Deals of the Year: Large Market Deal –

Buying a company like DynCorp, which hires ex-soldiers to conduct military-like operations around the world for the U.S. government, is not for the faint of heart. The company’s employees, for one, are constantly in danger of being killed in action, not to mention that the company carries a tangible amount of what the industry calls “headline risk.”

But that didn’t stop New York-based Veritas Capital-even when DynCorp’s offices were bombed and four employees were killed just when Veritas was preparing to cut the deal. The defense-devoted LBO shop bought DynCorp for $850 million in February 2005, then in September filed for an IPO, which observers anticipate will be a success, given the company’s strong fundamentals, the current war in Iraq and the lack of publicly traded defense companies.

“You do have to have the stomach” for these kinds of deals, said Bob McKeon, Veritas’s president. McKeon would know, as the DynCorp deal endured an attack from the Taliban, the murder of employees and a buyer on the fence.

The Fog of War….Acquisitions

When Computer Sciences Corp. (CSC) bought Dallas-based DynCorp in 2003, it was purchasing the asset for its IT business only. Irving, Texas-headquartered DynCorp’s operations are so diverse they seem to contain almost every occupation in the world. DynCorp’s employees dust crops in Columbia, train the police force in Iraq and Liberia, will build an airport in Nigeria and provide security to the President of Afghanistan.

A year after buying it, CSC brought on Goldman Sachs to explore selling the non-IT assets. Veritas had just come off a sale of DynCorp’s direct competitor, Vertex, to L-3. The Vertex deal had been a success-Veritas bought the company from Raytheon in 2001 for $270 million and sold it in 2003 for $650 million.

McKeon knew that Veritas was one of only a few that made sense as a buyer, so as soon as CSC appeared ready to sell McKeon flooded the company with calls. Within a few months, Veritas was in an exclusivity agreement and expected to sign a deal in late July. But from early summer 2004 through December, obstacles kept popping up.

First, determining the value of the company proved a massive logistical problem, said McKeon. The business, made up of about 50 contracts, was extremely complex. To figure out what it was buying, Veritas had to “reconstruct the company from scratch,” he said. Also slow in coming were audited financials in an industry whose numbers are intensely scrutinized by the government.

Next, CSC started to get cold feet. The fact was, said McKeon, DynCorp was growing so rapidly and throwing off so much cash, CSC was loathe to let it go. Veritas’s original offer was in the $650 million to $700 million range, but DynCorp’s forecasts were rapidly becoming obsolete, and it was clear CSC would ask for a higher price.

Headline Risk-Offices Attacked

July came and went, and by late August no deal had been signed. Then on Aug. 29, 2004, a car drove up to DynCorp’s offices in Kabul, Afghanistan. DynCorp had been providing security for Afghan President Hamid Karzai and had also been training police in the country. The car housed a bomb that detonated and killed four people. The Taliban later claimed responsibility. Immediately, TV cameras showed up in CSC’s parking lot and the company spokesman was busy taking calls about the terrorist bombing. “All of a sudden, the deal came back to life,” said McKeon. “All of a sudden, they were very cooperative.”

By the end of September, the forecast for DynCorp’s revenues had jumped to $1.8 billion from the original $1.4 billion. Veritas scrubbed its numbers again and came up with a new purchase price of $770 million. There was still a delay on audited financials which CSC said might not be ready until 2005. At the same time, CSC’s federal business, which included DynCorp, was struggling, and it was partly being propped up by DynCorp’s solid numbers. After six months, “it still wasn’t clear whether we had a seller on our hands,” said McKeon.

But finally in December, a deal was struck. New forecasts at DynCorp came in, and CSC told Veritas it needed $850 million or the deal was off. McKeon didn’t hesitate-his credo the entire time was that it will do the deal “as long as we can do it with $100 million in equity.”

The final deal price was $850 million, with equity coming out of Veritas’s second fund. Veritas limited partner Northwestern Mutual Life put up $50 million in preferred equity and invested $14 million in common equity.

The multiple was attractive-7x EBITDA and 0.4x sales. It sold Vertex for about 10x EBITDA and 1x sales a few years before.

At least one LP liked the deal. Tim Wegener, who is a senior director at Thrivent Financial but at the time of the deal was a director at Northwestern, said, “The deal is right down the middle of what they always said they were looking for. It could have gotten away two or three different times and other GPs might have walked away.”

A Rare IPO In Defense

The IPO had been planned almost from the start. There is a scarcity of public companies in the defense and federal services sector-the top few contractors make up about 90% of the market capitalization. Meanwhile, McKeon noted, there is no draft and Sec. of Defense Donald Rumsfeld has called for more outsourcing. Because the IPO hasn’t happened yet, McKeon couldn’t comment on the pending offering.

Cowen & Co. analyst Cai von Rumohr said before Buyouts went to press that the time looks good for the IPO. “Defense stocks have had a great year so far this year, earnings and cash flows are good.” And meanwhile, the market for IPOs is better than it was a few months ago. “Certainly it’s a better environment now than it was in December,” when there were some worries about budget cuts, he said. He added that the space is seeing continued M&A and DynCorp may be on a list of targets for larger contractors.