“Incubation Phase” of Federal Contractors in Health Care Now in Rearview Mirror

NOV 16

National defense spending is facing headwinds as the Department of Defense controller predicts the national defense budget to decline from its current level of $740 billion to $700 billion in 2012; and $650 billion in 2013.

For defense contractors reliant on this spending, TripleTree expects a continued focus on vertical expansion to intensify as early adopters expand on their existing footprints and late-comers feel the pressure to aggressively stimulate growth at any cost.

We predict that 2012 will be an active year in federal healthcare M&A because of four factors:

  • Military deployment drawdown and DoD budget cuts
  • Documented success of early healthcare initiative adopters
  • Fear of stockholder retribution by late-movers
  • Looming 2013 healthcare initiative deadlines mandated by the Affordable Care Act.

With that in mind, large contractors continue to trumpet new healthcare initiatives, redirect strategy teams, appoint new management, and realign spending priorities. Recent announcements underscore the trend:

  • CGI Group will record health care revenue as a separate vertical segment going forward. Behind this move was strong historical performance ($350 million in annual revenue), high growth (3 year healthcare CAGR of 28.1% vs. 5.3% for CGI), and strategic importance (order backlog of more than $1.2 billion)
  • USIS will form a healthcare solutions group providing fraud, waste, & abuse services targeting the federal market. The move reflects a strategic departure from its traditional business providing background investigations and screenings
  • Harris Corporation was awarded over a quarter of a billion dollars of healthcare contracts in the past 45 days – healthcare is part of the company’s fastest growing business segment
  • CACI International President & CEO Paul Cofoni announced on the heels of winning four HCIT contract awards worth a cumulative $69 million that “transformative healthcare IT solutions and services … are key components of our future growth strategy”
  • Pure play defense & IT contractors continue to woefully underperform their diversifying peers – Raytheon lowered its sales forecast by $500 million to $1 billion

Last quarter we predicted M&A activity would be carried on the backs of public asset divestitures, private equity platform transactions, and contract vehicle access acquisitions, or “golden tickets”. To that point, in the past three months we have seen a handful of corporate divestitures, including the spinout of SRA’s CRO division to biopharmaceutical company Aptiv Solutions. We’ve also watched as a near-record number of small government vendor acquisitions have occurred (71 last year, the highest since 2000), and at least one “golden ticket” transaction went down (ManTech’s $90 million purchase of Worldwide Information Network Systems, a cyber IT provider). Last week, consulting firm Grant Thornton acquired Computer Technology Associates’ Health Solutions division, expanding its healthcare and public sector presence with five military healthcare contracts.

Healthcare is not a sector that lends itself to being understood swiftly and easily and much of the hesitation from non-traditional global acquirers in diversifying into healthcare stems from this lack of familiarity. Contractor expansion into the healthcare vertical has been slower and more deliberate than peer verticals like cyber security and intelligence. We believe that contractor healthcare strategy teams are nearing the end of their incubation periods and once committed to healthcare, their business models and-go-to market approaches will be fully baked. Federal contractor healthcare initiatives will be key area of our research agenda and advisory focus in the quarters ahead, and we’ll opine often on developments…until then, let us know what you think.

Marc Baudry
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