An acquired taste: why mergers in govcon are a Thing
Suppose you run a govcon services company and you're trying to grow your book of business. One strategy might be to try to increase revenue with your existing clients by leveraging your knowledge about that client to win more work. Another strategy might be to win contracts with new clients.
Winning contracts with new clients can be challenging in government contracting because, to be a competitive bidder, you sometimes need to have good past performance at that agency. If you're trying to "land and expand," you sort of already need to have landed.
For large companies there are two tried and true strategies for landing. The first strategy is to subcontract to a small business. Subcontracting isn't an immediate path, but it has benefits: getting revenue on your balance sheet, picking up qualifications and knowledge about the account, and developing a network of smalls that can support your future, prime-bidding opportunities. But there’s a drawback too. It can take awhile to get a subcontract that isn't spoken for.
The second strategy is to just buy a small business.[1] Buying a small business means that you can have the logo! And presumably, you've also now acqui-hired the people who won that work in the first place, so you can gain that knowledge about the account.
The problem with using an acquisition strategy in govcon is that it requires capital. And typically, if you're running a govcon services company—even a large one—you probably don't have enough capital to make acquisitions on a whim.
But private equity firms have a lot of capital! As a result, the beltway has seen a fair share of merger and acquisition activity over the years, including the use of "rollups." A rollup is a fancy way of describing when a private equity firm buys a bunch of companies and smashes them together with the idea that the combination would be more profitable than the individual components.
A clear benefit of a rollup is that you can get the past performance from those companies. But there are some drawbacks. For example, when you combine a bunch of companies, with a bunch of contracts, you can run into potential organization conflicts of interest (OCI)!
Recently, the GAO offered a perfect illustration of how this can play out in a protest related to a task order by the Army for engineering support services. The incumbent on the contract, Science Applications International Corporation (SAIC), and 5 other companies submitted bids for the task order. After reviewing the bids, the Army awarded the task order to Peraton Aerospace and Defense, Inc., and SAIC protested.
Now, in govcon, there is perhaps no better example of a rollup than Peraton. I say this lovingly: Peraton is basically a govcon Voltron. Between 2017 and 2021, Peraton emerged from the acquisitions of 4 major companies (including one company, Perspecta, that itself was a roll up of 3 companies) with a price tag of at least $10B.
And one of the protest grounds was that Peraton would be conflicted from doing the engineering support services because Peraton already held a contract for doing engineering support services work at a higher level in the Army organization chart. According to SAIC, Peraton had an OCI because having both a headquarters-level contract and a program-level contract would impair Peraton's objectivity on both levels.
Making matters worse, as noted by the GAO, if SAIC were right, then Peraton was already conflicted. That's because—wait for it—Peraton is currently a subcontractor to SAIC:
The parties acknowledge that the [headquarters-level] task order was originally issued to DHPC Technologies, Inc., which has since been acquired by Peraton. [Peraton] points out that Peraton, through DHPC, is already serving in dual roles on both task orders at issue here where, in addition to its performance of the [headquarters-level] task order, it is also a subcontractor to SAIC as the incumbent contractor performing the [program-level] task order.
Wild, right? SAIC is the incumbent on the program-level contract with Peraton as a sub. And Peraton is the incumbent on the headquarters-level contract by virtue of acquisition. These sorts of arrangements are common, if complicated.
Fortunately, for Peraton, the government found that no conflict existed, arguing that the contract's scope was limited and ensured that Peraton would not be in a position "to provide analysis or recommendations with respect to any acquisition in which it could compete, or with respect to its own work product." Notably, the agency explained that it already had a rule to prevent such OCIs. Specifically, the Army prohibited a contractor from being a "prime developer." Because Peraton was not a prime developer, there was no likelihood of conflict. Ultimately, GAO denied SAIC's protest and Peraton won.
The case also showed another example of conflict. In this case, Peraton argued that SAIC's lawyer worked for Peraton before it was Peraton:
Specifically, according to [Peraton], [SAIC's lawyer] previously represented Perspecta Inc., now a subsidiary of Peraton, on various matters for several years, “including analyzing and advising on business transactions, contracts, and related [OCI] issues that include the very business transactions, contracts, and alleged corresponding conflict issues" raised in the protest.
Here, too, GAO rejected the allegations and allowed SAIC's lawyer to remain on the case.
Them's the breaks.
A lesson here is that, while mergers and acquisitions can open new opportunities for work, they also open the door for OCI allegations. Yet, the real lesson here, is that there's a reason why there's so much mergers and acquisitions activity: as long as companies are looking to grow, they're going to try and find a way to buy their way in. And it works, I guess, unless you're on the wrong side of a protest.
[1] A weird rule is government contracting is that you can’t just buy a government contract. Like, if I win a contract to sell widgets, I can't assign that contract to you to deliver those widgets and you can't buy that contract from me. But, this is America after all, so I can sell you my entire business. And once you've bought my business, you can now deliver those widgets. A fun loophole, right?