Leidos Views Doubled Scale in Lockheed IS&GS Merger as Buffer to Agency Spending Shifts

leidos_purpleLeidos Holdings‘ (NYSE: LDOS) impending merger with the information systems and global solutions segment of Lockheed Martin (NYSE: LMT) seeks to both diversify customer mix and lower risk to potential spending downturns in fewer market areas for the future combined company, Leidos CEO Roger Krone told investors at the New York Stock Exchange Monday.

Reston, Virginia-based Leidos expects 2017 revenue to total $9.8 billion-$10.2 billion at nearly double the scale versus 2016 sales guidance of $5.1 billion-$5.2 billion and puts the post-combination entity at nearly twice the size of the next-largest government services contractor Booz Allen Hamilton (NYSE: BAH) at roughly $5.27 billion.

Slides accompanying Leidos’ NYSE Investor Day presentation break out the post-deal revenue as divided roughly 16 percent in health, 27 percent in civil, 27 percent for intelligence and homeland security,  and 29 percent defense.

“Five plus five equals ten and ten is better distributed and more diverse. There’s less risk in our portfolio and we’re not subject to a single loss in any one area as customers shift spending, ” Krone said to analysts.

“If (the U.S.) is successful in the war on terror, they’ll move to spend more in civil and intelligence.”

Leidos’ 2017 guidance also forecasts $2.90-$3.20 earnings per share and a 9-10 percent adjusted earnings before tax, debt and amortization margin at net debt of $3.6 billion.

The company has targeted a compound annual growth rate of 3 percent through to 2019 and an EBITDA margin higher than 10 percent by the third year post-combination, according to the slides.

Krone also described Leidos’ approach to the GovCon merger-and-acquisition market before the IS&GS negotiations with Lockheed as “saying no to other businesses” as the government services industry went through a stretch of consolidation over nearly two years.

Some of those large deals included Engility Corp.’s purchase of TASC, the creation of CSRA (NYSE: CSRA) from Computer Sciences Corp.’s (NYSE: CSC) former U.S. public sector segment and the $550 million sale of L-3 Communications‘ (NYSE: LLL) national security solutions business to CACI International (NYSE: CACI)

“There were lots of things going on but we largely stayed out of that fray, looked at our competitive structure and didn’t see a lens that gave us a point of difference, ” Krone said.

Krone signaled Aug. 17 as “Day 1” of the Leidos-IS&GS combined entity, which confirms the timetable described by Lockheed executives in the latter company’s second quarter earnings call from July 19.

Leidos will report IS&GS as a separate segment for the remainder of the year as the company works to finalize details of the reorganization later in the fourth quarter, Leidos Chief Financial Officer Jim Reagan said at the NYSE.

Full 2015 revenue for IS&GS totaled $5.59 billion compared to $5.65 billion in 2014 and $6.1 billion in 2013 with the declines attributed by Lockheed in part due to expirations of contracts from the segment’s books and loss of some recompetes solely based on price, a trend defense contractor cited as a reason for its shift away from the government services buying market.

“We can see that (IS&GS’) history of revenue decline is mostly abated. Now that they’re on a much more competitive cost footing we expect it to turn around next year, ” Reagan said.

“This year and the first part of 2017, we see Leidos growth as higher than IS&GS as they get their feet on the ground with a new cost structure.

A slide in the presentation also listed these four executives as business group leads for the combined Leidos-IS&GS entity:

Leiter was appointed to head Leidos’ business development functions in November 2014 and has overseen the integration management office since its April formation, while Scholl joined the company in June 2015 as president of the health and engineering sector.

Reardon is an 18-year Lockheed veteran whose current title is vice president of IS&GS’ civil, defense and intelligence organization and Heise leads the defense contractor’s commercial cybersecurity business.

John Fratamico, current president of Leidos’ surveillance and reconnaissance group,  will transition into a new role as president of advanced solutions with responsibility over the company’s estimated $500 million research-and-development portfolio in fields such as C4ISR, sensor systems,  autonomous technologies and signals intelligence plus data-related aspects of collection, processing and analytics.

Gerry Fasano,  VP of strategy and business development at IS&GS, will become chief of BD and strategy for the combined company and Leidos Chief Technology Officer Gulu Gambhir‘s role is unchanged.

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