Experts ascribe the trend to several factors – the federal requirement to eliminate organizational conflicts of interest (OCI), the realignment of core businesses prompted by tight federal budgets and continuing resolutions on Capitol Hill, and in some cases corporate financial distress.
“Last year was really one of the first years when probably more than half the companies experienced organic shrinkage versus organic growth,” said Bob Kipps, managing director at investment bank KippsDeSanto.
“The market is tightening and companies are having to reduce their cost structure and sometimes it is more cost efficient to be on your own,” he said.
Brian Gesuale, senior vice president and government technology analyst at Raymond James, sees another factor driving divestitures.
Although a little less than 14 percent of the federal defense budget in 1990 went to the top five contractors, by 2010, that percentage had increased to 32 percent, he said.
When almost one-third of government defense contracting goes to the top five and another 20 percent goes to small businesses, there are fewer opportunities for mid-size companies and foreign prime contractors, Gesuale explained.
As a result, “companies are trying to become a little more specialized and a little more nimble, if that’s possible, from prime contractors’ standpoint,” he said.
So after years of acquisitions and growth, “you’re essentially starting to see these companies try to position themselves to be able to adapt in a much more challenging budget environment,” Gesuale said.
“In 2011, there were probably 10 or so divestitures that we would characterize as more services-oriented companies and there was more activity, perhaps even twice as much, in the defense electronics and defense technology and manufacturing sectors,” said Gregory Van Beuren, managing director and partner at Bluestone Capital Partners.
Cobham Plc.’s sale of Sparta Inc. to Parsons Corp. was picked as the top divestiture of 2011 by Washington Technology’s panel of merger and acquisition experts.
But obviously it wasn’t the only divestiture. L-3 Communications Holdings Inc.’s OCI-driven spinoff of its defense systems engineering and technical services business into Engility Corp. was a noteworthy transaction.
Others included ITT Corp.’s split into three publicly traded entities, including its multi-billion dollar defense solutions unit as Exelis ITT; SAIC’s sale of its oil and gas IT business to Wipro; and QinetiQ Group’s divestiture of its security business to ManTech International.
Contractors want to be squarely in the hot markets — cybersecurity, intelligence, cloud computing and health care IT, Kipps said. So, they are looking inward and “portfolio pruning” by divesting units that fall outside of those targets, he added.
Kipps said he expects to see further pruning and divestitures by some of the larger integrators that acquired numerous businesses during the past 10 to 20 years.