Michael Lustbader, left, and Peter Manos, both partners at Arlington Capital, which sold unmanned systems business Chandler/May in 2012. (Jeffrey MacMillan/Jeffrey MacMillan)

When Fairfax-based government contractor Anteon International was bought by Falls Church-based General Dynamics in 2006, it was a moment the private-equity industry couldn’t ignore.

A decade after a private-equity firm backed the $45 million deal for the federal technology business, it was sold for $2.2 billion.

The story of Anteon “drew private-equity interest into the industry like bees to honey,” said Bob Kipps, managing director of the McLean-based investment firm KippsDeSanto.

Since then, private-equity groups have taken over many of the well-known professional services contractors in the area. New York-based New Mountain Capital, which had previously invested in Herndon-based Deltek, bought Alabama-based Camber, which has several Maryland and Virginia offices, while Providence Equity Partners picked up Falls Church-based USIS, known for performing government background checks.

In 2008, the Carlyle Group, long comfortable in the contracting industry, bought McLean-based Booz Allen Hamilton, one of the largest government services contractors in the country.

“Private equity [plays] a much bigger role in the defense sector now than it has in a generation,” said Loren Thompson, a defense industry consultant.

From 2004 to 2013, private equity invested more than $30 billion in 358 U.S. aerospace and defense companies, according to Pitchbook data supplied by the Private Equity Growth Capital Council.

For a typically slow-moving industry such as contracting, private-equity investors can provide the money and motivation to help companies adapt and change.

But that push also puts pressure on contractors to show results in an environment where they face restrictive government buying processes and rules.

Today, there are signs that private equity may have some second thoughts about buying into the market, as government spending declines following the conclusion of two wars and the arrival of spending cuts.

Investors that bought contracting businesses in 2007 and 2008 might ordinarily be selling or turning companies public now in hopes of capitalizing on their investment, but they are instead holding, waiting for the market to improve. Others, meanwhile, are keeping to the sidelines, withholding investments some contractors could use to adjust to the slowdown in spending.

The first entrants

Private-equity firms are investment managers that raise funds to put into companies, often buying a stake in or all of the company. These investors typically make relatively short-term investments, hoping to bolster profits by cutting costs, partnering a company with other businesses or pushing other strategic initiatives. Then they can make money by taking the hopefully more valuable company public, selling it or recapitalizing it.

In the past, private equity was not a major player in defense contracting, which investors saw as reliable but hardly fast growing. There were those who had carved out a niche in the market — the Carlyle Group is the most frequently cited example. Defense contracting’s biggest asset was its reliability; it is a business relatively immune to short-term economic swings.

“The government pays its bills and pays its bills on time,” said Jason Kaufman, head of investment banking at Chertoff Capital.

Adam Palmer, who heads the aerospace, defense and government services sector team at the Carlyle Group, said the company saw early potential in the market as a place to score investment singles and doubles — not home runs.

Still, the Carlyle Group quickly developed a reputation for success, and in 1997, it completed one of its largest deals, buying United Defense and later taking it public.

Around the same time, Joseph Kampf and his partners purchased what was renamed Anteon with backing from New York-based private-equity firm Caxton-Iseman Capital.

Kampf, a former executive at a federal contractor, was convinced that the industry was in a trough that it would eventually pull out of — a case he convincingly made to his private-equity patrons.

Soon, the company started to rapidly grow. Kampf said he and his team tried to move the company from generic IT jobs — or the kind of work any company can do — and into very selective Pentagon and intelligence work. He focused on improving the company’s sales staff and bulked up with acquisitions.

In 2006, the 9,600-employee company was sold to General Dynamics for $2.2 billion.

Anteon’s sale was a signal moment that the industry had arrived, beckoning new investors looking for big returns. But it wasn’t necessarily representative of the kinds of gains that investors could expect.

“We got in at the very bottom, and I think we got out at the very tippy top,” Kampf said. “You can call it skill, or you can call it luck.”

Anteon’s attention-attracting sale sparked new interest from private equity as the economy began to sour in 2007, and firms looked for investments in sectors not tied directly to the broader market. In 2007 and 2008, Leonard Green & Partners bought Reston-based Scitor, Veritas Capital bought Reston-based CRGT and DC Capital Partners picked up McLean-based Kaseman (which now goes by KS International).

Then, in a 2008 deal, Booz Allen Hamilton separated its commercial work from its government business, and for $2.54 billion, the Carlyle Group acquired a majority stake in the government unit, which it took public two years later.

In recent years, Booz Allen has borrowed money to fund dividends for stockholders, including Carlyle.

As the recession took hold, “the commercial areas where people had invested were doing anything but growing,” Palmer said. “People were looking for places to leverage their skill sets in areas where there was growth.”

Even after government procurement spending peaked in 2009, the acquisitions kept coming. Michael Lustbader, who heads the government services group at private-equity firm Arlington Capital Partners, a longtime player in the contracting industry, said he and his partners started seeing more unfamiliar faces at industry conferences.

For investors seeking opportunity, Washington seemed to be the rare spot shielded from the recession.

In 2011, Providence added the homegrown contracting firm SRA International, which has its headquarters in Fairfax, to its portfolio, while an Ares Management affiliate bought Herndon-based Sotera Defense Solutions.

The problem, said Peter Manos, managing partner at Arlington Capital Partners, was that many of these investors didn’t understand the quirks of the market, such as the way Congress budgets money or the differences among various kinds of services. Some didn’t understand the set-asides — contracts specifically reserved for certain groups such as veteran-owned businesses or small businesses. As a result, he contends, many overpaid.

“It got more competitive, and we lost a few opportunities,” said Manos, because Arlington wasn’t willing to pay quite as much.

And it turned out Washington wasn’t immune to spending cuts.

Under pressure

In the past year, the pace of private-equity purchases has slowed. Some of the firms who were previously interested have backed off, as budget cuts at the Pentagon have dimmed optimism about the industry.

As revenues have fallen virtually across the board, companies already owned by private equity have seen their prospects become more uncertain.

At the same time, private-equity firms are continuing to exit past deals. The Carlyle Group bought Arinc in 2007 and sold the communications, integration and engineering firm last year in two chunks, one piece to Booz Allen in 2012 and the remainder to Rockwell Collins last year for $1.4 billion.

Arlington Capital, for its part, sold unmanned systems business Chandler/May to Lockheed Martin in 2012.

Other private equity-owned firms are trying to adjust to the changing budget environment.

Last year, SRA lowered the value of three of its four business units by about $300 million. The company said in filings with the Securities and Exchange Commission that it lost $317.3 million in fiscal 2013, and revenue fell 10 percent.

“The combination of sequester spending cuts, government shutdown dynamics and overall budget uncertainty have adversely affected our financial performance this fiscal year and in the prior fiscal year,” SRA said in the SEC filing. The company declined to comment for this article.

Last month, Moody’s downgraded SRA’s rating, citing declines in the company’s sales as well as a large amount of debt.

Put more simply, government contractors are still seeing work, but at lower rates than in the past. For private equity-owned companies that have heavy debt loads, that can be a problem.

Sotera last year breached a requirement for some of its financing, according to a Standard & Poor’s report. The company corrected the issue, but S&P’s report detailed concerns that Sotera has “less than adequate” liquidity and a “highly leveraged” financial risk profile.

Sotera declined to comment.

Some consultants and executives say private-equity buyers’ focus on financial metrics can come at the expense of performance.

“In this business environment, all defense companies are under financial pressure, but if you’ve got a private equity owner, chances are the pressure is even worse,” Thompson, the industry consultant, said. “Their focus is very much on the short-term, and their expectations for performance sometimes are not realistic.”

USIS has come under scrutiny for vetting security clearances for both Edward Snowden, the former National Security Agency contractor who leaked confidential information, and Aaron Alexis, the Navy Yard contractor accused of killing 12.

The Justice Department has signed onto a whistleblower lawsuit against USIS and, in a recent filing, accused the company of taking shortcuts in about 40 percent of the cases it handled. Providence declined to comment. USIS said in a statement that after learning of the allegations close to two years ago, the company has “acted decisively to reinforce our processes and management to ensure the quality of our work and adherence to [Office of Personnel Management] requirements.”

Leonard E. Moodispaw, chief executive of Hanover-based cybersecurity company KEYW, resisted private equity. When he started the company, he regularly received calls from potential investors.

But he said he didn’t want a company setting limits on compensation or telling him what contracts to pursue. KEYW instead became a public company.

“I’d much rather have a bunch of public company shareholders ... than have one private-equity fund helping me run the business,” Moodispaw said.

Another opportunity

Though the fervor among private-equity groups to buy into defense contracting has dimmed, there remain investors interested in the market. Some contracting executives are forecasting that 2014 could be the bottom for sales, meaning investors may take a chance on buying at lower prices now, hoping for an upswing in the coming years.

Devin Talbott has spent nearly a decade covering the defense and government services industry, and in 2012, he formed a new investment firm with Pierre Chao.

The company, called Enlightenment Capital, has thus far invested in five contractors. From his perspective, now is a great time to buy.

The market now “is not for the faint of heart,” Talbott said. “It’s people who have been through the cycles before and have insights into the industries.”

As the defense industry prepares to reshape to cope with leaner times, private-equity firms will likely play a shaping role. Contractors have been divesting and spinning off units, setting up an opportunity for companies to rearrange into businesses better prepared to succeed in a tougher environment.

Ernst Volgenau, who founded SRA in 1978, led the company for nearly 30 years and now chairs its board, said Providence, the contractor’s private equity owner, has helped SRA as it reshapes for a shrinking market.

“We just have to cut costs — but we would do that whether or not Providence had bought [SRA] at the peak,” he said. “We’re not cutting costs simply to achieve some profit target. What we’re trying to do is create a company that is a lot slimmer, yes, but is geared toward the long-term.”