By Joey Cresta, Research Analyst
Scitor’s inorganic contributions facilitated double-digit revenue growth, but not at the rate SAIC expected
Year-to-year revenue growth of 13.1% in 3Q15 belies SAIC’s early struggles to get the expected benefits of its Scitor acquisition. Scitor-related revenue was down 6% as it faced the same challenges as SAIC overall and the broader market, such as increased incidence of recompetes as cost-conscious federal clients seek more favorable contract terms. While SAIC stated one route to growth in its intelligence business is through increased cross-selling of its broader enterprise IT portfolio, there is more competition from peers for enterprise IT contracts, whereas Scitor’s specialized capabilities will prove more critical to success in this market.
Operating margin remained below peer average at 5.6% in 3Q15 due to acquisition integration costs and internal portfolio investments to pursue target markets such as healthcare. While Scitor provides higher-margin opportunities, we expect margin pressure to continue over the next year as SAIC identified facility consolidation opportunities that will result in an additional $10 million in acquisition integration costs. However, these initiatives will reduce operating expenses by $6 million annually, presenting opportunity to expand margins beginning in 2H16.
SAIC seeks to build a healthcare practice organically to avoid pitfalls of aggressive acquisition-driven expansion
SAIC’s portfolio-building focus shifted recently to healthcare, a market in which it can repurpose solutions related to analytics, cloud and mobility it delivers to other clients. The company hired Tom Anderson as vice president of Health Services in May to facilitate its entry into the healthcare space. Healthcare is a market SAIC exited during its split from Leidos in 2013, but it is an attractive adjacent market given the faster growth expected in federal health IT spend compared to overall federal IT spend, with healthcare projected to grow at a CAGR above 2% to nearly $5 billion in 2019.
Since Anderson joined, SAIC focused on building a healthcare-focused business development and capture team and engaging clinical experts for partnership opportunities. Early on, we believe SAIC will focus on healthcare opportunities in the federal market, from which it generates virtually all its revenue. As the practice becomes more established, SAIC will be able to pursue state and local deals, with commercial markets a tertiary long-term opportunity.
SAIC’s organic approach to building a healthcare practice differs from peers such as Lockheed Martin, General Dynamics and Leidos, which all entered the healthcare market via acquisition. We believe there is merit in SAIC’s strategy given peers’ struggles in healthcare — General Dynamics’ Vangent acquisition was a key driver of a $2 billion goodwill write-down in 4Q12, Lockheed is likely to divest its healthcare IT business as part of its IT services portfolio strategic review, and Leidos’ commercial health IT struggles continue to drag down corporate profitability, regardless of its federal healthcare success.
SAIC’s serious game studio will help it differentiate in the training market
In July SAIC opened a serious game studio to develop game-based training platforms for clients in the public and private sector. The studio is the first dedicated game development facility we have observed among companies in our public sector coverage, indicating SAIC aims to establish a leadership position in an emerging market with opportunities across government and targeted verticals such as healthcare.
SAIC’s experience with serious games includes supporting development of “America’s Army,” a computer game the U.S. Army uses for recruiting. While the Department of Defense is an early adopter of serious games, we expect SAIC will attempt to create nontraditional training and education tools for other public and private sector entities as well. Opening the studio in Seattle has strategic value, as it enables SAIC to tap into the vast technology talent in the region. This will help it build a diverse team of designers, artists, composers and animators to compete with Tier 1 vendors such as Northrop Grumman creating innovative training and simulation solutions.
Please feel free to use this content with TBR and analyst attributions. Contact Joey Cresta at +1 603.929.1166 or via email at joey.cresta@tbri.com for additional analysis.
