Interview transcript:
Terry Gerton Raymond James has recently published its Defense and Government Market Intel Report, looking back to May of 2024. Tell me what the big trends are that you’re looking at.
Sam Maness It has been a year of ups and downs for sure. We saw quite a lot of optimism across the indices going into the election last year. The world has been a dangerous place, which feeds into the national security attributes of the indices; certainly going into to the election there was not great concern about what may happen to the civilian side of our market. But what we’ve seen subsequent to the Trump administration coming into power is an overall pervading sense of uncertainty in many of the federal markets that we cover in the report. That led to a tremendous pullback in the valuations of the companies that we covered from a public perspective. But recently, interestingly, in that report, we’ve seen a rebound over the past month. Much of that has to do with the overall understanding that perhaps the DOGE initiative may be waning, at least in its fervor. And secondarily, but importantly, with the current reconciliation bill, the so-called “big, beautiful bill” being passed in the House and likely to pass the Senate, there’s a resurgence and optimism about the funding that is likely coming around the corner. So, optimism going into the election, less optimism thereafter, and then a recent resurgence in positivity.
Terry Gerton Well, that’s a wonderful stage setting. Let’s pick the segments apart a little bit. When I looked at the numbers, if I read this correctly, the European defense contract sector is up 80% since last May, with a big jump coming in February of 2025. Would you care to explain what’s driving that?
Sam Maness That’s interesting, Terry, because that’s an index that kind of tacks differently than the others that I was largely referencing in my overview. But it is also a reflection of a change in policy with the administration: the lack of confidence that our European allies, in particular the NATO allies, that they’ll be able to rely on the U.S. in the way they have for their defense policy or posture. So their contractors are likely to see increased funding from their native governments and the belief across the board is that defense spending will increase meaningfully across Europe and therefore the government contractors in Europe should be net beneficiaries.
Terry Gerton And then when we bring it back domestically, the U.S. defense sector really isn’t doing too badly, up about 43%, right?
Sam Maness That is correct. That index, while there was some pullback in relation to DOGE as I mentioned, the view is that compared especially to government services, defense technology should do quite well under the Trump administration. And I think they would have done well under a Harris administration as well, whereas the pullback from DOGE has been very heavily felt in the services sector, as opposed to defense technology. Again, as I alluded to earlier, the difficulties around the world, the nation-state challenge between the United States and China leads to bullishness for anything that is more meaningfully touching mission, and defense technology naturally does that.
Terry Gerton As you mentioned, though, the pullback in services, that looks to me like it shows up in the engineering and consulting sector, down about 11.7%. Are you hearing from that sector that the reviews that are being commissioned by GSA of the consulting contract firms and some of the other contract terminations and stop payments are what’s driving the change there?
Sam Maness I would say the trending from DOGE is most proximately felt in the IT services realm. There are many consulting services firms there, but it’s also felt, as you’re noting, in the engineering and construction side. These businesses, however, are more diversified. While they have large federal government presence, it’s not all that they do or even in the case of many of them the majority of what they do. What’s interesting here is the impact of the economic uncertainty brought on by the tariffs. And so really, for this sector, I would say it’s a double whammy of DOGE uncertainty and tariff uncertainty. Both of those have waned, however, in the last month. So hopefully, better days are ahead for that cohort.
Terry Gerton I’m speaking with Sam Maness. He is the managing director in the Defense and Government Group at Raymond James. Well, markets hate uncertainty, so it’s naturally going to be priced in there. Is that playing out in things like mergers and acquisitions in the defense space?
Sam Maness Yes, something that I’ve taken to saying recently is that uncertainty is worse than bad news. If there is bad news — I’ll pick a very specific, well-known case in the case of USAID. It’s been devastating for the contractors and employees of that agency, but it’s a known fact now what has happened. And so the businesses associated with that agency are able to plan accordingly, make difficult decisions and try to move forward. What has been difficult for much of the rest of especially government services, as I’ve noted, as DOGE has been a bit of a sword of Damocles hanging over the heads of the entire sector, the threat that isn’t presenting itself. We don’t know exactly when, you know, the DOGE folks may show up, what the impact of them may be. And so the uncertainty can freeze activity. And you mentioned mergers and acquisitions, where I spend much of my time, and for buyers and certainly for sellers, the inability to project the future, which is what any buyer is looking for to have confidence to move forward with a merger or an acquisition, is tough right now in many regards. So there has been activity, but I would say, especially from a total deal value perspective, it is meaningfully down from what we have seen in recent years. We have seen a number of smaller, “tuck-in” deals getting done, but the uncertainty has largely frozen the players in the market, both buyers and sellers from moving forward. I expect again, with the waning of DOGE, with the perhaps passing of the reconciliation bill, that some of this uncertainty will abate. You know, we are in new times with the new administration. That happens every time there’s an administration change. And while it may feel radically different to many than what has been in the past, we will get used to the proclamations and direction of the current administration. And once that is understood, good or bad for individual companies, at least decision-makers will have better certainty and can react accordingly.
Terry Gerton When we think about mergers and acquisitions, it used to be one big company buying another or merging with another. How is the growth or the increased play of private equity in government contractors and in the defense industry particularly changed the feel of how government contracting and support is done?
Sam Maness When I started in government mergers and acquisitions almost 25 years ago, there were very few private equity firms that cared about our sector. It was dominated by, as you’re noting, larger strategic buyers and their appetite for acquiring smaller businesses or larger mergers. Now there is a vast network of private equity firms that are interested in our space. Many of them are located here in the National Capital Region, but also private equity firms around the country have taken note. What has been interesting is historically those firms were attracted to our space for the predictable, stable cash flows of the federal sector. That has changed here recently and many of these firms are having to recalibrate their understanding, especially in the government services sector. But there’s a form of private equity that has come into the federal space in recent years that is quite new for many of us, and that’s the venture capital funds, many of which are coming from California. I think most noteworthy is the involvement of someone like a Peter Thiel, who is very close to the current administration, bringing in new technologies that are disrupting some of the traditional players in our space. The evolution of commercial technology in the government space has been at the tip of everyone’s tongue. Think of firms like Palantir or Anduril that have done quite well. So not only has private equity flowed into the M&A space, it’s actually reshaping our space by bringing in these venture capital dollars.
Terry Gerton It’s fascinating to watch and certainly all the conversation in DoD is about buying commercial and bringing in tech and moving faster. It will be interesting to see whether the venture capital culture invades DoD or the DoD culture invades venture capital.
Sam Maness I am curious to see.
Terry Gerton Well, as you look forward to the next 12 months, what do you expect to happen in this market?
Sam Maness I do expect, especially from a mergers and acquisitions perspective, for there to be more activity. And I think it’s because of the waning of this uncertainty that we’ve we’ve talked about. Again, change naturally leads to uncertainty until priorities become clear, until funding becomes clear, and we will all get used to the new way of operating for the new administration. I expect that the winners and losers will be more pronounced or clear to the market. I think again, I mentioned USAID, so it’s easy to mention that again here as someone or an entity that’s been a clear loser and anyone related to it. Who the winners are hasn’t been as clear perhaps to date, but with the spending flowing from the reconciliation bill, with some of the year-end fallout dollars that are likely to come between now and September 30, I think the winners under the new administration are going to be more pronounced. And so, again, dollars will follow the winners and abandon some of the losers in our sector. But I think there will be maybe a bit of a return to normalcy, if you will, from the relative chaos of the first few months of a new administration.
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