By Jacob Gordon, Research Analyst
SAIC’s 3Q13 revenue and operating margins declined by double digits but will recover in 2H14 after the impacts of separation costs and contract ramp downs disappear
SAIC continued to feel the impact of declining public sector spending as the ramp down of the DISN Global Solutions contract, reduced contract activity tied to the in-theater force drawdown and lost revenues from the government shutdown drove a 17% year-to-year decline in revenues. Operating income took a considerable hit, declining 49.3% due to lower revenue, separation and transactions costs and the government shutdown, which added approximately $25 million in costs. Despite the ongoing challenges in the public sector, SAIC was able to win several large deals with The Federal Retirement Thrift Investment Board, The Defense Threat Reduction Agency and the SSC Atlantic, which contributed to a 1.8% increase in funded backlog and allowed the company to keep its fiscal guidance unchanged for CY14 at $3.85 billion to $4.1 billion in revenue. SAIC’s new organizational matrix organization of customer groups and service lines will help the firm identify more contract opportunities and allow it to serve customers with greater efficiency due to enhanced focus on customer-specific needs. The firm’s core Protect, Expand, Grow strategy that revolves around protecting its core markets, expanding business with its closest customers and growing in adjacent markets will guide the firm through the deteriorating public sector. We believe SAIC’s new organization and strategy coupled with the removal of organization conflicts of interest will enable the firm to achieve revenue growth in 2H14.
SAIC is positioned for growth opportunities post-spin-off
SAIC unlocked $25 billion in contract opportunities after the spin-off of Leidos due to the removal of organizational conflicts of interest. Along with the spin-off, SAIC underwent significant organizational restructuring that realigned the group’s operational processes and segment focus. The company adopted a matrix organization where its technical and engineering services and enterprise IT service lines have a set of offerings designed to meet each customer groups’ needs based on agency. The company shifted from a focus on selling solutions to three broad customers segments that encompassed the intelligence agencies, the Department of Defense and civil/energy/health customers. SAIC is focused on selling to specific agencies such as the Army/Air Force, Navy/Marine Corps and the Defense Logistics Agency among others. TBR believes SAIC’s new sales strategy will build momentum due to its more granular focus that allows the company to deliver more customized solutions, have better account management and react to changes in market conditions more quickly. We believe the new structure will allow for better resource deployment due to SAIC eschewing the silo model and adopting an enterprisewide focus that seeks to leverage centralized shared services and to access skills and expertise across the company regardless of position.
SAIC is investing in its emerging IT solutions portfolio
SAIC will expand its emerging IT solution capabilities to provide revenue growth and offset declining spending on traditional public sector IT services. The company will bolster its emerging IT solution portfolio primarily through alliances and R&D, as they are more cost-effective relative to acquisitions. TBR believes SAIC will focus on ramping up alliance activity with cloud companies to bolster its growing cloud brokerage service and boost its range of cloud service offerings. We believe SAIC’s cloud business will eventually become a key growth driver in 4Q13 due to governments increasingly adopting cloud-based IT systems to reduce costs. Although SAIC is gaining traction in the cloud market as evidenced by its deal with Orange County to modernize its IT infrastructure, the company will face significant competition in the public sector IT market from competitors such as Lockheed Martin IS&GS and General Dynamics IS&T as well as commercial-centric firms such as IBM, HP and CSC.
SAIC will seek to expand its international and commercial market presence
TBR believes SAIC is seeking to reduce its reliance on the U.S. government, which it generates 95% of its revenues from. We believe SAIC will seek to change its over-reliance on the U.S. federal government by pursuing international contracts more aggressively and partnering with foreign companies. TBR believes SAIC will leverage its cloud, logistics, simulation and training offerings to build market share in overseas markets with increasing defense spending such as Japan, South Korea and Australia. SAIC will diversify its market focus by leveraging its emerging IT solution offerings such as cloud, cyber-security and mobility to win commercial deals. We believe the company will invest in R&D to develop solutions with commercial applications such as software-defined networks, big data and industry-specific software. We anticipate SAIC will focus on building out its commercial footprint in highly regulated industries such as energy and healthcare due to similarities to its core public sector customer base.
Please feel free to use this content with TBR and analyst attributions. Contact Jacob Gordon at (603) 929-1166 or email@example.com additional commentary.