For government contractors, the holiday shopping season has already kicked off.
Last week, Chantilly-based services contractor Engility said it would buy rival TASC for $1.1 billion in one of the biggest deals in the federal contracting market this year. The combined company is expected to employ 4,000 people in the Washington area.
The deal is significant because it could herald a wave of consolidations among professional services companies, many of which are based in the Washington region, analysts say. These companies often perform similar functions and are slugging it out for a shrinking pool of federal dollars.
Engility’s acquisition is going to spur contractors to look at each other and figure out how they can position themselves better in a weak federal spending environment, said Michael Lewis, managing director of McLean-based Silverline Group, a consulting firm.
“We will see an acceleration of consolidation moving into mid-2015,” he said. “It’s either hunt or be hunted.”
Services companies, which support government work in areas such as engineering, information technology and logistics, are more vulnerable to cuts in federal spending.
Unlike a decades-long program to build a new battle tank, fighter jet or other weapons system, services work tends to be short term. It’s also often the first area in which government agencies cut back when budgets are limited.
Defense Department spending on contracts for services and research and development was down by 35 percent in 2013 from 2012, according to a recent report by the Center for Strategic and International Studies, a Washington think tank.
The other reason this market is ripe for consolidation is the proliferation of companies with similar capabilities, analysts say.
“You have too many companies doing the same thing, going after fewer contracts,” said Randy Starr, vice president of the aerospace and defense sector at Strategy&, a consultancy.
Consequently, many firms are competing on the basis of price. When companies’ offerings are similar, the only way to stand out is to become the cheapest vendor, Starr said.
Executives at Washington-area companies have long been vocal about the need to combine, especially for the cost savings that can be realized. But the Engility-TASC deal could be a turning point for the sector.
Consolidation makes companies more efficient, ultimately benefiting the government, Lewis said.
“We have taken the approach that there needs to be consolidation in the [services] industry,” Tony Smeraglinolo, chief executive of Engility, said of the acquisition. “We are going to be a first mover in this space.”
The Engility-TASC deal is expected to save the company $35 million by 2016 as a result of cutting back on leases and other measures, executives said.
At Arlington-based CACI International, Kenneth Asbury, the company’s chief executive, has said the company is on the lookout for high-end health-care IT businesses. CACI acquired intelligence contractor Six3 Systems last year in a deal valued at $820 million.
Three kinds of professional services markets are emerging, James McAleese, founder of Sterling, Va.-based McAleese & Associates, a government contracts consultancy, wrote in a recent research note.
The first category is “top primes,” which includes the IT arms of big defense companies such as Lockheed, Raytheon and Northrop Grumman. The second group is made up of “differentiated pure-play” contractors such as Engility, Booz Allen and CACI, which specialize in work for intelligence agencies or other government clients that require specific skill sets.
The third group, which has been hit most by spending cuts and the drawdown of troops in places such as Afghanistan, consists of a range of other service companies, including DynCorp International and PAE.
The second and third groups are the spaces to watch, because that’s where the most merger activity is likely to occur, Starr said.
“Contractors that are relatively smaller will benefit the most from merging with either a larger acquirer or from a merger of equals,” he said.
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