General Dynamics (NYSE: GD) at long last has put its industry-best balance sheet to work, agreeing to acquire government IT firm CSRA (NYSE: CSRA) for $9.6 billion in cash and assumed debt. And while GD doing a deal was no surprise, the target was.
The deal, the largest in General Dynamics history, would beef up the company's services and IT business. It continues a wave of consolidation in the government IT sector in which most of GD's large defense rivals have gone in the opposite direction, lessening their exposure to the business. Lockheed Martin, for example, in 2016 shed much of its IT business in a deal that created Leidos Holdings, and L-3 Communications the same year sold its IT unit to CACI International.
Continue Reading Below
Upcoming budget bonanza
But General Dynamics has a history of going against the grain, and the company clearly sees opportunity here. CSRA, a $5 billion-sales provider of IT services for the Pentagon, Homeland Security, and civil agencies, was formed in November 2015 via the alphabet-soup merger of SRA International and the public-sector business of CSC.
CSRA has been a laggard at a time when defense stocks have soared, with its share price basically flat from its inception prior to the deal announcement. General Dynamics, by comparison, is up 50% over the past three years, and government IT rivals Science Applications International and CACI are up 92.9% and 69.7%, respectively. This despite CSRA's margins coming in well above those of its rivals.
General Dynamics CEO Phebe Novakovic on a call with investors last month said that growth at her company's internal IT arm was slowed in 2017 because of the impact of short-term government funding resolutions and delays related to the transition to a new administration. She said the unit's backlog remained healthy, and business began to pick up in the second half of the year, which she said, "leads me to be confident that the growth in this business will materialize beginning in 2018."
With Congress at long last seemingly near a breakthrough that would lead to a long-term budget agreement and a suspension of spending caps, previously delayed IT contracts could finally be awarded. General Dynamics should be well-positioned to receive a good deal of that new funding: The company after buying CSRA would have nearly $10 billion in IT and government services sales, on par with market leader Leidos in a business where scale and cost competitiveness are vital.
"We see substantial opportunities to provide cost-effective IT solutions and services to the Department of Defense, the intelligence community and federal civilian agencies," Novakovic said in a statement Monday. "It will allow us to deliver even more innovative, leading-edge solutions to our customers."
The General's time to shine?
Shares of General Dynamics, though up in recent years, have actually trailed shares of Lockheed Martin, Northrop Grumman, and Raytheon due to concerns over its Gulfstream business jet unit. With Gulfstream showing signs of stabilizing, a reinvigorated IT unit post-deal could give GD two differentiated segments that, by year's end, could help it to make up the gap, or even outperform.
The things investors love about General Dynamics are unlikely to change because the company is buying CSRA. GD said it expects the purchase to add to earnings and free cash flow in 2019, helped on with about $200 million in cost savings expected by 2020 after combining the operations.
General Dynamics, which has increased its dividend for 26 straight years, said it was committed to continuation of its dividend policy. And the company, which prior to the acquisition had less debt on its books than any of its competitors, said it expects a "rapid deleveraging" using free cash generation.
GD already looked like one of the better buys in the defense business even before buying CSRA. Though acquisitions always add a layer of risk, the company is well-positioned to be a solid performer in the years to come.
10 stocks we like better than General DynamicsWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and General Dynamics wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of February 5, 2018