* Booz Allen's revenue and earnings grew under Carlyle
* Carlyle's peers seen overpaying for companies in 2007-11
* PE-backed government contractors face tough road to exit
* Providence's USIS under pressure over background check
By Greg Roumeliotis and Soyoung Kim
NEW YORK, June 28 The Edward Snowden saga may be
a headache for his former employer Booz Allen Hamilton Corp
and its 67 percent owner, the private equity firm
Carlyle Group LP, but it could turn out to be a bigger
problem for some of Carlyle's rivals.
Like Carlyle, a whole host of other private equity firms
piled into the defense and intelligence sector between 2007 and
2011, snapping up various contractors and consultants. Unlike
Carlyle, though, most have not recouped their original
investments and some of them may be staring at losses if they
sold the assets today.
The industry is under growing pressure because of a series
of apparent security problems that allowed Snowden to leak
details of secret U.S. surveillance programs and, according to
government officials, badly compromise U.S. national security.
Among the questions being asked by lawmakers and
investigators are how Snowden, who worked as a Booz contractor
at a National Security Agency facility in Hawaii, obtained
security clearance despite red flags in his background. There is
also concern about how he was able to download many top-secret
documents and flee for Hong Kong only about a month after
starting in the job, without triggering massive alarm bells.
The result will likely be increased scrutiny of government
contractors by the NSA and other parts of the defense
establishment, and greater oversight from Congress. Some
contracts may be reduced or taken away from individual firms.
All of that could hurt revenue and margins in a business
that is already under increasing stress because of defense
industry cuts, including the sequestration that began hitting in
Still, while the storm could damage some companies, most
experts think it will blow over for the industry as a whole. It
isn't as if the Pentagon and related agencies are going to be
able to reduce their massive reliance on contractors overnight,
nor will they want to, given the huge skill set from the private
sector that they rely upon.
Indeed, NSA head General Keith Alexander said on Thursday
that "we couldn't do our job without the support we get from
industry. One individual has betrayed our trust and confidence,
and that shouldn't be a reflection on everybody else."
Hardest hit may be Providence Equity Partners. A U.S.
government watchdog is already examining USIS - the largest
private provider of federal government background checks - which
conducted a 2011 background investigation into Snowden. USIS is
a unit of Altegrity Inc, which in turn is owned by Providence.
On Thursday, the Washington Post reported that federal
investigators have told lawmakers they have evidence USIS
repeatedly misled the government about the thoroughness of its
background checks, citing people familiar with the matter. The
Post said that the problem is so serious that the watchdog plans
to recommend to the Office of Personnel Management, which
oversees most background checks, that it end its relationship
with USIS unless it can show it is performing responsibly.
This could exacerbate Altegrity's serious financial woes. In
April, Moody's Investor Service Inc downgraded Altegrity's debt
deep into junk territory, warning that unless its revenue and
earnings rebound significantly in the near term, its capital
structure may be unsustainable.
"USIS has been fully cooperating with the government
throughout this process and we continue to work closely with the
Office of Personnel Management to resolve this matter,"
Altegrity spokesman Ray Howell said in an email, declining to
Carlyle, Providence, KKR & Co LP and General
Atlantic LLC all bought businesses in recent years on the
assumption that areas such as cyber defense and intelligence
remained relatively safe from government spending cuts, and
could even prosper if there was more outsourcing of work.
The theory has turned out wrong so far for most of these
firms, with Carlyle the exception. The buyout firm was smart
enough to take Booz Allen public right before cutbacks in U.S.
defense spending triggered a downturn in the sector and reduced
investors' appetite for such IPOs. Part of that decision was due
to the desire to have publicly traded shares as part of the
compensation of Booz Allen executives.
Booz is also better-established than some, given its long
history of government contracting.
Over the past two years, Booz Allen's competitors have seen
their revenue take a hit and their valuations punished by
spending cutbacks. They are now stuck with deals that look
expensive in hindsight.
"A number of private equity firms paid significant prices
for defense-related businesses. Today, they will find it
challenging to exit those businesses and generate attractive
returns due to current valuation levels in both the public and
private markets," said Michael Urfirer, co-chairman and co-chief
executive officer of boutique advisory Stone Key Partners LLC.
KKR's and General Atlantic's TASC Inc, Providence Equity's
SRA International Inc, Leonard Green & Partners LP's Scitor
Corp and Veritas Capital's SI Organization were all bought for
close to 10 times or more their earnings before interest, tax,
depreciation and amortization (EBITDA), according to several
people familiar with those deals.
Publicly listed peers, including Booz Allen, now trade at
above 6 times their projected 12-month EBITDA, according to
Thomson Reuters data.
PUBLIC RELATIONS ISSUE
The leaks by Snowden are likely to increase scrutiny of
defense contractor hiring and tighten surveillance practices,
adding to costs and reducing the companies' profit potential
further, Moody's Investor Service Inc said earlier this month.
Moreover, few industry buyers are likely to come to their
rescue as long as the future of defense spending remains up in
the air amid the larger budget argument in Washington, bankers
"If you look at the private equity deals that took place
more recently, right before sequestration caused the market to
slow down, they have a long road to go," said William Farmer, a
veteran aerospace and defense banker who founded advisory firm
Twelve Rolling Capital LLC.
Representatives for the contractors and their private equity
backers declined to comment on their business prospects.
To be sure, these private equity firms still have time to
improve on their investments before they exit them.
Despite being at the center of the scandal as Snowden's
former employer, Booz has held up better than rivals, thanks to
its position of working for the most complex and classified
The McLean, Virginia-based firm has been on the U.S.
government's payroll since 1940, starting off by helping the
Navy prepare for World War Two. With Carlyle's help, the firm
shed a private sector consultancy business to focus solely on
For its bet, Carlyle has already been rewarded handsomely,
with its investment now valued at about three times its money.
Carlyle invested $956.5 million of equity in the deal in 2008,
and has since taken out $1.17 billion in special dividends. It
did not sell any shares in Booz Allen's 2010 IPO, and its stake
is now worth about $1.6 billion.
"It is certainly a public relations issue, not just for Booz
Allen but for the sector," said BB&T Capital Markets analyst
George Price, who rates Booz Allen stock a "hold." "But to make
it into something bigger than that which would have a material
impact, I think it's too early."
The mean price target of analysts who rate Booz Allen's
stock is $14.67, according to Thomson Reuters Starmine. The
company's shares, though, have recovered more than half the
losses they suffered after the Snowden saga began to unfold, and
closed on Friday at $17.38, above their 2010 IPO price of $17.