U.S. defense contractor General Dynamics Corp said on Monday it would buy CSRA Inc, a smaller provider of government services for about $6.8 billion, to expand the services it offers to the U.S. Department of Defense.
Federal information technology and services spending, down sharply over the past few years after the government mandated defense budget cuts, is expected to pick up again as President Donald Trump seeks to bolster military spending.
General Dynamics is betting that the deal with CSRA - provider of IT, mission, and operations-related services to the Department of Defense, the intelligence community and homeland security - will help it grab more of the revised budget.
Trump`s budget request for the Pentagon is set to be announced on Monday.
CSRA`s shares were trading at $40.50, just shy of the $40.75-per-share cash offer, which represents a 32 percent premium to CSRA`s Friday close.
General Dynamics` shares fell 0.5 percent.
"An increasing budget going forward gives us cause for optimism that the services market is going to come back to pre-2011 characteristics," said Daniel Johnson, head of General Dynamics` information systems and technology unit.
The move comes after General Dynamics disappointed investors with weaker-than-expected revenue in the past two quarters, hurt by Congress`s indecision to pass a federal budget.
Shares of General Dynamics, which also makes the Gulfstream aircraft, have underperformed the broader Dow Jones U.S. Aerospace and Defense index in the past 12 months, hurt also by a subdued business jet market.
"If we get a two-year budget deal ... it helps to allow a lot of big projects especially in IT to move forward without hesitation or uncertainty," Loop Capital analyst Joseph Vafi told Reuters.
General Dynamics, which also makes tanks and U.S. Navy ships, said the deal is valued at $9.6 billion, including $2.8 billion in CSRA debt.
General Dynamics said its information technology business and CSRA will be merged and report as a new financial segment. This business is expected to have about 60 percent fixed-price type contracts, which is a key to higher margins.
"CSRA has been trading at a slight discount to the other services companies in the government services sector. This combined with the fact that General Dynamics` own services business has a similar profit margin and business lines made it a more attractive purchase for General Dynamics," a person familiar with the deal told Reuters.
General Dynamics said it expects the deal to add to its earnings per share and free cash flow per share in 2019 and generate annual pre-tax cost savings of about 2 percent of the combined company`s revenue by 2020.
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