The defense industry gained momentum in 2014 and 2015. The Ryan-Murray budget deal in late 2013 provided much-needed clarity to investors and rewarded the industry with higher valuations. Although sequestration remains a very real issue for many, there is much more optimism about where the industry is headed. These factors appear to be driving an improved transaction market. Several large, notable deals were recently announced, including SRA, Exelis, TASC and Scitor. Values for all of these exceeded $700 million, and an average EBITDA multiple of 11.1x was reported (with Scitor being the biggest driver at over 15.0x).
Although large deals make a splash, they do not necessarily indicate overall market sentiment. Stout has compiled a database of private company transactions to assess current market conditions.
Transaction multiples dropped precipitously after several strong years. However, consistent with the general optimism within the government sector, recent deal activity and multiples appear to be improving. As Figure 1 highlights, LTM EBITDA multiples paid for deals since 2011 are materially below those paid between 2008 and 2010. Continuing resolutions during much of fiscal year 2011 and the possibility of a shutdown dampened industry expectations.
The mood did not improve after formation of a bipartisan super-committee that looked at cutting $1.2 trillion from the federal deficit over a ten-year period.
Figure 2 shows the annual change in multiples from 2008 through mid-December 2015, and it even more clearly illustrates the changes in transaction multiples. After a very robust 2008 market, multiples dropped in 2009 when in-sourcing became a key headwind. As that issue abated, the market improved slightly, but then additional budgetary constraints hit. Enthusiasm dropped until the past two years when spending priorities became clearer.
Figure 3 provides an annual trend from 2008 through mid-December 2015, but compares deals with publicly available information against our private company transaction database. The publicly available deals reported higher implied multiples in all but three of the past eight years — and often by a meaningful amount. Interestingly, the private company deal multiples exceeded those of the publicly available during the past two years, although that might be due to a limited number of data points for the publicly available data set in 2014. Another noticeable difference is the relatively consistent multiples paid for those deals as shown in publicly available information compared with sharp declines evident in the Stout private company database between 2011 and 2013.
The size of a company is an important driver of multiples: Larger companies often garner higher multiples. As Figure 4 illustrates, the Stout private company database supports this assumption, but not as dramatically as expected. In fact, the smallest deals appear to outperform larger ones. This might be because many deals never close and only those transactions that met specific strategic needs of buyers did close (e.g., buying a small cyber security-focused company). Further, this impact of size could be more pronounced for the largest of deals. Companies in the Stout private company database for all deals greater than $100 million, with an average deal size in this category of $200 million, reported a median multiple of only 8.7x EBITDA (see Figure 4) compared with 11.9x EBITDA for the publicly available transactions, which reported an average deal size of more than $800 million.
Overall, the evidence shows the deal market — whether private or public — is continuing to improve. The past two years have seen significant improvement in multiples, driven by a rebound in expected growth and improved industry conditions. As we continue into 2016, it will be interesting to see whether large deals continue to drive the market and whether multiples return to the highs seen between 2008 and 2010.