By Sebastian Lagana, Senior Analyst
IS&T’s operations and portfolio streamlining efforts are generating revenue and profitability benefits sooner than expected
General Dynamics Information Systems & Technology (IS&T) surged back into positive territory during 1Q15, capturing year-to-year revenue growth of 3.9%, significantly outperforming expected top-line contractions in the midsingle digits. While aided slightly by inorganic contributions, evidenced by a slightly lower organic growth rate estimated at 2%, the group’s ability to generate revenue through its legacy IT business and increasingly quick turn work completed within the Mission Systems (MS) business reinforces an increasingly positive revenue outlook for the remainder of 2015, which we believe will likely result in the group exceeding officially tendered guidance for mid-single-digit revenue contraction. Although our annual revenue projections remain aligned with General Dynamics officially tendered guidance, we expect revenue upside potential could result in full-year revenue contractions in the low single digits instead of the existing guidance range.
IS&T also achieved its strongest operating profitability in over three years during 1Q15, realizing an operating margin of 9.2% during the quarter. The improvement is a mix of corporate Back to Basics profitability enhancement initiatives and business-unit-specific benefits garnered through the consolidation of the legacy C4 Systems and Advanced Information Systems divisions into the new MS division. The additional scale achieved through the consolidation resulted in operations and delivery cost savings, impacting margins positively.
IS&T streamlines its cyber business to increase focus on federal pain points
In April General Dynamics announced it entered a definitive agreement to sell its Fidelis Cybersecurity unit to Marlin Equity Partners, a private equity firm specializing in corporate divestitures and extractions of business units between $20 million and $2 billion in value. Despite General Dynamics noting Fidelis had doubled in size during its tenure of two-plus years within the organization, albeit on a small revenue base, it was noted Fidelis’ commercially centric business was not core to IS&T’s operations and fit the profile of smaller-scale divestitures to lean down IS&T’s portfolio.
There have been some mixed signals from U.S. defense-led contractors recently regarding commercial cyber, as IS&T’s move aligns with that of competitor Boeing, who also announced the pending sale its commercial cyber business, Narus, to security giant Symantec during January. That said, companies such as Lockheed Martin, BAE Systems and most notably Raytheon have invested in commercial cyber capabilities over the past 12 months. This diverging opinion on future market opportunity for commercial cyber is tied to companies’ overarching cyber portfolio development within their services business, as those with a large cyber component exude more confidence in commercial prospects.
Aside from deeper cyber portfolios, larger cyber players such as Lockheed and Raytheon have sufficient cachet to pursue cyber opportunities outside their core markets, internationally and commercially. We believe the move by General Dynamics to streamline its focus into more niche areas of government-focused security will benefit the company’s prospects at the federal level, as IS&T will be able to invest more heavily in solutions that tackle important federal security issues such as top secret network encryption, the proliferation of insider threats, and state-sponsored attacks on defense and intelligence clients’ networks.
IS&T’ growing networked communication portfolio supports profitability improvement
Improving profitability remains a key initiative for IS&T, as the group leveraged cost-containment initiatives to help drive a 90 basis point improvement in profitability from 2013 (7.7%) to 2014 (8.6%). The second component in improving operating margin will be shifting the sales mix to support more profitable product sales, which dropped in 2013 in line with declining U.S. Army spend on communication-related products.
IS&T announced a handful of product updates recently, such as radio software updates, WIN-T Increment 2 and the TACLANE 10G network encryptor, which may help regain footing in the radio and tactical communications markets. Increased product traction will be critical to the company recapturing the 10% profitability threshold the company enjoyed in 2010 and 2011, when a favorable sales mix resulted in a lower proportion of more commoditized, lower-margin IT engagements.
Please feel free to use this content with TBR and analyst attributions. Contact Sebastian Lagana at (603) 758-1857 or via email at sebastian.lagana@tbri.com for additional analysis.
