Two summers ago, Science Applications International Corp., one of the Washington’s region’s biggest companies, made a surprising announcement.
After more than four decades of operation, the government services contractor was going to split in two. SAIC would spin off a $4 billion publicly-traded unit bearing its name. The parent company would rebrand itself “Leidos,” derived from the word kaleidoscope, which reflected its effort to unite solutions from different angles.
The reasoning for the split made sense at the time. SAIC’s old way of doing business — where units offering similar services operated in silos — meant the company often got in its own way because of organizational conflicts of interest, executives said. Its sprawling bureaucracy made it difficult to chase new markets.
So the company divvied up its operating segments. New SAIC, headquartered in McLean, would focus on helping government customers manage IT systems and provide technical services, an area of expertise for the former SAIC. Leidos, which moved to Reston, would continue old SAIC’s work in the field of national security, and target the commercial sector with its emerging health and engineering offerings.
On Sept. 27, 2013, the companies went their separate ways, just four days before the government entered a shutdown. SAIC’s chief executive, former Air Force chief of staff John P. Jumper, assumed the helm at Leidos. Anthony J. Moraco, the head of the previous company’s intelligence, surveillance and reconnaissance group, was appointed to lead the new SAIC.
Leidos walked away from the deal with the company’s more-promising business units and an established leadership team, according to analysts. New SAIC’s mandate was to keep the legacy business going and ensure a smooth transition for government customers whom the company had been serving for decades, chief executive Moraco said.
One year later, a glance at the stock charts of both companies shows a stark contrast.
Leidos has yet to win over Wall Street. It posted a loss of $438 million in its most-recent fiscal quarter, dragged down by its sagging commercial health-care business and losses related to an underperforming power plant in Connecticut.
Investors, meanwhile, have warmed to SAIC. After a rocky start, its profits have risen over the past two quarters.
The stock market performances reflect different perceptions for companies dealing with many of the same overarching issues. Sales at both companies are down, a result of the slowdown in federal spending that has hit most government contractors.
Few in the industry expected the companies’ fortunes to take such diverging paths in so short a time. And it can be tricky to make an apples-to-apples comparison between the two companies, said Roman Schweizer, a defense policy analyst at Guggenheim Partners.
Leidos aimed to forge its way in new markets; SAIC planned to stick to its knitting. One year isn’t long enough to judge a company’s strategy, added Michael Lewis, managing director of McLean-based Silverline Group, and an investor in Leidos.
“I think we need to give them at least 24 to 36 months” before saying whether Leidos made a mistake, Lewis said.
Leidos’s foray into health care and renewable energy is the main reason for its lackluster performance, analysts say.
“Anytime we see a big federal company buying a commercial practice, often it doesn’t end up very well,” said William Loomis, managing director at St. Louis-based financial services firm Stifel Nicolaus, which invests in both companies.
That’s because the commercial market is different from the government market, he said.
“While technically the solutions you provide may be similar between commercial and federal, how you sell them, manage the projects, understand the customers’ requirements and mission is very different,” he said.
Leidos was not a complete newcomer to the field. In 2011, the former SAIC acquired Vitalize Consulting Solutions, a health-care IT company. A year later, it acquired MaxIT Healthcare Holdings, a company that specialized in setting up electronic health record systems.
In the energy sector, the contractor had been selling its “Smart Grid as a Service” hardware and software product to utility companies since 2011.
But Leidos ran into difficulties with a biomass energy plant it had assumed in Plainfield, Conn., a project that also originated under the former SAIC. The company announced its intention to sell the plant but ran into operational issues in the meantime. Production shortfalls and outages at the plant cost Leidos $32 million in bad debt expenses and $9 million in operating losses, the company said.
At the same time, the commercial health-care business sputtered. Many companies that might have been interested in IT services were instead holding off on major expenditures until they understood the full ramifications of the Affordable Care Act.
“I think the market shifted on [Leidos], and it just caught them off-guard,” Lewis said.
The company posted a loss of $482 million in the health and engineering services segment during the last quarter, a drop of more than 120 percent compared with the previous year.
Chief executive Roger Krone, who was brought on this summer, noted that the company’s national security and federal health-care business remains strong, and helped offset the drop in its other segments.
“While the performance of Leidos has not measured up to earlier expectations, we still have a solid business,” Krone said in an e-mailed statement. “Many of our troubles in the past have come when we overextended into adjacencies that are outside of where our core competencies are.”
That means a renewed focus on government contracting. The Pentagon’s upcoming multibillion dollar initiative to overhaul its health system technology is “one of the biggest focal points for Leidos at this time,” Krone said.
As the current prime contractor for the Pentagon, Krone said Leidos is “a domain expert in military health systems.”
SAIC and Leidos have had different leadership stories over the past year. While Moraco has been a constant at the helm of SAIC, Leidos spent much of the year casting about for a permanent leader.
Jumper took over the predecessor company in 2012 and guided it through the transition. In February, he announced his decision to retire as soon as a successor was named. K Stuart Shea, the company’s chief operating officer, was widely expected to take over from Jumper. Instead, Shea announced his resignation in March. No reason was given for his departure, but the company said it was “a mutual decision.”
For four months, the board of directors searched for a replacement until they finally honed in on Krone, a former Boeing executive and industry veteran. Krone was selected because his “depth of experience [would] enable him to drive the Leidos strategy, while enhancing and optimizing the company’s operational and financial performance,” Lawrence Nussdorf, lead director of the company’s board, said in a statement.
Krone has only been at the top for a few months, but analysts said he appears to be an able candidate to guide Leidos during this difficult period.
“He seems to have an open mind on the direction for the company,” Loomis said.
Analysts expect Krone to bring significant changes to Leidos’s way of doing business and refocus the company on its traditionally strong areas, such as intelligence.
Krone confirmed that fact, saying he plans on being “rather boring.”
“The company and our employees have seen too many distractions in the recent past,” Krone said. “It’s now time to stop the drama and get everyone refocused on ... what we’re really good at.”
At SAIC, Moraco and his team have done a better job of executing the vision laid out for the company at the time of the breakup, analysts said.
“The leadership team knows the specific company lines of business very well and has realistic expectations about the market,” said Schweizer, the Guggenheim analyst.
At SAIC’s McLean office, spirits were high during the company’s first anniversary celebrations last week. The company held a silent auction to raise money for charity, and asked employees to send in photos of themselves as part of a company-wide photo contest.
The reason SAIC got off to a sharper start is largely thought to be its single-minded focus on providing technical services to government customers.
SAIC doesn’t have “the distraction of multiple market segments or business models,” Moraco said. “It’s that focus that allows us to perform very effectively.”
For almost a year before the split, company leaders were devising a strategy for the spinoff. That resulted in the “matrix” business model the new SAIC uses, in which different segments of the company collaborate to serve customers, whether they’re the Army, Navy or Air Force. The strategy was an intentional departure from the former SAIC’s operations, in which units designed similar services didn’t communicate with each other, even if the work overlapped, said Nazzic Keene, the company’s sector president for global markets and missions.
Then there’s the name “SAIC” itself.
Despite the logistical confusion that accompanied keeping the name, Moraco said it has served the company well because it is a familiar brand to government buyers.
“Having the name in this [competitive] market is a great advantage,” he said.
Leidos faced the challenge of establishing its personality in the market at a time when the slowdown in government spending had ramped up competition.
“It’s still a quality business, it just needs to be put back on track,” said Lewis, the Silverline Group analyst.
So what lies ahead for both companies? The same challenges that most contractors face, such as uncertainty about the level of federal spending over the next two years.
For Leidos, the key to winning back the confidence of Wall Street is in coming up with a plan that can stabilize the business, Schweizer said.
To that effect, Krone said he has a “clear vision” for Leidos.
“We need to invest in things like research and development, continued innovation and internal collaboration, and we need to take care of our people — they are the ones that will drive this company forward,” Krone said. “If we can do all of those things and be competitive in our markets, we will continue to have a strong business in the future.”
For SAIC, a long-term goal could be investing in some of the areas where Leidos is strong, such as defense intelligence, Loomis said.
Looking back, Moraco insists the decision to split the company was the right one, even if it the results did not immediately play out as expected.
“In this market, both companies are better positioned to be competitive and more responsive to our government customers,” he said.
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