J. Jurkowsky, a Lockheed spokesman, said it was not a decision the company's executives took lightly.
"We did not want the uncertainty that surrounded the transaction to continue indefinitely. We concluded that terminating the agreement was in the best interest of Lockheed Martin and its stockholders," Jurkowsky said at the time.
Executives with government contractors draw differing conclusions from the recent acquisition spree.
SRA International Inc. of Fairfax has bought one company a year for the past three years, a healthy acquisition pace. But chief executive Ernst Volgenau said he resisted pressures to buy more and bigger ones, thinking that the safest way to expand is to grow the company organically.
"It only takes one or two bad apples to do you serious damage," Volgenau said. "The bigger you get, the greater the chances that somebody who appears to be honest and ethical and competent really isn't that way."
But ManTech's executives said the turmoil that resulted from its MSM acquisition will do little to deter it from future purchases.
"We continue to aggressively look for acquisition targets -- particularly in high-end defense and high-end intelligence," Pederson said. In fact, he added, "we're talking as I speak to several firms."