Private equity makes big play for government services companies

In a move that seemed a little like the boa constrictor swallowing an elephant in “The Little Prince,” IBM Consulting made a deal for its biggest acquisition ever with the purchase of federal government digital services provider Octo Consulting. The $1.25 billion transaction included moving 1,500 Octo employees into IBM’s consulting business and it enhanced Big Blue’s place in the firmament of the government consulting and technology services landscape.

For Octo, the move created an opportunity for future expansion, and by acquiring Octo, IBM increased its foothold in the business of federal government.

“Our capabilities and the intellectual property that Octo invested in aligns very nicely with some of the platform plays and investments that we’ve made within IBM Consulting. So it was really looking at that complement. And then it really did come down to culture and cultural fit, a shared purpose, a vision and purpose,” said Susan Wedge, a managing partner with IBM’s U.S. public and federal market group at Washington Technology’s M&A Trends event Friday.

While the IBM-Octo acquisition stands out for its size and value, mergers and acquisitions within the sphere of government services companies saw a sharp increase over the past two years. The trend moved from 50-to-75 deals a decade ago to about 100 per year over the past 10 years. Then 2021 hit.

“I think in 2021, there were about 180 transactions just in government services deals, that doesn’t include aerospace, defense and hardware. In 2022, there were about 110,” said Kate Troendle, a managing director at investment banking firm KippsDesanto and Company.

Troendle said 2022 seemed like a pullback, but in reality it still showed a spike from average numbers prior to 2021, and she said that trend will continue.

“I think that absolutely will remain similar going forward and 2023, will we be at 180 transactions? Probably not. Will we be close to 110 or so? I think so,” Troendle said. “The drivers of that growth have been largely related to private equity. The proliferation of private equity in the government services sector have, created so many more buyers that have an absolute need to invest and acquire.”

Before moving into the IBM fold, Octo acquired four other businesses on its own. Working with Big Blue seemed like the logical next step for growth.

“What drew us to this is the fact that we had the ability to be that impactful to an organization that has that global corporate presence, an organization that has that legacy and a technology organization of that size and scale,” said Octo CEO Mehul Sanghani.

Wedge said the added benefits created by the acquisition were more than just expansion. It represented a strategic move for IBM to gain market share in government services like the Veteran’s Administration, where Octo already had a big established business.

“We want to double our business in the next three years; you don’t do that by doing more of the same. So I think we’re coming into this from the perspective of,  we need to change our business, we know we need to learn from the best of Octo, and the best of IBM, and bring those together to create this third culture, really grounded in that purpose. We have lofty goals,” Wedge said.

IBM announced the acquisition in December, and it was part of a buying spree for the company. Octo counted as one of eight acquisitions for IBM in 2022. Since Arvind Krishna became CEO of the company in April 2020, IBM acquired more than 25 companies focusing on hybrid cloud and artificial intelligence capabilities, according to a written statement.

Troendle said in the past five or six years, private equity in the federal government sector acquired or created about 125 new platform investments, or investments meant as starting points for more acquisitions, known as add-ons, to follow in the future. Investors exited 85 more platform investments, and about 50 new buyers came into the marketplace looking for deals. The overall result meant an increase in demand for mid-market M&A in the government sector.

Additionally, major investment firms focused on government like Arlington Capital Partners and Veritas Capital are aggressively increasing the funds they have to spend.

“When you have that much buyer demand, legacy investors like the Arlington’s, the Veritas, they’ve been raising massive funds. Arlington used to be executing out of an $800 million fund and they raised a $1.8 billion fund. Now they’re raising about a $3.5 billion fund. So the core investors in our sector are getting bigger. And that’s also fueling that kind of demand for acquisitions,” Troendle said.

 

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