Grow through Acquisition or Organically? A Government Services Contractor Enters Tech

It’s a frequent dilemma in corporate strategy.  A company knows it wants to expand to a new business area – but how? Should the company look to make an acquisition to enter the space?  Or would it be better to start a new business line from scratch?  One government services contractor, PAE Inc. (“PAE”), was faced with this dilemma as it decided whether to pursue higher-end, technologically advanced contracts in addition to more traditional logistics and operations & maintenance contracts.

Government services contractors have historically been integral in assisting US Government agencies achieve missions critical to the security of the United States.  PAE was founded in the 1950s to support the U.S. government’s efforts to rebuild Japan following World War II (1).  Since then PAE has expanded its services to provide Life Support Services at the US embassy in Iraq, to bolster the operations of the Navy’s submarine testing facility, and to refurbish helicopters for the US border patrol.  In doing so, PAE became a trusted partner with the US Department of Defense (“DoD”), Department of State, and Intelligence Agencies (2,3,4).

In recent years, these same government departments asked services contractors to bring a new kind of capability to crucial missions: high-tech services.  While the DoD commonly used large manufacturing contractors to produce high-tech vehicles and weapons throughout history, the DoD has increasingly demanded technology to be delivered as a service, in functions such as cybersecurity and systems integration.  The missions have remained as serious as before, however.

Supporting serious US Government missions like these new high-tech services contracts fit well with PAE’s business model and mission statement: “providing enduring support for the essential missions of the U.S. government, its allied partners and international organizations.”  PAE has delivered on its mission though a customer-centric operating model.  It has worked to understand a customer’s needs, and then executed reliably and at an excellent level.  PAE then used this performance to cultivate long-term relationships with its government customers.  At the same time, PAE expanded its capabilities, so that when customers had additional needs, they turned to PAE (5).

Since expanding into high-tech services fit with PAE’s business and operating models, the company needed to decide whether to seek to grow this business organically, or whether to look to acquire a business in the space.  One feature of the services contracting industry helped make this decision: government agencies awarded contracts based on contractors’ past-performance in a given contract area.  If PAE couldn’t plausibly argue that its experience qualified it for high-tech services, then PAE wouldn’t be able to win any contracts or grow its business.  PAE therefore decided to look to acquire a business with the past performance needed to establish it in the high-tech services space.ats

It found not one, but two businesses to acquire.  One was A-T Solutions, a high-tech national security company with experience in biometric-enabled intelligence, counter-IED (improvised explosive device, and counterterrorism more broadly (6).  The other was GS&S, a carve-out acquired from a distressed parent prior to its bankruptcy.  Among other capabilities, GS&S performed digital litigation support services for the Department of Justice (7).  PAE decided to combine these two acquisitions into a new National Security Solutions segment (“NSS”), under the leadership of a new hire – Kenneth Myers, the outgoing director of DTRA (Defense Threat Reduction Agency) (8).  While biometrics has little to do with litigation support, PAE and Myers presumably determined that these two high-tech services businesses had more in common with each other than with PAE’s legacy business.  Additionally, a separate NSS segment may better position the business for future growth.

When PAE entered the high-tech services space, it decided to do so through acquisition.  Now that it has entered, what is next?  PAE has stated that it is looking to expand the next NSS segment.  Should it once again pursue additional acquisitions?  Or is there another way?

The decision may once again already made for PAE, though with the opposite implication.  PAE’s new private equity owner, Platinum Equity, recently executed a dividend recapitalization, leaving PAE with $710 million in debt – significantly more debt than the business has ever serviced (9).  The resulting high leverage may make it difficult for PAE to finance additional acquisitions, at least in the near-term.  This may not be a bad thing, however.  Historically, high-tech cybersecurity firms have tended to sell for high valuations (10).  Thus, additional acquisitions could be a very expensive way to grow, when a cheaper option exists: grow organically.  Indeed, presumably that is the mandate of the new NSS President, Kenneth Myers.  By leveraging the past performance of the two acquisitions, as well as Meyers’ knowledge of the inner workings of government agencies, PAE can continue to expand its high-tech services offering in years to come.

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Bibliography:

  1. “Our History.” PAE – About PAE – Our History. PAE Inc., n.d. Web. 18 Nov. 2016.
  2. “PAE Awarded Contract to Provide Life Support Services in Iraq.” PAE Press Releases. PAE Inc., 24 Mar. 2014. Web. 18 Nov. 2016.
  3. “Under the InSpace 21® Belt: Case Studies & Past Performance.” InSpace 21. A PAE / Honeywell Joint Venture, 2014. Web. 18 Nov. 2016.
  4. “PAE Delivers Refurbished UH-1N to Customs & Border Protection.” PAE Press Releases. PAE Inc., 3 Mar. 2015. Web. 18 Nov. 2016.
  5. “Our Vision and Values.” PAE – About PAE – Our Vision and Values. PAE Inc., n.d. Web. 18 Nov. 2016.
  6. “PAE Completes Acquisition of A-T Solutions.” PAE Press Releases. PAE Inc., 1 June 2015. Web. 18 Nov. 2016.
  7. Wakeman, Nick. “Troubled USIS Finds Buyer for Global Security Business.” WT Business Beat. Washington Technology, 16 Jan. 2015. Web. 18 Nov. 2016.
  8. “PAE Names Kenneth Myers President of National Security Solutions Business Unit.” PAE Press Releases. PAE Inc., 17 Mar. 2016. Web. 18 Nov. 2016.
  9. Bach, James. “S&P: PAE Inc. Trims Debt Offering but Will Stay Highly Leveraged.” Washington Business Journal. N.p., 21 Oct. 2016. Web. 18 Nov. 2016.
  10. Hagan, John. “Cybersecurity Firms’ Values Soar as Attacks Increase.” Washington Technology. N.p., 5 Oct. 2010. Web. 18 Nov. 2016.

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3 thoughts on “Grow through Acquisition or Organically? A Government Services Contractor Enters Tech

  1. Dan, thanks for sharing this thought-provoking piece on how management and Boards should think about corporate strategy in the face of increasing demands for service players to become high-technology players. I believe there is a third option to consider – to grow capabilities in technology, PAE does not necessarily have to acquire a business or grow organically, but it can form partnerships with technology companies to add capabilities to its existing suite of services. More and more, we are seeing tech start-ups form strategic long-term partnerships with key industry players as part of a core tenant to their operating model. While there may be security/privacy concerns on information sharing when partnering with a high-tech cybersecurity firm, I believe if done correctly, this is a very viable path for a highly-levered, private-equity owned company to being successful in quickly building out its breadth of its National Security Solutions segment and landing future government contracts.

  2. Great post Dan. Thank you for putting this together. I believe this is a very god example of a company trying to adapt to the new challenges imposed by new technologies. Probably this applies to the majority of the companies globally. But is this the right answer to everyone? Probably no. After reading your amazing post I keep thinking: How should companies approach future? Should they spend money in advance to stay in touch with all new technology advancements or wait until they need something to acquire another company that is already working in that particular field and technology? Most of us I suppose would choose the first option intuitively. Nevertheless your post provides a good example for the latter one. In any case, great food for thought.

  3. Great read, Dan. The challenge you highlight is increasingly complicated through the company’s new private equity ownership structure. In making their decisions going forward, the owners must weigh both their own return targets (which are constrained by shorter investment horizons) and the growth attractiveness for prospective buyers in the future. Is the company more attractive if it acquires many businesses and highlights its capabilities as a consolidator? Or is it more attractive if there is universe of potential/un-tapped acquisitions that can turbocharge growth going forward? As you highlight, Platinum probably decided that integration and synergies were the priority, and that the next buyers can worry about making incremental acquisitions. At the end of the day, bolt-on acquisitions are challenging and usually high risk. They require competent management teams and a unified vision for the new organization. In my limited work experience, I’ve seen this strategy work well, but I’ve also seen it fail spectacularly.

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