As other contractors exit services market, General Dynamics bets big on it

By Marjorie Censer / February 14, 2018

L3 Technologies was one of the first to sell off its services business, spinning off what's now Engility in 2012. Lockheed Martin followed suit in 2016, divesting its information systems and global solutions unit.

BAE Systems briefly shopped its services business, while some analysts speculated General Dynamics might want to divest its information systems and technology unit.

But General Dynamics surprised many industry observers this week by taking the opposite approach, doubling down on IT services with a plan to acquire CSRA.

General Dynamics executives had long denied the company was interested in selling its IT services work. Two years ago, Jason Aiken, GD's chief financial officer, called the business a "tremendous cash-generation engine" that requires a low level of invested capital.

"We like what it does to our portfolio," Aiken added at the time. "We like where we are right now."

The new deal confirms General Dynamics' focus on this sector. Phebe Novakovic, General Dynamics' chief executive, told analysts this week she sees IT services as essential to the contractor.

"We are a platform and products business with a core IT services business," she said. "We're good at it . . . it's low risk, it's got terrific return on invested capital and great cash flow. So what we're doing with this transaction is taking our good [General Dynamics Information Technology] business and making it better, stronger, a more viable competitor."

The approach reflects the significant diversity of strategies among defense contractors, as they prepare for increased defense budgets.

Andrew Hunter, who heads the defense-industrial initiatives group at the Center for Strategic and International Studies, said companies are seeking to "identify the winners in the market," meaning the areas that will see increased funding.

"Here, GD is making a bet that it's going to be in the services end of the business," he told Inside Defense. "A case can be made that growth in IT services is probably a pretty reasonable bet. The argument would be: look at what's happening in IT services outside of DOD."

When Lockheed exited the IT services market, executives said the contractor was finding it increasingly challenging to be competitive in the market.

Bruce Tanner, Lockheed's CFO, said at the time past performance began to matter less and pure-play services contractors seemed to have an advantage.

"Our track record . . . didn't seem to matter as much as we thought it should," he said at the time.

Joey Cresta, an analyst at market research firm Technology Business Research, told Inside Defense the reasons Lockheed exited the market still exist.

"It's a very crowded market, it's a very fragmented market," he said. "All those things that concerned Lockheed about the market remain true."

For General Dynamics to stay competitive, "they essentially felt they had to make a move like CSRA," he said, describing CSRA, which has touted its partnerships with Amazon and Microsoft, as the type of contractor that threatens to erode GD's market share.

Now, he said, General Dynamics must demonstrate it can maintain CSRA's innovative approach.

GD will need to "really make sure that the new perspectives coming over from CSRA are not essentially suppressed by the corporate machine of General Dynamics," Cresta said. "Ostensibly, the reason that you're acquiring CSRA is that they're innovation focused."