Overview of the deal
Acquirer: General Dynamics (NYSE:GD)
Target: CSRA (NYSE: CSRA)
Estimated value: $9.6 Bn
Announcement date: 02/18
Acquirer Advisors: Stone Key Group, LLC
Target Advisors: Evercore and Macquarie Capital
General Dynamics (GD) offers products and services in business aviation, including combat vehicles, weapons systems, munitions and shipbuilding. Additionally, it offers communication and information technology services and solutions; improving this service is the rationale behind the deal. GD’s CEO has described the acquisition as “a significant strategic step in expanding the capabilities and customer base of GDI(nformation)T(echnology)”. The deal provides the opportunity to increase the cost-effectiveness of IT-solution through adoption of CSRA technology and to grow revenues and profits of GDIT which already accounts for about 35% of GD’s revenues.
Keen observers will notice that this acquisition is likely a response to weaker-than-expected revenues in the last 2 quarters, so we would expect that revenue synergies will be particularly focused upon when integrating CSRA into GDIT. Regarding the structure of the deal, CSRA and GDIT will be merged and will report as a new financial segment.
The FT highlighted a statement from Phebe Novakovic, General Dynamics’ chairman and chief executive, that promotes the idea that this combined entity provides opportunity for the US Government's IT costs to be reduced - “We see substantial opportunities to provide cost-effective IT solutions and services to the Department of Defense, the intelligence community and federal civilian agencies”
Company details (General Dynamics)
General Dynamics is an American Aerospace and Defense corporation operating heavily with the US Government. As of 2017, it was the 6th largest defence contractor in the world by defence revenues.
- Founded in 1899 and headquartered in Fairfax County, Virginia
- Chairman and CEO: Phebe Novakovic
- Number of employees: 98,800 (As of 2017)
- Market Cap: $60.4 Bn - EV: $69.28 Bn
- LTM Revenue: $30.97 Bn - LTM EBITDA: $4.64 Bn
- LTM EV/Revenue: 2.24x - LTM EV/EBITDA: 14.95x
Company details (CSRA)
CSRA is an American information technology company which supplies its services to clients of the U.S. government in areas such as national security and health care. It’s largest market is national security with clients such as the DoD, U.S. Army and U.S. Navy
- Founded in November 2015 and headquartered in Falls Church, Virginia
- President and CEO: Lawrence B. Prior III
- Number of employees: 19,000+
- Market Cap: $4.9 Bn- EV: $9.59 Bn
- LTM Revenue: $5.06 Bn - LTM EBITDA: $0.76 Bn
- LTM EV/Revenue: 1.89x - LTM EV/EBITDA: 12.59x
Projections and assumptions
General Dynamics (GD) will commence a cash tender offer for all outstanding shares of CRSA common stock at $41.25 per share. This represents a 38% premium on previous trading day’s close, a moderate premium for CSRA shareholders. The deal is expected to be financed through available cash and new debt. This will moderately alter the capital structure of GD as they are projected to have net debt, post-deal, of $10.5. This is unlikely to impede their future borrowing capacity, as the company will still retain its strong credit ratings. To emphasis the soundness of GD’s capital structure and to maintain their strong credit ratings, it is expected that new and existing cash flows will be channelled in the short-term in order to reduce the debt taken on for this transaction.
Although a commitment to GD’s existing dividend policy (roughly 10% annual increases) has been declared, it could come under pressure if the debt market changes its view on GD. Additionally, if the overall rising interest rate environment impacts the debt repayments more heavily than GD expects, this could pose another threat to return to shareholders. It is projected that the deal will also be accretive to GAAP EPS and to free cash flow per share in 2019 and so the deal, as one would expect, is to be beneficial to shareholders. Despite this, upon news of the acquisition, GD’s shares fell 0.5% - reflecting the fact that the majority of large acquisitions culminate in the destruction of long-term shareholder value.
The rationale of this deal is straightforward, increasing the new segment’s cost efficiency through the comparative advantage CSRA. This can be expected to manifest in GDIT by specialisation and economies of scale. Moreover, combined with GD’s extensive experience of acquiring companies, it makes this a deal with a high potential of success. In a blue-sky scenario GD’s history of acquisitions will render the integration of CSRA an easy process. This is further aided by the fact that a new segment is being created, as this will make the process of integrating the firm’s corporate culture more flexible compared to if CSRA was just assimilated into GD’s existing corporate structure. Overall, the deal is likely to be financially beneficial and is expected to generate annual pre-tax cost savings of about 2 percent of the combined company’s revenue by 2020.
An additional long-term factor that could come into play during this US election cycle lies in a two-year bipartisan budget deal Donald Trump signed in February, which pledges to increase military spending by $195bn over the next two years. Simultaneously, Trump’s new budget proposal also looks to raise military spending. Combined, this would lead to a higher long-term upside in revenues for defense contractors such as GD.
Risks and uncertainties
General Dynamics has come under pressure from competing bidders at recent times, the most recent from an unsolicited bid from CACI International Inc which has forced them to offer $41.25 from their previous all cash tender offer of $40.75. However, this is still shy of the $41.79 offered by CACI, which leaves GD exposed to decisions from CSRA’s Board of Directors in favour of CACI. Further bidding competition poses the risk of either 1) GD not winning the bidding 2) having to overpay for the deal, to the benefit of CSRA’s shareholders but at the expense of the long-term return to GD’s shareholders. However, because CACI’s offer is an equity-cash offer, it is less appealing to CSRA’s Board of Directors and so the risk is somewhat reduced because of the further premium CACI would have to offer to sway CSRA’s Board of Directors in their favour.
Moreover, as with most large scale acquisitions, this deal will face some moderate regulatory scrutiny, this time by the U.S. Defense Department. The concern is that the deal would make GDIT-CSRA one of the largest players in the federal IT industry and it is this concentration, which is being investigated. However, looking at GD’s acquisition history, which shows over 45 acquisitions and minimal divestitures over its lifetime, we see the ease with which it completes such large scale deals (and by extension passes any competition investigations) and the extent to which binding integration occurs over the long term.
US News quotes a Heights Securities Analyst who says that defense contractors could be big winners considering the US budget announcement - “The new two-year spending package will mean more money for the military, potentially boosting procurement contracts for defense contractors”
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