CACI (CACI 0.12%) earlier this year fell short in its audacious bid to steal CSRA from the arms of General Dynamics, but the company did walk away with an attractive consolation prize from the deal.

The company, which provides consulting and IT services to the Pentagon, intelligence community, and civil agencies, said Aug. 16 that it has acquired the Navy systems engineering business of CSRA that General Dynamics was required to sell as part of the regulatory approval process. The unit, bought for $84 million in cash, is expected to add about $150 million in annual sales and $0.15 to full-year fiscal 2019 earnings per share.

Military helicopters in flight.

Pentagon contractor CACI International is drawing up a battle plan. Image source: Getty Images.

This Navy business is new to CACI, but it is similar to work the company is already doing for the Army. CACI sees opportunities to sell products and services it is already developing in-house to a new customer, and to benefit from the Pentagon's push to expand the service life of its fleet.

The deal was announced at the same time that CACI released fiscal fourth-quarter earnings and updated investors on its outlook for the new fiscal year. CACI might have missed out on the grand prize, but the company still appears to have significant opportunities to expand over the quarters to come.

A beat and a raise

CACI delivered fiscal fourth-quarter adjusted earnings of $2.05 per share, beating consensus by $0.27 per share on higher profitability, lower interest expense, and the benefits of a lower tax rate. Revenue, at $1.17 billion, missed consensus by about $10 million, but it was up 2.9% from a year prior. Full-year EBITDA margin was 9.2%, up 70 basis points year over year.

The company also raised fiscal 2019 guidance to earnings per share of between $9.14 and $9.53, up from $8.98 to $9.38 previously, on revenue of between $4.7 billion and $4.9 billion compared with $4.55 billion to $4.75 billion previously. CACI generated $325 million of operating cash flow in fiscal 2018 and expects at least $330 million in operating cash flow in the new fiscal year.

CACI was awarded $1.5 billion worth of business in the quarter, including a $407 million Homeland Security contract and a $122 million Navy communications deal, and totaled $5.2 billion in awards for the full fiscal year. Both the quarterly and annual award numbers topped current quarter and year revenue, a useful metric to follow when trying to determine a contractor's outlook for growth.

A lot of government IT and support work was put on hold during the budget battles from 2011 to 2016, but the congressional budget deal reached in February has provided the Pentagon and other agencies the funding necessary to play catch-up. CACI goes into the new fiscal year with submitted bids for $8.2 billion in awards, including renewals, and expects to submit another $13.1 billion over the next two quarters.

On the hunt

While stepping in to try to buy the slightly bigger CSRA was a stretch, CACI has been a steady acquirer of smaller companies. In comments following the earnings report, management signaled that it remains interested in doing deals. In fiscal 2018 it bought a pair of IT and software engineering companies in the United Kingdom and added an IT vendor and an intelligence company domestically, and the new fiscal year is off to a fast start with the General Dynamics Navy deal.

CEO Kenneth Asbury on the quarterly investor call said that M&A "remains our priority" for capital deployment. CACI organizes its business around 12 markets served and is constantly looking at targets that could augment one of those markets.

Asbury said CACI pursued CSRA, despite its size, because "it accelerated our notion about where we want to be in solutions." He deferred on whether CACI has another similarly sized target on its radar but said CACI is growing more aggressive in how it pursues deals and that the range of targets "spans the gamut." Asbury said:

There was a time and a place, I think, we probably waited to see what was for sale. That is no longer our premise. Each one of our market strategies has a set of gaps or identified gaps. We regularly approach small, medium, and large companies about how to do it.

Scale is important in government IT, as agencies are looking more to the private sector to take on increasingly large and complex systems and because larger companies -- like in the case of the Navy business CACI has acquired -- can use their contacts across different branches to cross-sell services to multiple customers. CACI, at less than $5 billion in annual sales, is less than half the size of industry leader Leidos Holdings (LDOS 0.75%) or the newly merged IT business of General Dynamics, but Asbury seems determined to pursue deals that would narrow that gap.

A chance to ride the wave

I expect considerable further M&A among government services firms, as a growing federal budget spurs demand and has companies scrambling for additional talent with security clearance or to fill gaps in their portfolio. CACI figures to have a prominent role in consolidation, most likely as a buyer but potentially as a partner in a merger with a similarly sized company, or even as a target should a deal frenzy start and Leidos or another large industry participant feels compelled to expand further.

M&A always brings risk, but CACI is a prolific acquirer with a strong integration track record.

In the meantime, the outlook for organic growth is strong. CACI's raised guidance was almost entirely due to the GD Navy acquisition and seems conservative. CACI's fiscal 2019 revenue guidance is comprised of 81% existing business, 12% successful recompetes, and only 7% new business, meaning that CACI is not relying on a massive influx of new business to make its numbers. The company traditionally has won more than 90% of its recompetes and at least 30% of its takeaway attempts, but Asbury said he believes as CACI's capabilities grow, it should be winning between 35% and 40% of new business it competes for.

At worst CACI is set up well to meet expectations, and if cross-selling off the new Navy platform comes through or CACI gets other additional wins, it could handily beat expectations.

Shares of CACI have had a good run, up 42% on the year, but the company at 15.8 times trailing earnings trades at a 20% or higher discount to rivals including Leidos, Booz Allen Hamilton, and Science Applications International. I'd prefer Leidos over the long term, but believe CACI is likely to outperform and close some of that valuation gap in the quarters to come.

CACI if nothing else demonstrated its ambition by battling the much-larger General Dynamics for CSRA. The next few quarters figure to be exciting times for the company. Investors could do well by hopping on for the ride.