Computer Sciences Corp.’s [CSC] announcement last week that it plans to split into two separate publicly traded companies, one focused on commercial and global government customers and the other on the U.S. public sector, is consistent with expectations that the defense services sector is headed for a restructuring, according to defense analyst Byron Callan.
“We have expected that defense services sector restructuring would be a key theme for 2015,” Callan wrote in a client note for the strategic advisory firm Capital Alpha Partners. CSC’s plans combined with BAE Systems‘ announcement in April that it is exploring the divestiture of its U.S.-based government services businesses “confirm” this theme, he said in a May 24 research note.
CSC is separating the business following a three-year effort to reposition the company for long-term growth by cutting $1.9 billion in costs and reinvesting “large portions of our savings back into the business to build next-generation offerings, expand sales capability, and fund work force optimization efforts,” Mark Lawrie, the company’s CEO, said on an analyst call last Tuesday to discuss the separation and fourth quarter earnings results. “And as we were turning around the business, market shifts began accelerating, creating in some cases diverging opportunities and diverging challenges.”
On the public sector front, which includes the federal, state and local governments, Lawrie said “Clients want providers with specific experience in government-focused innovation,” while “on the commercial side, client want partners with deep understanding of their business who can help lead their digital transformations.” The demand trends in these two sectors “suggest different growth profiles and different capital requirements,” he said, adding as stand alone companies each one will have “the opportunity…to pursue long-term strategies tailored to their segments.”
Callan said that the shifting defense services sector has been driven by increased competition, “particularly in lower value-add businesses,” which due to two things, lower services spending related to the wars in Afghanistan and Iraq, and the Defense Department’s policy change that led some defense companies to shed portions of their services businesses to avoid conflicts of interest with government work elsewhere in their companies.
CSC hopes to have the separation complete by Oct. 25, subject to regulatory approval. CSC-Global Commercial, which will be led by Lawrie, will have about $8.1 billion in annual sales and 51,000 employees with more than 1,000 customers. The company will have strong positions in the insurance, banking and healthcare industries and a presence in more than 50 countries.
CSC-U.S. Public Sector has about $4.1 billion in sales, 38 percent of which is with the DoD, 14,000 employees, 35 percent of whom have top secret and above clearances, and a handsome 14.7 percent operating margin. CSC said it will be a top three pure-play government information technology services company.
CSC said the business has a 90 percent win rate on its contract recompetes and competitive extensions, with more than 1,000 projects underway with more than 70 agencies. Briefing charts accompanying CSC’s presentation indicate that the company expects 38 percent growth in next-generation information technology business during the next year.
Lawrie will be executive chairman of the public sector company. The leadership of the government services business hasn’t been announced.
Callan also noted that in the past few years private equity firms have purchased government services firms and may now be looking to rid these from their portfolios. He sees consolidation ahead in the various subsectors that make up the government services space.
As part of the separation, CSC will pay its shareholders a $10.50 per share special dividend at closing.
RBC Capital Markets is CSC’s financial adviser on the separation with additional financial advice provided by Guggenheim Partners.