Analyst: More PE Deals In IT Coming; CSC Is Best Takeout

A report from Jefferies & Co. today said that more PE deals in the information technology sector could be coming, with Computer Sciences Corp. as the best play.

Joseph Vafi, a Jefferies & Co. analyst, also named CACI International, ICF International and WNS Holdings as the best candidates with IRRs near or in excess of 20%, according to a Sept. 10 research note.

IT companies have emerged as favorites with PE firms. They typically have significant recurring revenue, long-tailed backlogs and relatively straightforward business models, Vafi said. Bank debt has also become easier to get.

Companies that focus on federal IT services screened the best, according to Vafi. Private equity firms, instead of strategics, have also been the major drivers of federal IT M&A, Vafi said. Earlier this year, Cerberus Corp. bought Dyncorp. for $1 billion, while last year General Atlantic/KKR acquired Northrop Grumman’s TASC Services business for about $1.65 billion.  Most recently, 3M announced a deal to buy Cogent for $943 million.

Computer Sciences got the highest marks from Vafi. While the company isn’t a “share gainer” in IT services, and he expects nothing but average growth for the company, the analyst said that every few years the CSC balance sheet creates an opportunity for the stock to go higher. About 40% of CSC’s business is in the federal sector, Vafi said.

CSC is not getting enough credit for the $2.8 billion sitting on its balance sheet, and the company could be LBO’ed with the same amount of overall leverage that exists on the balance sheet today, about 1.7x EBITDA, according to Vafi. In addition, many of CSC’s competitors have already been bought out: EDS is now part of HP and Perot is part of Dell.

“The bottom line here is that CSC has one of the highest IRRs in our entire analysis at 26%,” Vafi wrote.