U.S defense cost cutting to hurt IT providers

ATLANTA, US: The U.S. Defence Department's decision to step up cost cutting could hurt providers of government IT services and consulting firms, but might open opportunities for contractors that make military hardware for troops on the ground.

Defence Secretary Robert Gates announced plans this week to cut the number of generals, close a major military command and slash funds for outside service support defence contractors by 10 per cent a year over the next three years.

The initiatives are part of an overall effort outlined by the Pentagon this year to shave more than $100 billion over the next five years from bloated Defence Department overhead in the hope of providing more resources for soldiers in the field.

"If you take all of the cuts he proposed as a package, it really represents a good first step for the Department to start to get leaner and more efficient in its business operations," said Todd Harrison, an analyst with the Centre for Strategic and Budgetary Assessments in Washington.

Harrison said the latest move sends a signal the Pentagon intends to make sacrifices and foreshadows "potentially more serious budget problems and more challenging decisions" to come.

As the industry braces for slower overall spending growth, analysts said the latest drive could most hamper companies that provide systems engineering and technical analysis, such as CACI International Inc, SAIC Inc and ManTech International Corp. Bigger defence players such as Lockheed Martin Corp and Boeing Co also offer government services.

"For the most part, this does not smell good for the IT guys," said Alex Hamilton, managing director with boutique investment bank EarlyBirdCapital.

CACI International shares have fallen 11 percent this week, while SAIC is off about 7 percent.

Hamilton noted it was difficult to judge the impact on a company-by-company basis and said it remains to be seen how successful the Pentagon program to weed out waste will be.

Still, BB&T Capital Markets analyst Michael Lewis said in a note to clients that, if the initiatives outlined this week start as anticipated, "we could see the repercussions in top-line growth within the next 12 months."

Lewis covers defence IT companies, including CACI and SAIC.

Some government consulting and advisory service companies have already cited business pressures in the past year, including rising competition for contracts. Gates first announced plans to scale back on outside contractors for service work in 2009.

SAIC, which provides consulting and technical support for intelligence gathering and homeland security, said contract delays hurt bookings and financial performance earlier this year. It said it would boost investment in higher-growth areas such as cybersecurity as its core federal services business came under pressure.

This month, Ducommun Inc said lower revenue in engineering services caused overall company sales to fall in the second quarter.

"The insourcing has impacted our engineering services business to some extent and we've used that as the opportunity to go out and expand that base," Chief Executive Anthony Reardon said this week at a Jefferies & Co conference.

He added the company was seeking new business opportunities.

Still, some companies could gain new business if savings from the overhead cuts materialize. Harrison and Hamilton said companies that provide cybersecurity and unmanned technologies stand to benefit as Gates looks to better equip the military.

Rockwell Collins Chief Financial Officer Patrick Allen said the Gates announcement was a "real strong positive signal" should it mean more money is directed toward buying products.

"The fact that (Gates) is going directly for the bureaucracy of the Pentagon, eliminating the Joint Command, I think is in an effort to free up more money for procurement," Allen told the Jefferies & Co. conference.