Huntington Ingalls Industries [HII] on Tuesday said it has agreed to acquire Alion Science and Technology

in a $1.7 billion deal that will more than double the size of its Technical Solutions segment and better position it for evolving Navy requirements for future ships and the capabilities they’ll need.

The deal is subject to regulatory approval and is expected to close in the second half of 2021.

Alion, which is expected to generate about $1.6 billion in sales in 2022, is a portfolio company of the private equity firm Veritas Capital, which purchased the company in 2015. Once the deal is completed, Technical Solutions will make up about 25 percent of HII’s annual sales.

HII, which is predominantly a shipbuilder for the U.S. Navy, stood up its Technical Solutions segment in late 2016 following the acquisition of government services provider Camber Corp. Since then, HII has added to Technical Solutions with additional services deals, including in the areas of cyber security, C5ISR, software development and data analytics, and more recently unmanned maritime systems.

The company has built a solid portfolio of products and capabilities in the unmanned and autonomous systems portfolio but and “a pretty significant footprint…in C5ISR, training and simulation and this next-generation technology and solutions kind of business, but they were all a footprint that gave us an understanding of the business but they weren’t at scale,” Mike Petters, president and CEO of HII, said during a call with analysts to discuss the deal for Alion.

Technical Solutions had nearly $1.3 billion in sales in 2020 and is forecast to generate about $1 billion in sales in 2021 due to divestitures. Between 2021 and 2024, Technical Solutions is expected to grow between 4 and 5 percent annually but with Alion in the fold annual growth is projected at between 7 and 9 percent, Tom Stiehle, HII’s chief financial officer, said on the call.

Alion, which has a backlog exceeding $3 billion, does about one-third of its business with the Navy. Most of its work, 47 percent, is in the area of C5ISR, followed by cyber and electronic warfare, 32 percent, and training and simulation, 21 percent.

In addition to improving its growth outlook, Alion’s profitability will help Technical Solutions meet its target of 8 to 10 percent operating margin by 2024, HII said.

HII also touted deal’s importance in better positioning the company to meet the Navy’s future needs. One slide used in the investor presentation said Alion further aligns HII with the Navy’s modernization priority for distributed maritime operations, which “integrates manned and unmanned platforms for networked naval warfare leveraging AI (artificial intelligence) and automation for improved lethality and force resiliency.”

HII already has key capabilities here in unmanned and manned maritime platforms and Alion provides gives the company capabilities in AI, multi-intelligence analytics, and mission data processing and sensor fusion tools, and adds capabilities in networks and infrastructure, data architecture, and sensor effects and integration.

Several analysts on the call asked about whether HII, which is best known for designing and building Navy destroyers, submarines, and aircraft carriers, is straying too far from its core business with the Alion acquisition.

Petters said “we see ourselves as a security company that we have a big platform business that’s been our core” for decades. “What we see happening in the big platform business is that the platforms are the base for enhancing a future Navy that’s going to rely not just on the platforms, but is going to rely on unmanned, it’s going to rely on distributed operations, and it’s going to look for asymmetric solutions.”

Alion’s work for the Navy is “focused in on training and education, C5ISR and next-generation capabilities,” he said. “Those are exactly the areas that we have felt like we need to bring to our platforms to make our platforms more capable.”

In 2020, HII acquired Hydroid, a developer and manufacturer of small and medium unmanned underwater vehicles. Petters said that Hydroid’s talent team has helped HII’s shipbuilders “create more focus in the platform business to provide a solution for the future Navy and not for the past Navy.”

Byron Callan, an aerospace and defense analyst with the advisory firm Capital Alpha Partners, pointed out in a note for clients on Tuesday that HII’s largest competitor in shipbuilding, General Dynamics [GD], is also a diversified company.

“It remains to be seen how demand for large combatants will be impacted in the 2020s-30s by constrained defense spending and the degree to which autonomous vessels can fulfill roles now undertaken by large manned ships,” Callan wrote. “We expect that the Navy will move faster on this front in the latter part of the 2020s after it is satisfied that autonomous vessels can perform.”

There is limited overlap between Alion and HII’s Technical Solutions segment in terms of capabilities and customers. Alion has 3,200 employees, 84 percent of which have security clearances.

Stiehle said HII expects to incur $25 million in one-time pre-tax transaction and financing costs in 2021 and another $55 million in pre-tax interest expense in 2022. The deal is being funded through $1 billion in new senior notes and $650 million in a new term loan.

The deal is expected to be neutral to earnings in 2022 and accretive beginning in 2023. The deal is also expected to boost free cash flow in 2022 and add about $200 million in free cash flow between 2022 and 2022.

HII said its capital deployment strategy remains unchanged including a $2 billion investment in its shipyards that will conclude this year as planned, dividend growth, and the use of excess cash for share repurchases, and acquisitions. The company also plans to aggressively reduce debt once the Alion deal closes.

Alion’s financial advisor on the deal is Macquarie Capital and Credit Suisse is advising HII.