CACI International [CACI] on Tuesday said it has agreed to acquire most of the National Security Solutions segment of L-3 Communications [LLL] for $550 million in cash in a deal that that will significantly expand the company’s capabilities in large enterprise information technology and mission systems IT programs.

CACI officials expect the acquisition, which will be financed through a combination of existing and new credit facilities, to close in late January or February 2016 subject to regulatory approval. CACI said that NSS would add about $1 billion in annual sales, bringing the company’s annual sales to at least $4.3 billion.

CACI President and CEO Ken Asbury
CACI President and CEO Ken Asbury

The NSS business fills a gap in CACI’s capabilities in enterprise and mission systems IT, Ken Asbury, CACI’s president and CEO, told Defense Daily in an interview. He also said the deal will help CACI scale up to go after more opportunities with the increased domain knowledge and expertise it is obtaining.

“We had a reasonable enterprise IT and mission IT business but when we saw theirs come on the market…we thought that would be an ideal match because they bring us scale and a lot of breadth in that marketplace,” Asbury said.

The ascension of new commercial companies in the federal IT support space is changing the way the government “collects, processes and distributes information,” Asbury said. No longer is the government building brick and mortar data centers when those capabilities can be acquired more easily in the commercial world, he said.

The NSS acquisition adds the “scale and breadth” to help CACI be “able to go partner with those kinds of commercial companies, have the mission and very classified context for how that gets done inside of certain intelligence and national security related agencies, and that’s where we see our business model going in the future,” Asbury said. “We’re now more of a knowledge business than the experts at IT because we can buy that as a commodity.”

L-3 earlier this year announced its plans to divest its NSS business, which isn’t growing and has low margins. CACI executives said Tuesday on an investor call to discuss the pending acquisition that as part of their company, NSS will achieve cost savings synergies and improvements to program performance to allow the business to operate at more competitive rates, thereby enabling it to match CACI’s near-term sales and margin targets.

In the near-term CACI’s expectations are for low single-digit organic revenue growth and operating margins of at least 7.5 percent. Asbury said that NSS margins are below 6 percent.

Excluding one-time transaction-related expenses, CACI expects the acquisition to be accretive to its earnings in its current fiscal year, which began in July, and be at least 10 percent accretive to its fiscal year 2017 earnings.

The NSS business also expands CACI’s capabilities in big data analytics, intelligence analysis, cyber, and training, Asbury said on the investor call. The NSS business has about 4,000 employees, 90 percent of whom have security clearances.

The Defense Department makes up 54 percent of NSS’ sales, the intelligence community about 20 percent, federal civilian agencies 17 percent, and international customers about 6 percent, according to CACI. Key long-term customers include the Army, National Security Agency and National Reconnaissance Office, the Air Force, Navy, Department of Homeland Security, NASA, Federal Aviation Administration, and Special Operations Command.

CACI said it may have to divest one small contract that NSS performs due to potential organizational conflict of interest issues.

L-3 is reshaping its portfolio to focus more on its higher margin defense electronics, communications and ISR businesses. The company said in October that it is looking at additional divestitures to help it drive organic growth and margin improvement.

Michael Strianese, L-3’s chairman and CEO, said in a statement that “the proceeds from the sale will provide L-3 with additional flexibility to continue focusing on a disciplined and balanced capital allocation strategy to drive shareholder value and enhance the market-leading products and systems we provide to our customers.”

During an L-3 investor presentation on Tuesday, Strianese said L-3 is interested in acquisitions in the $50 million to $100 million range.

L-3’s financial adviser on the deal is Deutsche Bank Securities, Inc.

News of the sale of the NSS business follows recent announcements by Lockheed Martin [LMT] and Britain’s BAE Systems related to their federal IT businesses. Lockheed Martin said this month that it is delaying the sale of its roughly $6 billion federal IT business until early next year because of interest from a lot of potential acquirers. BAE decided not to sell its federal IT business after it said the division can still create value for the company and shareholders.

And in November, CSC [CSC] completed a spin-off of its federal IT solutions business, which has been renamed CSRA Inc. [CSRA]. As soon as CRSA was divested, it acquired SRA International, making it a $5.5 billion federal IT solutions and services provider.

Byron Callan, a defense analyst with the advisory firm Capital Alpha Partners, said in a client note on Tuesday that with NSS CACI’s pro forma sales of about $4.4 billion are below the consensus estimates of Booz Allen Hamilton [BAH], CSRA, Leidos [LDOS], and Science Applications International Corp. [SAIC], but “close enough to the [approximately] $5 billion in sales/scale these companies have.”

Callan also said that “While there is debate on this subject, we continue to believe that appropriate scale could be re-defined upward in defense services in 2016-18 and a period of portfolio sorting may be followed by a period of consolidation.”