The rest of fiscal 2023 is shaping up to be an extra-rocky time for contractors

The usual uncertainty over budget negotiations, coupled with the debt-ceiling brinksmanship, mean contractors should be highly prepared. This as federal spending continues to set records. For one view of the situation, Federal Drive with Tom Temin spoke with federal sales and marketing consultant Larry Allen.

Interview transcript:

Larry Allen Tom, I think that this debt ceiling crisis is going to have a more immediate impact on contractors than many people think, and it’s going to have more immediate impact on government agencies than many people think. And that is, because agencies have to plan as if their operations will be affected. I think we talked previously about continuity of operations, and that’s certainly something that is increasingly a focus. The closer we get to a purported deadline on when we will reach the debt ceiling as a country, and what that might mean in case we don’t have a deal in place to fix that. So I think if you’re a government contractor, you want to anticipate a slowdown in business. You also want to anticipate whether or not you might get paid on projects, at least paid in a timely manner. If there is a debt default, I think Tom, like many crises in government, this one is going to last right up until the last possible minute. We saw the House Republicans come out last week with the first salvo in what they think a deal might want to look like and is important to understand that just really is the first salvo. It’s kind of like, if you’re in a football game, that’s the first drive of the game after the kick off and it’s not going to go anywhere, even if it put points on the board, it’s usually not going to be the final points in the game. So there’s going to be other plans, we hope. We hope there will be other proposals. Right now, the administration and others that are involved in these discussions haven’t really come up with a counterproposal, yet. Maybe we’ll see some of that this week. So far, the counterproposal has just been no cuts. Well, I think everybody understands that a debt ceiling extension that comes with no cuts in any sort of domestic spending is as much of a nonstarter, as perhaps portions of the plan unveiled last week by House Republicans.

Tom Temin Right then with the debt ceiling actually looming, the government will have to pay itself its employees and those obligations first. Contracting obligations would be second in line if they thought they really had to stop spending in a dramatic way. It’s almost like throwing a monkey wrench into an operating engine. You can get it to stop quickly, but you can’t get it going again that fast.

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Larry Allen That’s exactly right. That’s a really good analogy. So what happens to the extent that we know, because remember, we’ve never actually had a debt ceiling default before. But mandatory spending, that is spending for Social Security, Medicare, Medicaid, things of that nature that will continue, and that’s a lot of spending. But that means there are fewer dollars left over for so-called discretionary spending. Those are the dollars that go to pay government contractors for work performed. And even inside their Tom, there will be a hierarchy. All of the things that are deemed imperative to support national security, they will most likely get a higher priority for payment than more routine acquisitions of commercial items and services. Now, if you’re a small business listening to this and you think, hey, that could affect my ability to get paid on time, you’re probably right. Unless you’re performing on one of the intelligence community or high level national defense projects. This is a thing that could disproportionately hit small businesses, Tom, who really need the cash flow, but aren’t always providing those things that are at the top echelon of what the government needs to meet its missions.

Tom Temin We’re speaking with Larry Allen, president of Allen Federal Business Partners. And I wanted to ask you about some figures that have come out from Bloomberg that you’re reporting on, and they have kind of outlined the shape of the current spending in information technology and general government. And I guess we knew that the services portion was on the rise, but now they’ve delineated just how big services are as a component of federal spending.

Larry Allen Tom, I thought that this was interesting. We haven’t talked about this in the media for a while now. Ten years ago, there was, I think, much more steady tracking on what the percentage of federal IT spend was every year, in proportion to total federal contract spending. So Bloomberg came out recently and said, look, when you look at the information technology spend and the professional services spend together, those two areas alone account for 26% of non-classified government spending every year. That’s a significant part of the government acquisition budget. When you think about all the missiles, boats and planes that the government buys every year, which are usually very large ticket items, to have professional services and IT come up to that level, that’s pretty significant. What it really tells people is that professional services are indeed as ubiquitous as you might think they are. I’ve said before that government agencies can’t go to war, can’t process benefits checks, can’t maintain their IT without contractors. These numbers underscore those types of things, Tom. But I think maybe a potential surprise that there’s so much being spent on IT, in terms of modernization and also supporting projects that are already in place.

Tom Temin Well, that gives contractors or would be contractors, a kind of roadmap of where the growth is. And I wonder what effect that phenomenon has on mergers and acquisitions.

Larry Allen Well, we’ve certainly seen a lot of merger and acquisition activity in the IT and professional spaces lately, Tom. You never know, in this marketplace, there’s always a certain amount of activity. But I will tell you that the Allen federal phone has started to ring much more often in the last 90 days from people who are looking for companies to buy, whether it’s a company that has a certain contract vehicle or whether it’s a company that’s looking for somebody with a certain socioeconomic status. It’s not empirical for sure, but we already have some decent M&A activity going on in the market that’s being chronicled. There’s a lot more going on behind the scenes, and I think people are looking at this for a couple of reasons. One, they certainly want to strike while the iron is hot and leverage relationships that the companies that they’re looking at might have, because that’s very important. But two, Tom, is I think some people might realize that we may very well be at or near the top, in terms of annual federal contract spending for a little while. It’s nice to think as a contractor that it goes continually up, but history shows that it does not. So one way to get some extra business now and protect yourself in any downtime is by consolidating resources.

Tom Temin Although it makes it difficult, I think, to evaluate in some ways, because when you buy a services company, you’re buying people, you’re buying a body shop. And people are a lot more prone to coming and going and departing, than if you buy a company that has a factory and machinery and a definitive product that you know is going to be in demand, a piece of hard product.

Larry Allen You raise an excellent point. I think you always have to be concerned as a buyer of a professional services company that you’re going to have the main people, the critical core, come with you when you buy it. And that’s what any buyer wants to see. They want to see that the talent that they think they’re getting is actually going to be part of the deal. But coming into these discussions now in federal is this whole discussion of doing away with non-compete agreements, which makes it easier for one person to leave one company and go somewhere else. It makes it harder for the company to say, yes if you want Jerry Jones to be part of the deal, we can make sure that Jerry has a non-compete and that we raise his pay. So the likelihood that Jerry will stay will be good. And that’s the type of stuff that used to always work. But now Jerry Jones has a lot more portability options, and that makes evaluating professional companies much more risky. Another way that people look at it, though, Tom, is by looking at existing contracts and existing projects, the size, scope, the likelihood of those being sustainable over some period of time, that’s still going to stay there. And for companies that have that good install base and have the good relationships, they’re still going to be very viable takeover targets.

 

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