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The Deal: Investors Flee Beltway Bandits

NEW YORK ( The Deal) -- So-called Beltway Bandits are in focus as investors look for potential collateral damage from the political war that has led to a government shutdown. But these government services firms have challenges that run far deeper than a temporary spending freeze, and which could impact them for a number of quarters to come.

When Congress failed to agree on a continuing resolution to fund the U.S. government Monday night, it was not just federal employees who were told not to report for duty Tuesday morning. Firms that specialize in providing technical support, IT management and other services to the government were also impacted, and have no more clarity on when payments will flow again than a federal staffer does.

Moody's Investors Service is worried the shutdown could take its toll on mid-sized government contractors like Booz Allen Hamilton Holding Corp. (BAH - Get Report), CACI International (CACI - Get Report), Computer Sciences Corp. (CSC - Get Report) and ManTech International Corp. (MANT - Get Report), especially if there is not a quick resolution. The firm said that contractors are only marginally better prepared to withstand a payment disruption now than they were in 2011, the last time a potential shutdown was in the news.

"Any delay in government payments would quickly weaken defense contractors' liquidity," senior analyst Bruce Herskovics wrote in a report out this week. "Although diversification away from declining U.S. military sales and higher backstop liquidity arrangements have modestly improved companies' liquidity profiles, the risks remain elevated, particularly in the event of a government shutdown wherein no payments are made for a protracted period."

Of course, as Herskovics noted, there has been no shortage of gloomy reports and warnings for government services firms in recent years, and the companies and their investors have had fair warning. But despite the rhetoric, 2013 has actually been a good year for these stocks. The group on average was up 30% year-to-date heading into the shutdown, compared to an 18% gain in the S&P 500 and a 26% rise in the small cap Russell 2000 index.

Raymond James & Associates analyst Brian Gesuale said that optimism "defies fundamentals" and is unlikely to hold up to continued political infighting. "While the shutdown is temporary, the dysfunction is not and will ultimately hold the fundamentals of the group hostage through the midterm elections or longer," Gesuale wrote in a note earlier this week.
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