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Avinash Gandhi

SAI AT A GLANCE

P/E ► 7.76 AVG EV/EBITDA ► 6.34 AVG ROA ► 11.2% HIGH ROE ► 24.1% HIGH Debt to Equity ► 1.37 AVG Current Ratio ► 1.96 AVG Interest Coverage Ratio ► 10.8 AVG

 

 

 

 

 

 

Science Applications International Corporation (NYSE: SAI), or SAIC, is a defense company with the 5th largest dollar volume of federal IT contracts.^[1] It manages networks, transfers information safely, and develops software to manage computer resources. It also provides consulting services for renewable energy projects.

National defense expenditure has more than doubled from 2001 to 2008^[2], spending that the War on Terror and the Iraq War have greatly influenced; since sales to the US federal government accounts for 87 percent of SAICs total revenue^[3], this increase in spending has benefited SAIC.

With a significant portion (50%) of the government’s technology workforce soon to retire^[4], SAIC also has the potential to benefit from the government increasingly outsourcing IT jobs to the private sector. Additionally, as consumers demand alternative energy sources because of high oil prices, SAIC's energy consulting business is poised to reap the returns.

Business Overview

Business Financials

SAICs revenue in 2008, ending January 31, 2008, totaled $8.94B, up 11 percent from the previous fiscal year.^[5] It has continued this strong growth into the 2009 fiscal year, with revenue increasing 18 percent compared to the first quarter of fiscal year 2008, totaling at $2.37B.^[6] In 2008 SAICs wallet took home $415M, a 6 percent increase from 2007.^[7] An important driver of such gains was and continues to be the mine resistant ambush protected (MRAP) vehicle.^[6]

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With a $15 billion backlog^[9], representing nearly two years of revenue, if SAIC succeeds in exercising these orders it will continue realizing solid revenue growth. And to further increase its backlog, SAIC continues to win new contracts like the $6.9B three year deal it has made with the Air Force to support the Future Flexible Acquisition and Sustainment Tool (F2AST) program.^[10] In this contract it will support Air Force weapon systems, and technical assistance to their platforms, among other work.

Orders for which funding has been agreed to by a customer is funded backlog, while orders for which funding has not yet been agreed to is unfunded backlog.

Operating Segments

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Corporate and Other segment, which represents corporate costs not allowed under Cost Accounting Standars of operating business units, accounted for a 5 percent loss of total Operating Income, a loss of $34M.^[11]

Government (94% of total Revenue and 98% of total Operating Income, Fiscal 2008)^[11]

Accounting for services to the US federal, state and local government agencies and foreign governments, this segment generated 94%, 93%, and 93% of total consolidated revenues in fiscal 2008, 2207, and 2006, respectively.^[11] Although SAIC does contribute to the US military and Department of Defense (DoD), it is also involved with the US Department of Homeland Security (DHS), intelligence agencies, and other domestic agencies. As a defense company, it provides night vision and communication capabilities. Additionally, it aids the Air Force train units worldwide via the internet. For domestic tranquility, it aids in anti-terrorism and DHS efforts producing vehicles that contain inspection systems for contraband detection such as the mine resistant ambush protected (MRAP) vehicle, and develops software that assesses the effects which population, resources and infrastructure can potentially have through technological and natural disasters. 87% of all consolidated revenues for fiscal 2008 come directly from sales to the U.S Government, their key customer.^[3]

Commercial (6% of total Revenue and 7% of total Operating Income, Fiscal 2008)^[11]

SAIC provides information technology services such as data management and software development; it can manage networks, transfer information safely, and if needed by the customer, develops software to manage computer resources. It advises on alternative energy sources by assessing risk and modeling energy-efficient programs, and many times serves as the leading project manager to implement such programs. This segment accounted for 6%, 7%, and 7% of total consolidated revenues in fiscal 2008, 2007, and 2006, respectively.^[11]

SAIC has taken the role of project manager and lead consultant to direct the production of energy-efficient and self-sufficient communities. The Drake Landing Solar Community, a 52-home suburban community in Okotoks, Alberta, Canada is the first solar community in North America with consulting and managerial services from SAIC.^[12] SAIC will also provide Chevron USA with environmental remediation, engineering design, and risk assessment. SAIC will be awarded $150M from services to Chevron.^[13]

Acquisitions

SAIC plans pursuing strategic acquisitions in areas dealing with defense transformation, intelligence, and homeland security; areas in which the firm expects growth. Credit goes to previous acquisitions for the firm’s broad expertise, enabling it to be well-positioned. In the past five years, SAIC has acquired about 28 companies. SAIC barely has finished its first quarter of fiscal 2009 and is already on its way to acquire new companies. This fiscal year alone it has acquired two new companies, Icon Systems, Inc.^[14] and SM Consulting, Inc.^[15] The former designs and produces state-of-the-art laser-based products for military training and testing^[14], and the latter provides language, intelligence, management consulting among other services.^[15]

Trends and Forces

SAIC generates 87% of its revenue from the US government^[3]

An overwhelming portion of SAICs revenue is generated from Uncle Sam, making it vulnerable to opportunistic budget cuts. Since the terrorist attacks on September 11, 2001 there has been an upswing in government spending on national defense. The US government spent $625.9B in 2007 on national defense, almost double what it spent in 2001.^[2] The US government estimates it will spend $693.2B on national defense for fiscal year 2008, more than double what it spent in 2001.^[2] Thereafter, it is forecasted that in 2009 spending on national defense will decrease by 13.5% and will remain in the $550B range.^[2]

Since SAIC is reliant on Uncle Sam’s wallet; if the government decides to alter or terminate any large contract, SAIC's growth will be hindered. Most government contracts are unfunded (orders for which funding is currently not contractually obligated by the customer), and so customers have the right to not exercise the contracts. Unfunded orders are common when governments are customers, as funding hinges on the availability of cash in budgets, as well as the risk of failure associated with many high-tech projects. About 70% of SAIC's backlog pertaining to government contracts are unfunded, a value of $9.7 billion. However, historical experience demonstrates that Uncle Sam likes exercising his contract options. For example, SAIC and Boeing are running a joint combat modernization program, called Future Combat Systems (FCS), worth $160B.^[16] FCS will provide unmanned sensors and robotics, along other high-tech equipment, to ground forces. The Army exercised its FCS contract in June 2008, and then revised the calendar, accelerating it three years ahead of schedule - a decision which was influenced by the Army’s confidence in the program.^[17]

Development of renewable energy sources

Increasing financial and environmental costs of fossil fuels are driving development of other energy resources, in particularly clean and renewable energy. With crude oil having reached a peak price of over $140 a barrel^[18] atives are becoming more necessary. SAIC provides energy efficient programs and consulting services on energy optimization. It assesses renewable energy sources and technologies to advice, assess risk, and model the best energy source for every customer. It provides its consulting services to communities or businesses wishing to decrease their dependency on fossil fuels, just as it did to a small Canadian community which now runs on solar energy; additionally, it advises government energy agencies and energy providers. Renewable energy composed 7% of all energy consumed in USA in 2007, with an average growth rate of 3 percent.^[19] Consumption of renewable energy had a 30 percent increase in the transportation sector and a 12 percent increase in residential sector.^[19] The fast growth of this emerging market means SAIC has the potential to grow, if it is able to keep up with technological progress on renewable energy.

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US Government outsourcing keeps on growing, translating to potential contracts for SAIC

In 2005, about 35,000 (50 percent) federal government IT (information technology) workers became eligible for retirement.^[4] With a significant portion of the government’s technology workforce soon to leave, the federal government has started to outsource jobs to the private sector. Since Uncle Sam is not able to compete with the pay and benefits that the private sector offers its employees, it is much more difficult to attract workers and keep pace with hiring requirements, especially for such highly technical positions. It has been estimated that the federal government’s IT outsourcing will increase 55 percent to $17.4B in 2009, from $11.7B in 2004.^[20]

Competition

SAIC competes with large defense contractors to smaller and more specialized companies. Just how SAIC wins contracts to be the lead company, there are times where it contributes or partners with other companies on a single contract. Many times it competes as a team with some of its own competitors for some of the larger contracts. A large defense contract worth $6.9B from the Air Force for spare parts is split between Boeing, L-3 Communications, Lockheed Martin, Northrop Grumman, Raytheon, and SAIC.^[23]

These are smaller defense companies which compete and\or partner up with SAIC. The Air Force has awarded a $900M contract to six firms, which include SAIC and CACI, who will split the work of providing services to the Pentagon’s unit that controls nuclear weapons.^[30]

References

1. ↑ ^{1.0 1.1} 2008 Top 100 Government IT Contractors
2. ↑ ^{2.0 2.1 2.2 2.3 2.4} Budget of the United States Government, Fiscal Year 2009, Pg 89-90
3. ↑ ^{3.0 3.1 3.2} SAIC 2008 10-K, Pg 4
4. ↑ ^{4.0 4.1} The US Government's IT Challenge, May 2005
5. ↑ SAIC Announces Financial Results for Fourth Quarter and Fiscal Year 2008, March 25, 2008
6. ↑ ^{6.0 6.1} SAIC Announces Financial Results for First Quarter Fiscal Year 2009, June 3, 2008
7. ↑ SAIC 2008 10-K, Pg 21
8. ↑ Wall Street Journal Online SAIC Annual Earnings
9. ↑ ^{9.0 9.1 9.2 9.3} SAIC 2008 10-K, Pg 24
10. ↑ U.S. Air Force Selects SAIC for $6.9 Billion Contract, July 29,2008
11. ↑ ^{11.0 11.1 11.2 11.3 11.4 11.5} SAIC 2008 10-K, Pg 1
12. ↑ SAIC Canada Helps Create North America’s First Solar Community, March 31,2005
13. ↑ SAIC Awarded Master Services Agreement by Chevron U.S.A., Inc., May 5, 2008
14. ↑ ^{14.0 14.1} SAIC Completes Acquisition of Icon Systems, Inc., April 21,2008
15. ↑ ^{15.0 15.1} SAIC Completes Acquisition of SM Consulting, Inc., May 21, 2008
16. ↑ Army Revises $160B 'Future Combat' Schedule, June 27, 2008
17. ↑ Army Revises $160B 'Future Combat' Schedule, June 27, 2008
18. ↑ Crude Falls to Three-Month Nadir, August 12, 2008
19. ↑ ^{19.0 19.1 19.2} Renewable Energy Consumption and Electricity Preliminary 2007 Statistics, May 2008
20. ↑ US Government Outsourcing To Grow 55 Percent by 2009, May 2005
21. ↑ Department of Defense is beginning to build the Global Information Grid, April 29, 2007
22. ↑ SAIC to supply National Guard with IT learning tools, July 4,2008
23. ↑ Defense firms split $6.9B parts deal, July 23, 2008]
24. ↑ Boeing Reports Record Revenues, Earnings, Cash Flow & Backlog for 2007, January 30, 2008
25. ↑ General Dynamic 2007 10-K, Pg 13
26. ↑ Lockheed Martin 2007 10-K, Pg 30
27. ↑ Northrop Grumman 2007 10-K, Pg 47-48
28. ↑ Raytheon Company 2007 10-K, Pg 29
29. ↑ ^{29.0 29.1} Wall Street Journal Company Research
30. ↑ Air Force awards $900M contract to several firms, July 25, 2008
31. ↑ CACI International 2007 10-K, Pg 10
32. ↑ ManTech International 2007 10-K, Pg 11
33. ↑ SRA International 2007 10-K, Pg 9