Leidos Holdings Inc. announced that it has entered into a definitive agreement to combine with Lockheed Martin's realigned Information Systems & Global Solutins business (IS&GS) in a Reverse Morris Trust transaction which will preserve the tax-free nature of the split-off. IS&GS has approximately $4.7 billion in sales and over 16,000 employees. The combined company will be the largest US government servicess business with approximately $10 billion in revenue and EBITDA margins of 9.5-10.0% after projected annual cost synergies of approximatel $120 million. The deal is expected to close in the second half of 2016.
IS&GS provides IT infrastructure, mission and business solutions, facilities M&O and logistics services to a diversified government customer base. Approximately 60% of the business serves civil agencies including those in aviation, energy, space and science, civil IT, and health while the remaining business serves defense, intel, and commercial cyber markets. The business is prime on 90% of its work with a contract mix split between cost plus (45%), fixed price (42%), and time & material (13%). Over 5,500 of the 16,000 employees hold security clearances (67% Secret/Top Secret, 33% SCI).
According to Roger Krone, Leidos Chairman and CEO: “The combination of IS&GS with Leidos creates truly significant value for our shareholders, and brings together a $10 billion portfolio of solutions, mission IT, and technical services. The combined company will be a more diversified leader in the markets we serve, giving us the scale and access to markets that enable further growth."
The total transaction value for IS&GS is approximately $5 billion including $3.2 billion in Leidos stock and $1.8 billion in a special cash payment to Lockheed Martin. At closing, Leidos shareholders will receive a special cash dividend of $1.0 billion or approximately $13.50 per share. After the closing, Lockheed Martin shareholders will own 50.5% of the combined entity with Leidos shareholders owning 49.5%. The combined company will have approximately $3.4 billion in net debt which is approximately 3.5 times pro-forma EBITDA.
So what do we think of the deal? In some ways, it appears Leidos is doing the deal just for the sake of getting bigger. Only 40% of the IS&GS business serves the more attractive defense, intel, and cyber markets and the high level of cost-plus work with relatively low cleared staff ratio doesn't necessarily scream high margin work. Actually, when you couple these factors with the type of services IS&GS provides (IT infrastructure, mission support, facilities and logistics services), the combined company looks a whole lot like the old SAIC prior to the Leidos/new SAIC split. In addition, cost synergies look great on a PowerPoint but they're a whole lot harder to realize in real life.
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