BAE Systems North America announced a deal Saturday to acquire Herndon-based DigitalNet Holdings Inc. for $595 million in cash, pushing it further into the growing government information technology market.
The deal, which must be approved by shareholders, continues a consolidation of the market and would create an $1.2 billion information technology division ranked among the federal government's top 10 information technology providers. The acquisition would also result in a significant payoff for the DigitalNet investors who founded the company in 2001 and took it public last year.
"With all the talk about war spending and smart ammunitions and deployments to Iraq and Afghanistan, where an awful lot of the money is being spent is IT," said Jon Kutler, chairman and chief executive of investment bank Quarterdeck Investment Partners LLC.
Rockville-based BAE Systems North America already provides information technology services to the federal government, but DigitalNet, which integrates and provides security for computer networks, would broaden those capabilities, said Mark Ronald, BAE North America's president and chief executive. Contracts with the Defense Department made up more than 35 percent of DigitalNet's 2003 revenue, while intelligence agencies made up another 20 percent.
Both firms said the deal was prompted by the government increasingly bundling small contracts into single large deals. Information technology "is one of the fastest growing areas of government spending and scale makes a big difference," said Mark Ronald, BAE North America's president. "This puts us at a scale to compete for almost any contract." BAE North America had about $5 billion in revenue last year and could reach nearly $6 billion this year if the deal closes as expected.
DigitalNet found itself competing for work against industry giants like Lockheed Martin Corp. and Northrop Grumman Corp., said Ken Bajaj, DigitalNet's chief executive and chairman. Since the company, expected to reach about $374 million in revenue this year, is too big to pursue contracts set aside for small businesses, DigitalNet either had to be acquired or begin buying smaller competitors to bulk up, he said.
"Size really matters in the government space, you have to be a $1 billion company to go after the big contracts, and we were in the middle," Bajaj said.
"For BAE, it shows a commitment to reaching critical mass, to becoming a tier one player," said Robert D. Kipps, head of the defense group at investment bank Houlihan Lokey Howard & Zukin. For DigitalNet, he said, "perhaps it was a realization it would take a long time to get to critical mass."
BAE, which is owned by London-based BAE Systems, agreed to pay the equivalent of $30.25 a share for DigitalNet, a premium from where its stock closed Friday: $23.56 a share. As part of the deal, which is expected to close by the end of the year, BAE also agreed to assume $93.25 million in DigitalNet's debt.
The deal would result in a large payout for some of DigitalNet's largest shareholders, including equity firm GTCR Rauner LLC, which committed $100 million to start the company in 2001, and owns 49.3 percent of its outstanding shares, according to a Securities and Exchange Commission filing. Bajaj owns 10 percent and the chief financial officer, Jack Pearlstein, holds 2.5 percent, the report said.
"It's a home-run transaction," Kipps said. "It's a nice premium to where the stock has been and a nice financial return to investors."
No layoffs are expected among DigitalNet's 2,200 employees, officials at both firms said. About 1,700 of the company's employees are in the Washington region. "Nobody is getting laid off, we're still in hiring mode," Bajaj said, adding that he would leave after the company was acquired. "The only person being laid off is me. . . . I don't know what I will be doing."
DigitalNet followed a path familiar to Bajaj. In 1997, Bajaj created AppNet Systems Inc., an e-commerce consulting firm, which went public two years later and was acquired in 2000. "He's a serial entrepreneur who likes transactions," Quarterdeck's Kutler said.