Shares of CSRA (CSRA) have jumped after the company announced it will be acquired by General Dynamics (GD) for $40.75 in cash. The news also sent several other government service stocks higher, including Leidos (LDOS), CACI (CACI), SAIC (SAIC) and Booz Allen (BAH). Meanwhile, RBC Capital analyst Matthew McConnell told investors that the deal price looks “reasonable” and the likelihood of another “prime” defense contractor coming in to top General Dynamics’ offer is low. GENERAL DYNAMICS BUYING CSRA: General Dynamics and CSRA announced that they have entered into a definitive agreement under which the former will acquire all outstanding shares of the latter for $40.75 in cash. The transaction is valued at $9.6B, including the assumption of $2.8B in CSRA debt. General Dynamics expects the transaction to be accretive to GAAP earnings per share and to free cash flow per share in 2019, and expects to generate estimated annual pre-tax cost savings of approximately 2% of the combined company’s revenue by 2020. ‘SURPRISING’ MOVE DEEPER INTO SERVICES: Commenting on the news, Citi analyst Jonathan Raviv told investors that he had expected General Dynamics to pursue M&A given its “robust” balance sheet position, but was “a bit surprised” by this move, which takes the company deeper into the services world just as other defense primes reduce their services footprint. Nonetheless, the analyst noted that this highlights General Dynamics’ relatively unique position in the industry as they are not really competing against the other primes on a business to business basis. Raviv also expects other service stocks to outperform on the news. The analyst reiterated a Buy rating on Leidos, CACI, SAIC and a Neutral rating on Booz Allen. However, he argued that he cannot think of another prime interested in consolidating more services. The analyst also expects Buy-rated Harris (HRS) to underperform following the announcement as there may have been some takeout speculation baked into shares due to overlapping radio businesses. Meanwhile, RBC Capital’s McConnell told investors in a research note of his own that the deal price looks “reasonable.” The agreement puts General Dynamics’ chronically underlevered balance sheet to work in a niche it knows well, and without margin dilution given CSRA’s premium profitability in the IT Services space, he said. Overall, the analyst sees this as a positive for both companies, and is not surprised that CSRA is selling as it had struggled to attain a market multiple despite growing backlog and consistent execution that showed that its premium margins are sustainable. McConnell noted, however, that the Defense primes are mostly de-emphasizing their IT services businesses, lowering the likelihood that another one of the primes comes in to top General Dynamics’ offer. PRICE ACTION: In morning trading, shares of CSRA have jumped over 31% to $40.48. Also higher are Leidos and Caci, which have gained about 2% and 3%, respectively. Shares of SAIC and Booz Allen have advanced 2.5%, while Harris has dropped more than 1%.
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