NEW YORK (
) -- 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.
Computer Sciences Corp.
ManTech International Corp.
, 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.
The analyst said that much of the gains have come from multiple expansion and not earnings growth, with earnings estimates actually coming down at some companies during the time period. Some of that multiple expansion is just a bounce back from lows hit as the political infighting first intensified, but Gesuale said more recent gains appear to assume that sequester cuts would eventually end and the government would not grind to a halt.
With a large number of companies chasing a shrinking revenue pot, consolidation should be in order. But defense bankers say that despite the long-term risks seller expectations remain high, stunting deal talk. Buyers want a bargain if they are to buy rivals that could see their business shrink in the years to come, but sellers are asking for prices that assume no such shrinkage will occur.
"Until we know what the future will look like, it is hard to make plans," one defense banker said.
Written by Lou Whiteman