The large defense contractors not only provide services and hardware to the Pentagon but also support many other parts of the Federal and State governments. Northrop Grumman Corporation (NYSE:NOC), for example, has a large contract to manage all of the IT services for the State of Virginia. It is also always on the lookout for new business lines as the government changes requirements or needs.
As the pressure builds on the defense budget, this growth into other parts of government spending will continue and accelerate. While these are not the traditional market experience with writing, executing and managing government contracts will help win and execute the work.
One area that these companies have seen significant expansion into is Health IT. The Affordable Care Act and general trends in government healthcare programs like the Veterans Administration, TRICARE military health management, Medicare and Medicaid have been stressing the use of Electronic Health Records (EHR) and integrated information sharing systems with the idea of reducing overall cost of the system.
In the last two years, corporations such as Lockheed Martin (NYSE:LMT) and General Dynamics Corporation (NYSE:GD) have acquired companies providing those services to the civil and government market. These have not been unsubstantial investments as General Dynamics spent over a $1 billion on Vangent a private corporation.
Now SAIC, Inc. (SAI), a top 10 defense contractor, has announced that it plan to acquire maxIT Healthcare Holdings. SAIC estimates the cost of this transaction at close to $473 million. The acquisition will help expand their existing healthcare group to include EHR expertise.
SAIC has recently struggled with poor earnings reports. The most recent for the first quarter did show a positive result compared to the two prior which had losses. Closing Wednesday at a little over $11, its stock has reflected this with a decline of almost 50 percent since its last 52-week high, which came almost exactly a year ago. For the second quarter, which will report in August, the consensus is 33 cents a share—a decline from the 35 cents recently reported. Interestingly, health services grew 7 percent while the rest of the business lines contracted 3 percent.
SAIC won't be alone as it adjusts to a changing market and still faces stiff competition across all of its business lines. If the defense budget is seriously reduced, the need to expand efforts such as its healthcare support will only grow if the company does not want to see a fall in revenue and earnings. This will also lead to more M&A activity with these healthcare IT-related companies, which are very attractive to the defense industrials.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.