by John Caucis, Analyst
The threat of aggressive defense budget cuts inches closer to becoming a reality as the federal government adopts greater austerity measures to cope with mounting budget deficits. Seeing the writing on the wall, TBR believes General Dynamics Information Systems & Technology (IS&T) group moved decisively to diversify its revenue base and protect against looming cuts in defense outlays with the acquisition of Vangent. TBR estimates that Vangent will add between $950 million and $1 billion new revenue to IS&T’s 2012 topline (revenue from the acquisition will not be accretive until 2012), which TBR had initially projected would grow 4% to 5% over 2011 and reach between $12.5 billion and $12.6 billion. Once the deal has closed, TBR estimates the IS&T group will realize between 11% and 13% top-line growth in 2011, surpassing $13 billion for the year. TBR estimates the acquisition of Vangent will add between 700 and 900 basis points of inorganic growth to IS&T’s top-line expansion rate in 2012.
TBR believes the purchase of Vangent will immediately give General Dynamics IS&T a large, fast-growing a business unit in the health IT (HITS) space; a market sector in the U.S. expected to grow between 20% and 25% annually through 2014. In the federal space, demand for healthcare IT services is expected to grow at 5% annually, outpacing projections for the general budget growth of 1% to 3%. While Vangent’s client focus is on the U.S. departments of Health and Human Services (HHS), Education, Labor, State and Defense, the firm did realize over 30% growth in its most recent fiscal year (calendar 2010). TBR estimates Vangent realized 20% to 23% organic growth in 2010, accounting for the estimated revenue impact of Buccaneer Computer Systems and Services, Inc. acquired in 4Q10. Vangent’s core services are health information and information exchange, EHRs and data analytics.
The HITS market is in its infancy, but TBR expects the federal government’s initiative to drive the adoption of Electronic Health Records (EHR) will be the primary catalyst for the expected surge in growth. Federal stimulus spending will also fuel growth in the HITS space as will new infrastructure investments to support EHRs and other new applications, the development of mobile applications and social media solutions for healthcare organizations and the introduction of new hardware and software for patient care, patient records, and new medical diagnostics and imaging. Buying Vangent will enable General Dynamics to accelerate its penetration into the HITS market and will augment capabilities purchased with General Dynamics’ $225 million acquisition of ViPS in 2008. TBR estimates General Dynamics generated $250 million in HITS revenue in 2010, which implies the acquisition of Vangent will put IS&T on track to increase the 2010 amount as much as five-fold in 2012. TBR also believes General Dynamics IS&T will be able to expand its wallet-share within Vangent’s core federal HHS, Education, Labor, State and Defense department clients, and we do not rule out the potential for IS&T to expand beyond the federal government into the state and local government space, or even the commercial space. Furthermore, the capabilities General Dynamics IS&T will acquire with Vangent will provide additional services that can be leveraged to expand IS&T’s international footprint. Demand for government healthcare management solutions continues to grow in the APAC region, for example, where improving standards of living have created higher expectations of healthcare delivery.
TBR expects the purchase of Vangent may not be the last acquisition General Dynamics makes in the HITS space in 2011 or 2012. We estimate the company likely will retain over $1 billion in cash on its balance sheet after the acquisition of Vangent. While this would be sufficient for the firm to make one or more smaller HITS-related acquisitions, General Dynamics central focus on improving operational efficiencies to affect positive cash flow from operations will replenish its liquidity to fund further M&A activity.
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