Defense IT company Perspecta (NYSE:PRSP) has filed a formal protest with the Government Accountability Office (GAO) to try to reverse the loss of a contract that accounts for nearly one-fifth of its total revenue.

The U.S. Navy announced on Feb. 5 it had awarded Leidos Holdings (NYSE:LDOS) a $7.73 billion contract to modernize and maintain computer networks for the Navy and Marine Corps. Perspecta was the incumbent on the contract, and its shares dropped by 16% the day after the award was announced.

Perspecta is actually the second contractor to protest the so-called N-GEN award. General Dynamics (NYSE:GD), which also lost out to Leidos, filed a protest last week.

IT technician runs a maintenance program,

Image source: Getty Images.

Contract protests are not uncommon -- Leidos now has about $18 billion worth of awards spread over three recent wins currently under protest -- and are occasionally successful. It's hard to handicap the chances the award will be overturned or sent out for recompete without knowing the details of the argument, which none of the companies are providing.

Contractors need to walk the line between fighting for what they believe is correct, and not gaining a reputation as a nuisance with their government customers. So, it is rare for a large contractor to file a frivolous protest.

Modest win by just playing the game

Even if unsuccessful, the protest should help Perspecta ease the loss of its largest contract by adding some revenue to the company's future quarters. The current contract is set to expire at the end of December, but the Leidos deal calls for a nine-month transition period, and the GAO could take until mid-June to rule on the protest.

Perspecta management said on a call with investors last month that N-GEN is expected to contribute about 18% to 19% of fiscal 2020 revenue, or about $800 million, and without the protest was set to contribute an estimated $580 million in revenue and $65 million in EBITDA in the fiscal year to begin April 1, 2020.

If the GAO takes its time reaching a decision and the nine-month transition period stretches the Perspecta contract into calendar 2021, the company could see a revenue boost of upward of $200 million in its next fiscal year, even if the protest is unsuccessful. A ruling or a settlement could come sooner, but given the complexity of the deal and the number of parties involved, it seems unlikely to be a quick decision.

Perspecta's future could be at stake

Perspecta is at an interesting point in its history. Formed via a three-way merger in June 2018, the company still has close ties to private equity firm Veritas Capital Fund Management. Veritas as of last year owned about 14% of Perspecta, but at some point will likely be looking for an exit.

The company despite the N-GEN loss has an attractive growth profile, with bookings in the last quarter coming in at an impressive 1.42 times what was billed and a bid pipeline totaling $80 billion. With N-GEN behind it, only about 8% of current business is up for renewal in the next three years. Yet the company trades at just 8 times projected earnings, well below the multiples of rivals including Leidos (18.2 times) or CACI International (14.5 times).

Stock photo of a aircraft carrier with support ships.

Image source: Getty Images.

Given the rapid rate of consolidation in the IT corner of the defense industry and the makeup of its shareholder base, Perspecta looks like an attractive buyout target. A sale is unlikely while the N-GEN protest is ongoing and could be off the table if the company is able to reverse the decision and retain the business. But if this protest doesn't go as planned, Perspecta seems destined to face questions about its future.

It's dangerous to invest based solely on speculation of a potential sale, but fortunately the factors that make Perspecta an attractive takeover candidate also make the company an intriguing investment. Perspecta lost the initial battle for N-GEN, but shareholders still have a lot of different ways to win the war.